Contributed By Fasken
Canada’s insurance industry is in the midst of change. This article takes stock of current trends and developments in this industry, providing an overview of the key drivers of change in 2018. The key trends and developments are grouped under the following headings: M&A; Distribution; Technology; and Regulatory.
On the property and casualty insurance side, the market is still relatively fragmented. Mergers and acquisitions occurred steadily for over 20 years until 2017/18, during which period little has happened. While several players are highly motivated to grow by acquisition, few targets of sufficient size are available, particularly since the market comprises a large number of Canadian insurers (including mutual and cooperative insurers), a few foreign-owned insurers, Lloyd’s and a number of international commercial players.
The situation is different on the life insurance side, where three large Canadian-based insurance groups dominate the market. Each of these groups has a significant international presence. At the same time, there continues to be a number of smaller life insurers in the market.
Some expectation of increased activity in Canada is supported by a general increase in the level of insurance M&A activity in the US during the last few years, as well as a number of underlying trends identified by various commentators, including:
In addition to the broader trends, there are some additional factors in the Canadian market that support the expectation of increased insurance M&A activity, including:
The eighth largest P&C insurance company in Canada, the Economical Insurance Company, is going through a demutualisation process. It should become a share capital company in 2019. It is then exempt from takeover for two years and there is speculation that it will be a target after that.
In a landmark transaction in 2016, Aviva acquired the general insurer from the largest bank in Canada, Royal Bank of Canada, and renamed it Aviva General Insurance Company. At the same time, Aviva and RBC entered into a 15-year strategic partnership, whereby the insurance agency owned by RBC distributes Aviva’s insurance products and Aviva underwrites and services them. This has been perceived as a unique transaction, increasing Aviva’s position as a leading P&C insurer and diversifying its broker as well as its multi-channel distribution platform.
Looking at the financial performance of the top 20 P&C insurers in Canada gives rise to the question of who might be a seller? There are some real differences among insurers in their combined ratios and profitability, which could be a motivator for some to sell or buy.
There are certain larger companies that will be acquirers of any large-sized insurer that is available and certain other mid-size insurers that will be acquirers of mid-size insurers, but hardly any of these in either case are for sale.
It is notable that during 2017 and 2018 there were no particular acquisitions where all of the shares of an insurer were acquired. The largest player, Intact, has a 16% market share, Aviva 10%, Desjardins 8.6%, Co-operators 6%, and TD 5.8% (there has been speculation that it might do a deal with an insurer like RBC did with Aviva), with the top ten having 68% of the total market share. The next ten insurers have a combined 17%, giving the top 20 an 85% market share. That top 20 includes large foreign insurers who want to be in Canada for strategic and international market reasons. Transactions that did occur in 2018 included Cooperators Group acquiring the 27% share interest it did not own in CUMIS Group, which includes a P&C insurer and a life insurer. Also of interest in 2018 is that The Travelers Companies, Inc acquired a majority position in Zensurance, an Insurtech insurance broker, while the Founders retained a notable minority position.
The life insurance business has largely consolidated in Canada with the last deal being Securian’s acquisition of Canadian Premier, a small acquisition in 2017.
The real story in Canada is broker acquisition, predominantly by insurers and other brokers. Broker acquisition has been commonplace in Canada by insurers for many years. There is clearly widespread belief that owning brokers, or ownership positions in them, or having financing and other relationships with brokers, is critical for growth and market share for insurance companies in Canada.
The deals that come to mind are almost all distribution-related as opposed to carrier-related deals. The trend continues to be controlling/influencing distribution, with deals including:
HUB has recently acquired Hometown Insurance Brokers, a full-service insurance brokerage, Clearwater Insurance Group, and Access Insurance Brokers.
On the carrier side, there is the pending acquisition of Genworth Financial and, by extension, 57% of Genworth MI Canada by ChinaOceanwide. There is also Intact’s purchase of OneBeacon, a US deal. This was done for potentially two reasons – there was no sizable acquisition available in Canada for Intact to buy, so purchasing a successful niche commercial carrier in the US could help Intact learn those lines of business in the US and aggregate more data along with its Canadian business in the relevant niche and commercial lines.
Cybersecurity has become a very high-profile issue in M&A – whether for due diligence to review the network security of the target, or concern for the value for the target affected by cybersecurity concerns, or doing the deal at all if there has been a material or high profile data breach.
Given the market share of each of the top ten players as above, which are not as large as they could be under Canada’s competition laws, and increasingly intense competition in the insurance industry, along with the need for scale including for greater amounts of data to analyse, it is almost certain there will be some notable acquisitions in the next two or three years.
