These are unprecedented times in the Canadian life insurance industry, Neil Skelding, President and CEO of RBC Insurance told The Insurance and Investment Journal during a strategic interview. Anticipated regulatory changes combined with the coming of new accounting standards will bring fundamental changes to product offerings, he believes.
“The environment we’re operating in, moving forward, is going to change dramatically… Certainly the capital rules are changing. You’re going to have to have more capital backing any particular product. That’s true of all companies in this business including ours. There’s certainly more regulatory oversight.”
Interviewed in late July, RBC Insurance, like other insurers, was undergoing stress testing imposed by the federal regulator, the Office of the Superintendent of Financial Institutions (OSFI). The stress testing involves running a company’s portfolio through various challenging scenarios to see how it holds up. This testing is aimed at informing the regulator on whether capitalization is adequate in the industry.
Mr. Skelding believes one result of this exercise will be higher capitalization requirements for insurers, particularly when it comes to backing long-term guarantees.
Such anticipated changes are prompting deep reflection on the nature of the insurance products that can continue to be offered. “We’re responding by looking at the types of products we sell. Are they sustainable in this new environment? What kinds of guarantees can you offer…depending on how regulations will change, modify or otherwise?”
As well, over the next few years, the Canadian industry will be obliged to adopt new accounting standards, the International Financial Reporting Standards (IFRS) “which could, depending on how they come out in the final analysis, dramatically change some of the financial dynamics of our business…” adds Mr. Skelding (see page 16).
In the wake of the financial crisis, segregated funds are of particular concern to regulators. “It seems that OSFI generally, and regulators generally, are looking at segregated funds and that type of long term guaranteed product and asking, ‘Is the risk fully reflected in the capital rules? Is there enough capital backing it?’ It would appear the regulator wants to see increased capital behind those products,” Mr. Skelding says.
If capital requirements do increase, some products will be less profitable. “Whenever you increase capital, you reduce return on capital. The denominator is getting larger, and the numerator is staying the same.”
Mr. Skelding adds that higher capital rules would “fundamentally change how (insurers) operate and certainly the types of products that are offered. There’s some point where the capital is so expensive relative to the returns, that you simply can’t continue to offer the product or you have to modify it, or remove features that affect the capital backing it.”
For insurers, this situation would require them to closely look at their products, how they distribute them and the guarantees, he explains. “What are the minimum amounts that you are guaranteeing? Can you sustain that in this environment? And, how do you respond, because you can’t just put your head in the sand.”
Insurance rates could rise
What will be the likely result of this kind of reflection? “I think what you’re going to see is consumers paying more for the same product.” Any kind of guarantee, whether it be an interest rate guarantee, a guaranteed payout, etc., will require more capital behind them, he believes. “So [insurers] are going to have to increase the price or withdraw the feature or both, and I think that’s going to permeate for the foreseeable future.”
Increased capital requirements would especially impact pricing on new products, Mr. Skelding explains. “If you have a lot of risk in your portfolio, you have to reflect that because you have to carry more capital to run that portfolio. And, you have to extract that return from new products because you may not have pricing flexibility on your in force. So, somehow you have to account for that and I think that is a big challenge that we have ahead for us [as an industry].”
He also thinks that the North American market will shift increasinly from long-term guarantees to shorter duration guarantees, which are typical in the European market.
Mr. Skelding anticipates that all product lines will be affected by the changing environment, although some simpler protection products may not require modification, such as a yearly renewable term products.
He sees much greater change coming in the segregated fund market. Guaranteed withdrawal benefits (GWBs) have already undergone changes in recent months due to issues of sustainability, but Mr. Skelding expects more changes to come for GWBs as a result of the expected new capital requirements. “That chapter probably has not been fully written.”
Change in the industry is coming, but this isn’t necessarily negative. “Where there is regulatory change, there is opportunity,” says Mr. Skelding. “There is an underserved mass market that will be interested in protection products and we think we can serve that well and others can as well. So, I think we’ll just configure our products accordingly and we’ll just reshape our companies going forward to match the environment that we live in.”
He adds that in a shifting business environment, the need for life insurance products will stay. “The need is not going to go away; it’s how you’re going to fulfill it that will change. What are the products and services that you can offer?”
Does he expect the changes he anticipates to happen rapidly? “Yes, I think it will happen fairly rapidly. If you look at where the capital rules are going, the stress testing… The regulators are very active today. We’ve come through this crisis so it has focused everyone and I think regulators have been emboldened by that experience.”
Mr. Skelding says there are two aspects to this situation for the insurance industry. “There’s the in-force business that you have which comprises a great deal of your destiny so to speak. That I think takes longer to evolve because you might have 80-year guarantees that you’re stuck with. That’s the way it is, so I think you’ll see strategies around hedging and transactional solutions to that and you may see new sources of capital coming into the market place to try to fulfill that.”
Mr. Skelding speculates that capital markets are likely to come up with some solutions to help alleviate insurers’ needs for capital. “You could see private equity, mutualization could come back. There are any number of potential solutions to those in force blocks that are large and have those guarantees that are becoming difficult to sustain.”
The second aspect of the situation is new business. In this area, he expects continuing changes in terms of pricing and features. “I think there will be all kinds of imaginative structures that will come out but they won’t have the (same kind of) guarantees. You won’t buy a policy and forget it for 80 years. I don’t think that kind of policy will be as available.”
In the developing new market, he sees RBC Insurance as well positioned with its multiple distribution lines including its ability to serve a mass market with shorter term simpler products online or through call centres, and its independent advisor network which serves more complex insurance needs.
Any new product plans for RBC Insurance? Mr. Skelding says the company continues to hold off on introducing a guaranteed withdrawal benefit product to the market. It has been considering launching a product for some time but has stayed on the sidelines of this market due to its concerns over the sustainability of such products.
Now the company wants to see how the business environment evolves in terms of capital requirements and the coming new IFRS accounting standards. “We want to put out products that are sustainable and stand the test of time. With all the uncertainty, it is just not a good time to be putting out long term guaranteed products.”
Considering that the Canadian insurance industry came out of the market crisis well in comparison with their foreign counterparts, is all this change necessary?” Mr. Skelding replies, “IFRS is definitely skewed toward shorter term book. If you look at long-term books, it’s more punitive. And, where are North American companies generally? They’re in the long-term business. So having said that I think the regulators say, okay lets stress test these lifecos…”
Because of the long-term nature of Canadian insurers’ guarantees, Mr. Skelding says he understands that regulators must be vigilant. “We do, in Canada and the U.S., write a lot of long tail product. I think the regulator has to make sure it is…adequately capitalized under various scenarios.”
Is it an interesting time to be the leader of an insurance company in Canada? “Yes, these are unprecedented times…and it’s an interesting time. We are going to look different I think than we do today. But [RBC Insurance] has all the pieces. We don’t have to fundamentally change our strategy. We just have to tweak at them.”