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Defn of insolvency, insolvency risk, liquidity risk
- Insolvency: exit from market following winding-up order (when insurer becomes insolvency risk or a liquidity risk).
- Insolvency risk: when assets become insufficient for insurer to meet its contractual and other financial obligations.
- Liquidity risk: when it has sufficient assets to cover obligations but high level of risk that those assets could disappear.
- Liquidity risk more common in Canada: due to larger importance of foreign companies (all liquidity risks have been branch)
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Foreign owner - Advantages, disadvantages
- Advantages:
- More competition which leads to more affordability
- Diversification (international opportunity to diversify portfolio -> less likely to be insolvent)
- Allows access to international sources of capital
- Disadvantages:
- Foreign parent failure is a main cause of Canadian insolvency
- Profit transferred to parent
- Counters goal to promote Canadian ownership
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Cost of exits
- Insolvent insurers' claim costs and UEP which are borne by surviving ins companies in the industry
- Costs incurred by regulatory authorities, agents, accountants and reinsurers
- Lost wages, commissions, taxes
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PACICC
National guarantee fund, established to protect p.h. from financial loss in the event of an exit
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PACICC assessment
Assesses member companies for the resources required to pay loss claims and UEP, up to its limits, on eligible policies
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External factors influencing insolvency
- UW cycle/profitability: exits increase during soft markets or periods of poor profitability
- CAT: severe weather events
- eco and financial market volatility: not level of financial variables but their volatility
- International exposures: multinationals more likely to exit
- Reinsurance Risk: failure of a reinsurer
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Company characteristics that play a role in most insolvencies
- Governance and Internal Controls: mgt and governance issues lead to decisions or failed processes that cause companies to fail
- New Entrants: face strong competion from experienced firms
- Growth:
- usually accompanied by deteriorating loss reserves
- during periods of diminishing capital strength, more incentive to embark on aggressive expansion
- may also enter new areas of business where they lack expertise
- If high interest rates, may hope to offset UW losses
- Firm Size: small more sensitive to financial distress due to
- less diversified more diversified
- limited access to capital
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Leading causes of insolvency in Canada
- Inadequate pricing / deficient loss reserves
- Firms with foreign parent
- sometimes need to provide capital to parent to offset their losses
- Capital strain from being responsible for a parent ’s profitability could lead to insolvency
- Rapid growth
- risk increases when UW cycle hits a soft market and profitability deteriorates
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Problems with reinsurance assets (3)
- Can deteriorate quickly
- Cannot be readily sold
- Must be actively managed
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Why PACICC is in good financial position to handle insolvency in the future
- can make special assessment
- Small reserve already exists
- Canada less prone to CAT
- Access to subrogation (TP payer)
- PACICC recover insurers' assets when sold (liquidity risk)
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Why PACICC is NOT in good financial position to handle insolvency in the future
- assessment rates not high enough
- designed to deal with median insurer but size has increased
- reserve too small
- top 10 insurers too big
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OSFI vs. PACICC
- OSFI role: to minimize insolvency risk
- PACICC: to provide p.h.'s with reasonable recovery for unpaid claims and UEP in event of insurer's insolvency
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