Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 7 - Evidence - Meeting of February 17, 2005
OTTAWA, Thursday, February 17, 2005
The Standing Senate Committee on Banking, Trade and Commerce met this day at 11:02 a.m. to examine and report on consumer issues arising in the financial services sector.
Senator Jerahmiel S. Grafstein (Chairman) in the Chair.
[English]
The Chairman: The Standing Senate Committee on Banking, Trade and Commerce is pleased once again to resume its hearings on the oversight of consumer protection mechanisms within the financial sector. We are delighted to welcome our next witness from the Canadian Federation of Independent Business, which is essentially a small business group.
Ms. Swift, if you would, please introduce yourself and your colleague. Again, I would hope that you could be as brief as possible in your opening comments, because I know the senators have a number of questions that will allow them to explore the topic more fully.
Ms. Catherine Swift, President and Chief Executive Officer, Canadian Federation of Independent Business: Thank you very much, Mr. Chairman. We are delighted to be here. My name is Catherine Swift. I am the President of the Canadian Federation of Independent Business, and yes, we are indeed a small business organization. I am accompanied by my colleague Andre Piché, our Director of National Affairs, who is based here in Ottawa.
I will try to be brief. I believe you received our material yesterday, so I hope that will help. I want to highlight some of the major concerns for us. This whole area is a very important issue for the small business community, both from the banking side and from the insurance side.
In opening, I must reiterate the importance of the small business sector in Canada. Currently, just under half of the gross domestic product in Canada is represented by this sector. When we look at net job creation in any given time period, we find that about three-quarters of net new jobs are created in this sector. There is no question that it is a very vibrant and growing component of the Canadian economy.
One practice of the CFIB that is unique to us is that we never take a position on any issue until we have polled our members on it. We have included on page 3, figure 1, the results of one of our ongoing surveys, which we call our quarterly business barometer. This is basically a measure to attempt to predict what will be happening in the economy and with employment, and so on.
We have conducted this survey since 1987. The graph here just gives you the last few years, but it shows that this is an amazingly accurate predictor of the Canadian economy, which we are delighted to see. It is an interesting tool that we find is used quite extensively by everyone from the Bank of Canada to finance departments across the country.
In terms of the banking side of the equation, we have done a great deal of research as an organization. We are coming up to our 35th anniversary later this year at CFIB; and over that period we have done a lot of research on various banking matters. However, we do not want to burden you with it today. Instead, we want to highlight a few of the main findings in the recent past.
We have seen some trends that are not encouraging in the banking area. As you will note in figure 2, we asked our members fairly recently — this was 2002, and we ask usually over a three-year period — whether they had improvement in competition. As you may recall, with the Mackay report, there were changes made — and we were very supportive of them — to encourage more competition in the banking sector in Canada, and I broaden it beyond banks to credit unions and other financial institutions of that nature. We found that our members really have not felt it; perhaps other groups have, but our members have not yet felt that there has been an improvement in competition; and that is a key issue.
We also have seen a great move towards more use of technology, which is not surprising — everyone has, in every sector. However, even though our members are happy to adopt technology, they do not find it a perfect replacement for the full-service local branch. As we have seen, in this trend towards almost complete dependence, in some areas, on electronic technology, we have lost that personal contact which is very important to a small business member.
We have also seen much consolidation of bank branches. Again, that is not surprising given what is happening in the industry, but this is happening especially in non-urban areas. In the rural areas, we find the impact has been quite staggering in terms of reduction in availability of credit-granting institutions.
Overall, lending to small business is quite intriguing. This is illustrated in figure 4 on page 6 — charter bank lending to business. You can see that we have disaggregated it — and this is Bank of Canada Review data — into the over $200,000 lending size and under $200,000. As you can see, it has increased on the larger side and been pretty stagnant, or even declining a bit, on the under $200,000 side. The average credit that our average member would be pursuing is about $80,000, so it is even significantly lower than that $200,000, but that is how the Bank of Canada presents the data.
Then again in figure 5, we see that, overall, our members are relying less and less on the so-called traditional financial institutions. There are many different reasons for that, which we can get into if you so choose.
What we also find interesting is that this trend does not seem to have changed during different cycles in the economy. Normally, if you see a strong economy, you would think there would be increased lending demand, and the converse when you have a more sluggish economy. Indeed, we have not found that it had much relation at all to what is happening in the business cycle, so there are a lot of interesting issues that arise there.
Getting back to that personal connection that is important to the small business borrower in dealing with a financial institution, one thing we have consistently found over decades with our research is that the higher the rate of account manager turnover in the institution, the higher the loan rejection rate. You can see in figure 6 that it really is very dramatic — from almost one-third being rejected when they had four or more account managers over a three-year period versus 11 per cent, literally one-third of that almost, when they actually had the same account managers. That is not surprising; a new person who does not know the business or the owner will perceive more risk, even if that is not accurate. We have seen this consistently over time.
