Like Banks, Insurance Companies can also Fail

While doing some research recently on the history of insurance company failures in the US, it suddenly struck me that you, Dear Reader, might be interested in the “Canadian Experience”—hence this article.

First some comments on the differences between banks and both Property & Casualty (P&C) and Life insurance companies in terms of what may trigger a failure (which includes seizure by a regulator).

Banks are, by definition, highly leveraged institutions and vulnerable to “runs” should confidence in them fail (see my previous article: “Don’t Frighten The Children”, Canadian MoneySaver, June 2013) as depositors seek to withdraw their money (of which banks keep proportionately little in their tills). This is one reason why governments in most developed countries have created state-backed deposit insurers—in Canada, the CDIC.

In contrast, licensed and regulated P&C and Life carriers are not financially leveraged and not easily subject to “runs.” In the case of a P&C company, the worst a policyholder can really do is cancel a policy, at which point the carrier (at least for personal lines business) is no longer at risk of a claim; while in the case of a Life carrier, the same result would apply to a policy of term life (no cash value) insurance—no premium, no policy, no further risk for the carrier. With policies that have some form of cash value, a Life carrier is potentially vulnerable to the consequences of a policy cancellation in that it may have to realize investments and pay out cash. However most, if not all, protect themselves by policy terms that include all “haircuts” (you get back less than you thought!) or payment periods (you get it back later than expected!)

Of course, all legitimate Canadian P&C and Life carriers are regulated at the federal or provincial level; and subject to oversight and reporting requirements intended to enable the regulator(s) to foresee any stresses or issues that may presage a potential failure. And by and large, OSFI and its peers have done a good job of protecting Canadians against the likelihood of failure.

That said, even if it happens rarely, Canadian P&C and Life carriers do fail—so the questions are: why, and what can you do to minimize the risk of being caught up in such an event?

Dealing firstly with P&C carriers, their failure is usually the result of inadequate pricing (trying to “buy” business), reserves for losses that are inadequate (not enough set aside to pay claims) and defective risk management (for example, taking on exposures that, while rare can be catastrophic if they occur and which the carrier misunderstood or had more exposure too than it realized). In addition, their investment portfolios may be too aggressive and inappropriate for the type of risks they write.

So far as Life Carriers are concerned, their failure usually stems from a combination of promising too much (giving guarantees which they become unable to honour), investment mistakes (too illiquid, too volatile, too complex) and actuarial mis-steps (getting longevity wrong, for example).  

How can you minimize or monitor the potential risks?  Firstly, size is an advantage: the larger a carrier is, the more likely it is to receive greater scrutiny not only from regulators, but also from investors and other entities with which it deals. This is not to say that “small is inherently bad,” just that one needs to be careful. Secondly, having a publicly-quoted parent company helps, because it forces more disclosure. Thirdly, (in spite of the rating agencies’ faults!) dealing with a carrier that is publicly-rated, particularly for “Insurer Financial Strength” or “Claims Paying” does add a layer of additional oversight. And, finally, any insurance agent worth his or her remuneration should also monitor those entities on whose behalf they sell policies—if they give you a blank look or downplay your concerns when you ask their opinion of the carriers which they represent, find another agent!

In spite of all this, Canadian insurance companies do fail. Looking at Life carriers, there was a “spate” of three failures in 1992-4, with Confederation Life’s failure in 1994 being probably the most well-known and then a gap of some 18 years until the failure of Union of Canada Life in early 2012. (Full disclosure: the author worked briefly for CL until a year before it failed, and, no, he was not responsible for it!)

In terms of P&C Carriers, there have been 34 failures since 1979. However, the last failure was that of Home Insurance Company in 2003; and none of the carriers which did fail would be considered as “major,” unlike CL in the Life insurance context.

Let us say that you do, unfortunately, find yourself caught holding a policy of insurance issued by failed Canadian carrier: what protection do you have against a loss?

Interestingly, in Canada, the protections afforded to insurance policy holders are not formally back-stopped by the federal or provincial governments, but rather are funded and supported by the respective P&C and Life carrier groups themselves. This is not to malign them, but it does show how governments fear the consequences of a bank failure somewhat more than that or a bank.

For a P&C carrier, your first port of call (after you have berated your insurance agent!) should be the website of the Property and Casualty Insurance Compensation Corporation (PACICC); while for a Life Carrier it should be that of Assuris. There you will find a lot of helpful information about what is covered and how a carrier failure or insolvency will be dealt with.

You should also take some comfort from the fact that:

a) Absent massive, hidden fraud, the disorderly failure of a Canadian carrier is quite low;

b) In an insolvency, books of business are very often transferred from the insolvent carrier to a major, solvent one;

c) Regulators may be human, but they are not stupid; and the risk management and monitoring tools they have available to them improve all the time; and,

d) The likelihood that you will suffer a material, realized loss, or find yourself without adequate cover in the event of an actual P&C or Life carrier failure is actually very low to vanishingly small.

So, should you ignore the risks posed by owning a P&C or Life policy (which may sound somewhat ironic, but nothing is “risk free” in this world)? No. Should you be prudent and informed? Of course. But should you lose sleep over the issue, or become paranoid? Absolutely not!

And one final point, if something seems too good to be true, it usually is. Caveat Emptor: Buyer Beware!

David Ensor, Risk Management Consultant;

david.ensor@btinternet.com