In Canada, the dominant method of distribution in the P&C insurance industry is the insurance broker channel, which is competing to maintain its position as much as possible versus direct distribution, whether over the internet, by phone, affinity programmes or through direct writers. Direct distribution is gaining market share steadily and is now at about 24%, with agencies at around 12% and broker distribution about 64% of the market in Canada.
Insurtechs have received significant attention recently. While in some cases this could potentially disrupt the traditional insurance market, in many cases insurers are looking to collaborate with the right technology innovators to improve and grow their business, including in relation to distribution. Insurtechs in Canada include Zensurance, Lemonade, Metromile, and others.
Venture and corporate venture arms provide most of the risk capital and funding to support start-ups. Insurers are actively looking at venture activity and increasing their innovation strategies, whether by being the creator, by joint venture, or by acquisition. There is increasing interest, action and momentum in Insurtechs among brokers as well as Managing General Agents (MGAs), which are essentially brokers who also have authority from insurers to underwrite certain risks to certain limits and manage claims.
Brokers are focusing on Insurtechs and innovation in order to compete for customers with insurers and to be responsive to the market, as consumers want simplicity, speed, 24/7 access, transparency around product and policy, customisation to address their risks/needs, and price based on the foregoing. One reason brokers are adapting is because they need to. The market wants to be able to access brokers or direct writers or their insurers as it chooses.
In Canada, some of the larger insurers that distribute through brokers also distribute directly through a company with a different name. Aviva, largely a broker distribution company, recently decided to distribute direct in its own name. Targeting fans of two of the strongest and largest sports team markets in Canada, it created its own direct distribution model.
It has been said that brokers should be looking to do what insurers are doing, which is to deal with their customer segments or markets, like Aviva did with the sports fans. Brokers can and do work with the insurers they represent, to work with their innovative client centres. Brokers can learn from these, but they can also leverage from them.
Brokers can have greater interaction with the customer than the annual renewal of their policy and any claim, if it occurs. But it will depend very much on their adaptive abilities.
There is a general belief that artificial intelligence (AI) and machine learning will enhance processes and broker decision-making rather than replace it. AI should be able to increase productivity, as workers can then spend time where they should on more unique or challenging risks. One such AI application is Chatbots, which can successfully process or automate customer interactions and engagement, allowing productivity around what customers want or are asking about. Generally speaking, brokers can adapt to AI by engaging independent contractors, developing it in-house, or licencing applicable technologies.
Online price aggregators, essentially online brokers, are enabling consumers to find web-based products and comparisons, and robo-advisors are expected to appear soon. Price comparison tools and social media recommendations are playing a role in customers’ decisions when obtaining insurance.
It is clear that brokers who understand the market are innovating and adapting in the knowledge that if they do not improve processes, accessibility, convenience and in real-time, insurance companies will evolve to take over the customer relationship.
In Canada, the increasingly proactive thinking is that the broker model is still very important, so insurers are working with brokers and their technology to get the best customer relationships and underwriting results.
One company, Wawanesa, the largest mutual P&C insurer in Canada, has just announced that it is fully transitioning to the broker distribution model in Quebec and intends to carry that out in the rest of Canada. On the other hand, the largest two companies, Intact and Aviva, as well as being in direct distribution, appear to be supporting the broker channel fully, including making their client service centres – which include innovation – available to brokers to use when working with the customer. All of this is for insurers and brokers to exploit, to increase the value add and create differentiators, to meet increasingly demanding customer needs and compete effectively.
Also at play here is recognition by insurers that the combined ratio of expenses and claims in relation to premium income varies among the broker, agent and direct insurance distribution models, including that where a model such as an agency or direct can save on expenses, it may cost more in claims.
Amendments to Canada’s Insurance Companies Act
Technology-related activities are a major focus for insurers. Historically, federal insurance companies have had limited powers under the Insurance Companies Act (the “ICA”) to engage in technology-related activities.
Bill C-74, being an “Act to implement certain provisions of the budget tabled in Parliament on February 27, 2018 and other measures,” introduced some amendments to the ICA to expand these powers. This Act, which received Royal assent on 21 June 2018, amends the ICA to give more flexibility to insurance companies to invest in technology entities and participate in technology-related activities. This should result in more in-house technology-related activities, as well as more technology activities through subsidiaries.
The key changes introduced by Bill C-74, which are all intended to afford to insurers the added flexibility to engage in technology activities, can be summarised as follows:
Some of the introduced amendments are subject to regulations that have not yet been drafted and published. The amendments will come into effect on a day or days to be fixed by order of the Governor in Council. Regulations will need to be finalised first.
In recognition of the growing importance of technology, many provinces have introduced changes to their legislative regime to allow electronic dealings.
The most recent developments are summarised below. They all give more flexibility to insurers, brokers and agents and their clients in the methods they elect to use to deal with each other.
