Canada has long been considered a strong and reliable fixture of the global insurance market and remains a key player in the sector today. But the increased globalization in the industry has been mirrored in the growing magnitude of the challenges faced by Canadian insurers in 2021. We asked the Insurance team at Dentons to assess the health of the Canadian corporate insurance market and tell us what we can expect to see now and in the near future as consolidation, regulation, and globalization plays an increasingly strong role in shaping its fortunes.
PART 1 – Consolidation and Regulation
Canada continues to be a very attractive market for insurance participants to grow their business as a result of the profitability and stability of the Canadian business environment and the sophistication of Canada’s insurance regulatory regime. Global insurers view Canada as a safe bet to deploy capital and expend resources.
Canada has a complex dual insurance regulatory system. The Office of the Superintendent of Financial Institutions (Canada) (OSFI) oversees the solvency of federally regulated financial institutions, including insurers and reinsurers. In addition, each province and territory has its own regulator(s) that generally regulates market conduct, agents and brokers and adjusters. OSFI is a principles-based regulator that aims to take a balanced approach to the fulfilment of its mandate of protecting depositors, policyholders, financial institution creditors and pension plan members, while allowing financial institutions to compete and take reasonable risks.
Foreign companies have several options for writing business in Canada, including the establishment of a subsidiary or an authorized Canadian branch, a fronting arrangement, or use of a Lloyd’s syndicate or coverholder. However, a significantly large amount of Canadian commercial risks are also written on an unlicensed business basis, particularly by offshore insurers based in jurisdictions like Bermuda.
There is continuing consolidation and increased M&A activity in the insurance market at the insurer level. Notwithstanding the amount of consolidation, the Canadian P&C market remains fragmented with a large number of participants. One significant exception is Intact, which has completed a number of transactions in recent years and following the Intact and Royal & Sun Alliance merger, Intact will have approximately 20% of the Canadian P&C market share in Canada, doubling its closest market participant. We will likely see more consolidation in order to compete with the insurance giant. In contrast, the Canadian life insurance market is very consolidated and dominated by a small number of life insurers.
We have also experienced significant M&A activity for both the brokerage and managing general agent (MGA). Private equity firms and strategic buyers in Canada and the U.S. have increasingly pursued acquisition approaches fuelled by low interest rates. While Canada has not seen significant MGA consolidation, there has been an increase for start-up MGA’s. There are still significant organic growth opportunities for MGA participants in the Canadian marketplace, and insurers have been turning their attention to investing in these businesses in an effort to penetrate new markets. However, the broker space in Canada is consolidating to a much greater degree than MGA’s in order to keep pace with the “mega” transactions such as the proposed Willis/AON merger. Consequently, what was previously considered to be a midsize brokerage has quickly become a relatively small brokerage. Brokerage consolidation will be a necessity in order to ensure capacity and support of insurance markets, to retain top talent, and to invest in the necessary technology and data analytics to keep pace with the evolving insurance market. We are seeing both new entrants from the United States like NFP Corp. that have made significant investment in the Canadian distribution market over the past few years, and from regional Canadian brokerages striving for national presence by expanding across provinces, like Westland Insurance. At the same time, larger brokerages like Brokerlink, HUB, and Navacord continue to gain market share through targeted acquisitions.
As a result of the rapid changes in the Canadian insurance market, we have also witnessed increasingly heightened insurance regulatory and oversight activity both at the federal and provincial/territorial levels. Regulators are more engaged with the insurance licensing process and are taking a more proactive role to supervision, particularly with respect to market conduct and consumer protection matters. It is easy for foreign insurers, reinsurers and insurance brokers to inadvertently trigger Canadian licensing and oversight requirements. Insurance and insurance-adjacent clients should be aware of their legal and compliance obligations before launching a new product line or program, underwriting a Canadian risk or entering into an agreement or transaction that may have regulatory implications in Canada.
PART 2 – Evolution and Adaptation
Canadian financial institutions operate in an ever-changing environment where early risk recognition and assessment, crisis preparedness and strategic and flexible approaches are keys to continued success. The COVID-19 pandemic, climate change and cyber-security risks have impacted the Canadian insurance market and how Canadian insurers and other market participants are responding to the changing landscape.
How can clients incorporate climate change risk into their insurance policies? How do you foresee this market being regulated in the future?
OSFI is currently reviewing whether, and to what extent, it should regulate climate-related risks in its discussion paper, Navigating Uncertainty in Climate Change – Promoting Preparedness and Resilience to Climate-Related Risks. With the exception of earthquake exposure data filings, OSFI does not currently regulate climate risk as a separate type of risk.
The increased severity and frequency of loss and damage caused by flood, fire and wind due to climate change is likely to spur greater demand for both property and liability coverage exposures. In addition, primary insurers will need greater amounts of reinsurance to deal with catastrophic (cat) exposures tied to climate change. As part of its review of the Canadian reinsurance framework, OSFI is currently in the process of revising Guideline B-2: Property and Casualty Large Insurance Exposures and Investment Concentration, which proposes to restrict the issuance of large limit policies. This will likely lead to higher premiums and may contribute to a hardening of the P&C market as it relates to the insurance of property that is subject to climate-related risk.
