Canadian P&C insurers need a compensation fund four times bigger than its current size of $60 million to handle “systemic contagion” associated with the insolvency of a Top 70 P&C insurer or bankruptcy related to a major earthquake, says the Property and Casualty Insurance Compensation Corporation (PACICC).
In its June 2022 edition of Solvency Matters, PACICC notes its compensation fund is “no longer large enough for its initially intended purpose,” PACICC president and CEO Alister Campbell writes.
“This year, in follow-up analysis, Eckler [an actuarial consulting firm based in Toronto] has now…given us an indication of how much financial capacity PACICC would require to handle larger insurer failures. It appears from this work that a more realistic target would be in the $225 million to $250 million range.”
In parallel research, PACICC also looked to see how much capacity the fund would require to pay out earthquake claims to policyholders in the event of an insurer bankruptcy. The earthquake scenario assumed industry-insured losses of between $30 billion and $35 billion.
“In last year’s update to our systemic risk model, we posed a question regarding the amount that would be required in our Compensation Fund to allow PACICC to avoid the need for a special assessment [of its members] for the first 12 months after the quake — to buy time for the industry to stabilize itself without the additional burden of funding such a cash call….
“…Significantly, we determined that for a quake event which generated between $30 billion and $35 billion in insured losses, a fund of $230 million or so could make a big difference in mitigating the risk of systemic contagion.”
The term “systemic contagion” refers to a domino effect in which one or more insurers collapse because of the insolvency of other insurers. For example, PACICC’s special membership levy to recover enough money to pay the claims left by one insolvent insurer may become too high for other insurers to maintain financial stability.
Canada’s last insurer to declare bankruptcy was Markham General Insurance in 2002.
As Campbell points out, PACICC has the power to levy its membership for larger financial outlays should an insurer become insolvent. But collecting these funds is a slow process.
“PACICC has substantial financial resources to draw upon in the form of special assessments on the industry — up to 1.5% of DWP [direct premiums written] in covered lines of business (roughly CAD$1 billion) each year,” he writes. “But raising this money takes time — more than 30 days. Simply not fast enough to address the concerns of panicked policyholders. The solution was to create an industry fund that was ready in advance.”
The industry contributed seed capital for the current PACICC Compensation Fund via a series of capital levies in 1998-2000, as Campbell notes. The levies were $10 million a year, with allocations based on market share in covered lines. That initial fund of $30 million has now grown to roughly $60 million.
But it’s not enough, as Campbell suggests.
PACICC is currently seeking ways to bulk up the “firepower” it has in its reserves. Options before PACICC’s board to raise more capital for the compensation fund include:
- Capital levies
- Standby lines of credit (like the one originally used to establish PACICC)
- A mix of some or all the above
The June edition of Solvency Matters includes a guest column by Rozanne Reszel, CEO of the Canadian Investor Protection Fund (CIPF), who discusses a “tower” of financial capacity CIPF has built using capital as a base and supplemented with both a standby-line-of-credit and reinsurance. CIPF is a compensation fund that pays out to consumers if or when an investment dealer declares bankruptcy.
“Today CIPF maintains slightly more than $1 billion in liquid resources comprising a bond portfolio of government and provincial bonds of $525 million, a committed line of credit of $125 million with two Canadian chartered banks, and $440 million of insurance in two tranches, accessible in any year that CIPF pays over $200 million in claims,” Reszel writes.
“The line of credit allows time to determine an estimate of the total advances that may be required from CIPF to permit a bankruptcy trustee to transfer customer accounts from an insolvent member firm to an active member firm. If the debt market conditions are unsettled, it also prevents the need to sell bonds into a volatile market.”
Feature photo courtesy of iStock.com/selimaksan