Blockchain and smart contracts
Blockchain is a distributed ledger that runs on a peer-to-peer network and secures transaction records through cryptography. Transactions are grouped into blocks and then chained together to resist later modification of the data. It is designed to be immutable, unalterable and unfalsifiable.
One benefit that can arise from the utilisation of blockchain is more secure databases for insurance companies. Since privacy of information is crucial to the sector, the operation of consortium blockchain will likely prevail where a few important industry players will determine the selected nodes per opposition to a public blockchain in which all internet users have access to data.
Because there are many different people involved in the insurance business, such as brokers, insurers, reinsurance brokers and reinsurers, massive operational efficiency gains can be achieved if all parties agree to work together to set common standards. One of the problems facing the industry today is that each party in the chain cannot rely on any other parties in a transaction, thus creating the need for repeated steps. With the blockchain, once a document is validated, approved, timestamped and locked down by a party, it becomes visible to all parties simultaneously.
In recent years, consortiums such as The Blockchain Insurance Industry Initiative, known as B3i, have arisen and become means of “collaboration of insurers and reinsurers to explore the potential of using Distributed Ledger Technologies within the industry for the benefit of all stakeholders in the value chain.” With the ability to use blockchain to establish a single and shared version of the truth between the different actors in the consortium, a distributed ledger among a consortium would allow different parties along the chain to enter the data once and have others add on throughout the data chain.
Smart contracts are programmed scripts “that execute and enforce themselves as pieces of code in a blockchain.” For example, smart contracts can verify that negotiated conditions are met, then triggering their execution if conditions are fulfilled while monitoring the compliance of parties to an agreement.
When a pre-determined event occurs, parametric insurance can be fully automated since it offers reliable and accessible data. For example, AXA’s product, Fizzy, using the Ethereum blockchain, can automate the compensation process for policyholders covered against flight delays of two or more hours. Eligible passengers are then indemnified automatically through smart contracts that are connected to global air traffic databases, thus eliminating the need for paperwork.
Similarly, the blockchain has already been implemented in simple systems such as proof of insurance and payment of expenses, salaries, premiums and claims. This technology allows insurance companies to operate more efficiently by cutting out bureaucratic processes.
OSFI Corporate Governance Guideline
On 18 September 2018, the Office of the Superintendent of Financial Institutions (OSFI) released its revised Corporate Governance Guideline (“CGG”). The CGG articulates OSFI’s expectations with respect to the corporate governance of federally regulated financial institutions (“FRFIs”), including insurance companies. The CGG takes a more principles-based and outcomes-based approach and is intended to provide Boards with greater discretion as to how they meet OSFI’s corporate governance expectations. The CGG is based on the highest standards of corporate governance in the world today applicable to financial institutions and corporations generally.
Most significantly, the CGG reflects an increasing emphasis on the importance of the role and responsibilities of the Board of Directors, and the significant duties that go with them.
The CGG provides as follows:
“In addition to the roles and responsibilities of the Board outlined in federal legislation, the Board should discharge, at a minimum the following essential duties in relation to the FRFI.” A number of these essential duties are listed below. Upon review, one appreciates how significant and extensive these “essential duties” are.
A very important point is that the requirement for the first set of duties below is to “approve and oversee,” not just “approve,” and for the second set of duties below to “provide challenge, advice and guidance,” not just “review and discuss,” compared to the previous CGG of 2013, with a longer and greater set of duties in each case than the previous CGG of 2013.
The Role of the Board
1. Approve and oversee:
• Short-term and long-term business plans and strategy; and
• Significant strategic initiatives (eg mergers and acquisitions).
Risk management and oversight:
• Risk appetite framework;
• Internal control framework; and
• Significant policies, plans and strategic initiatives related to capital and liquidity.
Board, senior management and oversight functions:
• Appointment, performance review, and compensation of the CEO and other key members of senior management, including the heads of the oversight functions; and
• Succession plans with respect to the Board, CEO and other key members of senior management, including the heads of the oversight functions.
• External audit plan and internal audit plan.
2. Provide challenge, advice and guidance to the senior management of the FRFI, as appropriate, on:
Operational and business policies:
• Significant operational, business, risk and crisis management policies of the FRFI, including those in respect of credit, market, operational, insurance, regulatory compliance and strategic risks, and their effectiveness;
• Business performance and effectiveness of risk management;
• Performance of the FRFI relative to the Board-approved business plan and strategy;
• Effectiveness of the risk appetite framework;
• Effectiveness of the internal control framework;
• Effectiveness of the oversight functions; and
• Effectiveness of significant policies and plans related to management of capital and liquidity (eg stress testing, ORSA).