Climate change has not yet materially impacted insurance underwriting in Canada; however, we expect that climate change will continue to evolve as an emerging risk. Underwriting will become more sophisticated and science-based in the lines of business that are most susceptible to climate change, such as agriculture and hail insurance.
The insurance market cannot be expected to shoulder all of the risk associated with climate change. Government private partnerships will need to be formed. If there is insufficient capacity in the Canadian insurance market, a government mandated plan or a government private enterprise partnership may be necessary to subsidize companies and individuals for loss or damage resulting from climate-related risks. Alternatively, additional insurance capacity may be introduced by OSFI loosening its regulatory restrictions as it relates to group capital requirements. Since its inception, insurance has been a global industry with multinational participants. Most large insurance companies form part of international groups. One of the most important impacts of globalization on the insurance industry has been the increased sharing of reinsurance capacity, particularly with respect to catastrophic P&C risks. We expect that globalization will continue to play a key role in facilitating risk coverage around the world.
Do you see changes coming in terms of the types of coverage offered by firms in the aftermath of the pandemic?
The COVID-19 pandemic has forced many industries to adapt to survive. Given the global nature of the insurance industry, we expect that any international changes in insurance coverage due to COVID-19 will be reflected in Canada as well. Most insurers are currently focused on excluding pandemics and infectious diseases from coverage or alternatively offering specific business interruption coverage caused by a shut down due to a pandemic or governmental closure.
Coverage could, theoretically, be offered for loss associated with COVID-19 on a standalone basis, although whether the cost would be prohibitive is not clear. A large amount of reinsurance would be required to properly capitalize these policies, which would increase the primary insurer’s cost. It would be unlikely for coverage of this nature to be underwritten in Canada, particularly given the current discussions around the reinsurance framework and single maximum exposures. Similar to climate-related risks, the pandemic has given rise to certain societal risks that cannot be fully addressed by the risk transfer mechanism offered by the insurance industry alone.
How have federal and provincial regulation of insurers and reinsurers changed during the pandemic? Do you expect any of these temporary measures to be made permanent?
Overall, the Canadian insurance regulatory regime is robust and has not fundamentally affected or changed due to the pandemic. Although there are several class actions launched in respect of business interruption coverage denials, insurers and reinsurers remain adequately capitalized to cover the exposure related to these claims.
Regulators at all levels have pivoted to dealing with the institutions they oversee on a virtual basis. OSFI has been in constant communication with the institutions subject to its purview and monthly reporting regarding the effects of COVID-19 on operations and capital have been required of insurance carriers. On-site examinations have been replaced with virtual examinations for the time being and virtual town hall meetings and industry updates have been held by OSFI. Certain policy changes have been enacted by regulators as a result of COVID-19. OSFI announced restrictions on the issuance of special dividends, regular dividend increases, and share repurchases for all financial institutions in March 2020, given the level of economic uncertainty at that time. We expect the aforementioned restrictions to be lifted once economic conditions have stabilized.
Provincial and territorial regulators have relaxed on-premises supervision requirements for insurance brokers and agents and certain licensing examinations are being offered online. However, market conduct supervision has increased. Provincial and territorial regulators have been vigilant about ensuring proper licensing, market conduct and fairness and disclosure to policyholders. A “new normal” for supervision has arrived, and we expect many of the changes, including increased communication and reporting between market participants and their regulators, to become permanent.
PART 3 – Globalization and Digitalization
What does the increasing globalization of insurance companies mean for Canadian clients and investors? Which insurance areas are most impacted by this trend, for better or for worse?
Insurance and reinsurance has always been a global industry. The Canadian insurance market has long been dominated by foreign insurers and reinsurers. However, it is interesting to Canadian based insurers such as Intact, Fairfax, Manulife, Sun Life and Great-West Life become global players themselves. We expect that all aspects of insurance regulation will continue to change rapidly in response to the rate of change that we have observed throughout the pandemic. The pandemic has increased the need for novel products and coverage, including parametric policies. Driving and working habits have changed immensely due to the pandemic and will require insurers to adapt and provide new types of policies and solutions. For example, many new InsureTech products are underwritten based on actual usage rather than the nature of the risk (i.e., an automobile policy that is underwritten based on miles driven rather than other facts such as the age of the driver). This increased demand for novel products and coverage from businesses and consumers alike will attract increased oversight and regulation, particularly in areas that have managed to evade regulation. Insurtech platforms, for instance, have largely gone unregulated, as they do not fit within the traditional insurance regulatory framework. We anticipate that the increased solicitation of, and interaction with, consumers will prompt the regulation of these platforms.