To approve and oversee, and to provide challenge, advice and guidance to senior management of all of these “essential duties” requires ever deeper knowledge of all aspects of an insurance company’s business and risk management. It is clear from the revised wording in the CGG that OSFI’s view is that the duties of directors are increasingly deep and broad. It is important that directors of FRFIs understand the increased expectations provided for in the CGG.
Directors of FRFIs will be required to take their roles even more seriously and to dedicate significant time and effort to carry out their duties properly. Directors will need to know more, read more, prepare more for meetings, and follow financial, industry and risk management developments on an ongoing basis.
OSFI’s Reinsurance Discussion Paper
In June 2018, OSFI released its Discussion Paper on OSFI’s Reinsurance Framework, outlining a number of proposed changes to the reinsurance regulatory framework. The Discussion Paper follows a multi-year review by OSFI of reinsurance practices, and addresses a number of concerns OSFI has identified. This is the first comprehensive review of Canada's reinsurance framework in ten years, and proposes a number of significant changes.
The process being undertaken by OSFI will be divided into three phases. Phase I involves a parallel consultation process for reinsurance related measures included in the draft Minimum Capital Test (MCT) Guideline for 2019. Phase II will involve amendments to guidelines addressing (1) prudential limits and restrictions (ie OSFI Guideline B-2 Investment Concentration Limits for P&C Insurers) and (2) sound business and financial practices (ie OSFI Guideline B-3 Sound Reinsurance Principles and Practices). Phase III will involve revisions to the MCT Guideline and Life Insurance Capital Adequacy Test (LICAT) for 2022 or later years.
The Discussion Paper reflects a shift in OSFI’s approach to reinsurance from a principles-based approach to a more prescriptive rules-based approach. OSFI clearly has concerns with some of the practices that it has observed, and has set out a number of proposals to clamp down on these. Some of the key items addressed in the Discussion Paper are summarised below.
A key take-away from the Discussion Paper is that it contains a number of proposals that would, if adopted, require a significant amount of additional capital. This gives rise to the possibility that changes to the reinsurance regulatory regime will impact how attractive the Canadian insurance market is perceived to be. It is also possible that these changes could have undesired consequences for the availability and affordability of insurance and reinsurance in Canada.
The insurance and reinsurance industry has strongly objected to a number of the proposals in the Discussion Paper. The general view seems to be that there are no significant problems that need to be addressed, and that any problems that exist are better addressed by OSFI using its existing tools vis-à-vis specific companies, rather than adopting new rules that will apply to everyone. It will be interesting to see how OSFI reacts to these concerns.
Fair treatment of consumers
Fair treatment of consumers is an area of increasing regulatory focus. The Financial Services Commission of Ontario (FSCO) recently released the final version of its Guideline Treating Financial Services Consumers Fairly (the “FSCO Guideline”). This follows industry and public consultation that took place in 2018.
The FSCO Guideline sets out eight categories of expectations, which apply throughout the life cycle of a financial product. These expectations apply to all four of FSCO's regulated sectors: insurance; credit unions and caisses populaires; trust and loan companies; and mortgage brokers (“licensees”).
Each licensee is expected to implement the expectations set out in the FSCO Guideline, regardless of whether the licensee is consumer-facing. At the same time, the FSCO Guideline is intended to be principles-based, and FSCO recognises that implementation may differ based on factors such as the licensee’s size, risk profile, the complexity of the financial product or service offered, and the sophistication of the financial services market or consumers.
Some of the expectations may seem like common sense. For example, FSCO expects that a core component of a licensee's business governance and culture is fair treatment of consumers. In addition, FSCO expects licensees to promote financial services and products in a manner that is clear, fair and not misleading or false.
Nevertheless, the FSCO Guideline clearly articulates higher expectations than statutory requirements imposed on licensees. Furthermore, the FSCO Guideline serves as a good attempt to codify best practices in the financial services industry. It will be interesting to see how industry participants change their practices to meet these expectations, and whether this will result in more consistent experiences for consumers.
It is also important to recognise that the FSCO Guideline is part of a broader trend of increased focus on consumer protection. The Canadian Council of Insurance Regulators (CCIR) and the Canadian Insurance Services Regulatory Organisations (CISRO) have recently released guidance in this area, which is generally aligned with the FSCO Guideline. There is also the CCIR's Annual Statement on Market Conduct introduced in 2017, which is extensive and required to be completed by insurers annually, and the Autorité des marchés financiers' Fair Consumer Credit Practices Guideline introduced in July 2018. As financial products and services become more complex, and as consumers become more vocal, it should be expected that consumer protection issues will continue to have a high profile.
The M&A, Distribution, Technology and Regulatory developments discussed in this article will continue to drive change in Canada’s insurance sector for the foreseeable future. There are, of course, many other trends that are also important. Privacy, cyber risk and climate change immediately come to mind.