The insurance market in Canada adapted well to a work from home environment. The day-to-day operations of insurers and intermediaries have changed significantly due since March 2020. Most insurers had flexible work capabilities prior to the pandemic, but not to the scale that market participants quickly mobilized and created in 2020. Insurers are increasing their investment in technology at all levels, from direct online placement strategies, to using automated underwriting systems, online claims adjustments and data analytics to assist with risk assessment and modelling. Artificial intelligence (AI), big data and blockchain will enable far more sophisticated rating algorithms to be used by insurers to personalize insurance. Rating systems will become more complex and the traditional role of actuarial science will need to evolve to enable insurers to remain competitive, particularly with the introduction of more consumer-centric insurance solutions, such as usage-based insurance and Peer-to-Peer (P2P) insurance. Consumers are no longer satisfied with paying for long-term premium contracts that do not suit their respective individual needs. However, the use of new automation and AI in the insurance industry will necessitate increased regulatory scrutiny and understanding of the “black box” behind underwriting, pricing and claims algorithms.
Insurers and intermediaries will need practical, proactive and tailored advice to navigate the evolving business environment and to capitalize on opportunities to offer new products and programs that achieve their unique goals while remaining compliant with the Canadian insurance regulatory framework. As insurance is a global industry, many industry participants have business operations and relationships that transcend borders, resulting in the application of various regulatory regimes in addition to Canada’s insurance regulatory framework.
Has the global nature of the insurance industry led to an increase in demand for cyber insurance? What advice do you have for clients considering it, and what cross-border factors affect this space?
Cyber insurance capacity continues to be a dominant issue for the Canadian insurance market. There is currently increased demand and a reduction in capacity owing to a very high loss experience when compared to other lines of business. Ransomware has become the primary source of claims activity. Hackers continue to detect holes and vulnerabilities in systems around the world. With more and more people working remotely, the risk of phishing attacks has increased since the onset of the COVID-19 pandemic. Cyber claims are unique and where ransomware is involved, often result in payments being made in Bitcoin.
Ultimately, prospective purchasers of cyber insurance coverage should consult a knowledgeable specialty insurance broker or MGA to ensure they are getting the right coverage. There are a small number of brokers, insurers and MGAs in Canada with the requisite knowledge to effectively underwrite cyber insurance risk, like Ridge Canada Cyber Solutions. The nature of globalization means that many organizations require a policy with global coverage. As well, clients should be proactive about managing risks in this area, as the reputational damage that can result from a data breach is long lasting and civil liability can increase significantly if a class of plaintiffs is granted certification to proceed as a class in connection with claims arising from such a data breach. It is also critical to ensure that business continuity and disaster recovery plans are up to date and sufficient to address any crises.
Final Thoughts – Looking Ahead
While 2020 has been a difficult and most unusual year, we are optimistic about the ability of insurance market participants to tackle the continuing challenges created as a result of the pandemic and have faith that Canadian regulators will adapt to these challenges and technological disruptions by implementing practical insurance legislative reforms. The accelerating amount of change in the Canadian insurance market will require practical, proactive and innovative legal advice in order for market participants to be successful and avoid regulatory issues. More than ever, success in the insurance market depends on harnessing the latest technologies to respond to market opportunities quickly and effectively, all while playing within the regulatory rules. The Canadian insurance market will require specialized insurance regulatory and transaction legal advice that is based on experience with where the market currently is as well as where it is likely to evolve in the future. We will continue to pay close attention to market developments and to any shifts in the regulatory approach towards the unique characteristics of the current insurance market in Canada.
Laurie LaPalme leads Dentons Canada’s National Corporate and Regulatory Insurance practice and is Co-Lead of the National Insurance sector group. Her corporate and insurance regulatory practice involves mergers and acquisitions, portfolio transfers, demutualization, corporate reorganizations, formation of insurers, federal and provincial licensing, corporate governance, compliance matters and working with both federal and provincial regulators. Laurie advises on the establishment and operation of captive insurers, self-funded deductible programs and other risk retention and transfer structures. She also advises on entry into Canada, including the incorporation, organization and financing of companies, the drafting of shareholder, partnership and joint venture agreements, purchase and sale agreements, and drafting of a range of commercial agreements, including outsourcing, security, and service agreements.
Marisa Coggin is a partner in the National Corporate and Regulatory Insurance practice at Dentons. Marisa’s practice focuses on corporate and commercial law with an emphasis on corporate and regulatory insurance. She regularly assists with corporate reorganizations, mergers & acquisitions and financing. Marisa has experience establishing branches for foreign insurance companies; incorporating and licensing insurance brokerages and managing general agents; establishing captive insurers; advising warranty providers; and assisting clients with structuring warranty programs. Marisa also regularly advises on regulatory compliance management, reinsurance and market conduct matters.
Derek Levinsky is a partner in the National Corporate and Regulatory Insurance practice at Dentons. He provides legal services to a wide range of clients in the insurance market, including brokers, agents, and other actors in the insurance space. Derek’s work focuses on corporate and regulatory matters and complex, high value commercial transactions, including M&A, joint ventures, corporate finance, and reinsurance. He is respected in the field for his knowledge of insurance and security interests and work on insurance issues for lenders.