We do share this information regularly with the financial institutions, but the problem is there. We have always said that this is a risk factor created by the financial institutions. It has nothing to do with the risk relevant to that individual business. Therefore, that account-manager relationship is something on which we still believe we could make some good progress, and it would be a major benefit to small business borrowers. Also, the smaller the business, the higher the loan rejection rate is. Typically, a newer business would often be smaller than a well-established business. Part of that rejection rate relates to not having a long-term track record. That being said, we want our smaller, new businesses to thrive, become larger and provide employment opportunities. Measures that could improve that rejection rate among smaller businesses would be good economic policy.
From a regulatory standpoint, a number of years ago the banks established their own code of conduct, which we tabled with the Clerk of the Committee today. We thought it was positive for many different reasons. However, some banks are not adhering to their code of conduct. In some areas we found in our surveys that about 27 per cent of owners were not provided with a reason for the rejection of a loan application by a financial institution. We know that some institution had focused on this oversight, and that can be helpful. Some institutions might deem an application unsuitable for them and so they might help the applicant change the nature of the application somewhat that could result in acceptance at the same or another institution. We did not find that kind of information, and we asked our members whether their institutions offer any information on alternative financing sources. More than 83 per cent said no. We believe that the chartered banks in Canada enjoy a great deal of privilege and protection in their markets. There is a quid pro quo in these areas. Some institutions are serving us well, and I believe it is working for their bottom line, too. However, banks could be encouraged to adhere a little better to their own codes of conduct.
There is no question that the insurance sector has been a white-hot issue for small- and medium-sized businesses for the last number of years, not to mention for most Canadians, I suspect. We always see an inordinate focus on the auto sector, which comprises about one half the insurance industry. From a political standpoint, politicians hear much more about auto insurance than they hear about business property insurance premiums. We are well aware of this, and have worked with the insurance industry in many different ways over the last number of years, initially to try to understand what was happening and to determine whether policies or practices could be put in place to help the situation in any way.
We know that many of the crises in the insurance area over the last number of years took place for many reasons. It is a global problem, and is by no means unique to Canada or North America. Many things are out of anyone's control, certainly out of any government's control, given times such as the post-9/11 impact on the stock market. However, we have tried to focus on whether there are constructive areas to determine whether the problem is policy or practices in the industry. As an organization we have made a major effort to educate our members because many of the issues can be improved somewhat by an informed consumer. As I mentioned earlier, we know from a political standpoint that auto premiums received much deserved attention. On the business side, we heard amazing, awful stories from our members about what was happening to them in the areas of property and casualty. Some premiums were tripling or quadrupling, some were experiencing reduced coverage and, worst of all, some businesses were not able to get insurance for any amount of money. They were left self-insuring or crossing their fingers and hoping for the best. We heard about all manner of unfortunate scenarios.
We have been asking for some time now for some kind of government investigation into the industry, notably business insurance. It is not strictly P and C because there are other business insurance products. However, P and C did seem to be in the worst shape from the feedback we are getting from our members. We have done quite a bit of surveying of them on this issue for a number of years. In figure 7 of the brief before you, you can see one of our most recent surveys. This was taken in the last half of 2004, so the data is relevant. We are continuing to be surprised, even though we knew this issue had hit crisis proportions in mid-2002. To this day, we ask our members which of the following input costs are having a significant impact on their businesses, and insurance is still number one, ahead of fuel. Of course, fuel costs have gone up wildly over the last year or two as well. We were surprised to learn this. Of course, all of these input costs have seen increases, but insurance is still out there as number one. The problem has not gone away. Even though we have seen improvement in the rate of that increase, we have not seen much in the way of reductions in costs for small firms. We are beginning to see reductions in auto insurance but the issue has not gone away. We want to bring the message to this committee that the issue has not gone away, by a long shot.
Given that this committee looks at both of these sectors, we compared financial input costs across the country for you in figure 8. We found that insurance costs outweigh bank service charges, which have also increased significantly and are an ongoing concern for small firms. Insurance costs significantly outweigh bank service charges across the country.
When looking at banking issues, we found that there has been much research, documentation, data-gathering and analysis over the last little while. Back in the mid-1980s, CFIB promoted the public reporting of results of the small business financing survey that was done by Statistics Canada. The House of Commons Industry Committee has worked regularly on improving the data from this industry. I remember at the time how the banks were opposed to disseminating more information about lending to the small business sector. One committee of an institution was asked how many small business loans they had, and their response was: We do not know. It was intriguing that their own data did not allow them to analyze the data in that way.
Since then, we have greatly increased our data researching ability. If you do not have the information then you cannot do the analysis. It has been greatly improved upon in the area of banking. We find it intriguing that the banks, who initially resisted having more data available in a public kind of way, now find it a wonderful marketing tool. They now understand their small business clientele better, and the small business market is a very profitable market for banks. You would think that better understanding would lead to a better bottom line for the institutions.
In the insurance area, however, we have major gaps in data. However, there is good data on auto insurance premiums. For so much of the business insurance products, P and C being a good example, the data are partial, spotty and difficult to break out by sectors. Some sectors have no problems whereas others are deemed to be high risk. Those are the ones that cannot get insurance at all. An analysis and database has been our major thrust over the last number of years. We cannot get a handle on what kind of beneficial policy we could bring to bear until we have a much better idea than we have currently about the data.
This whole statistical question is something that could be constructively acted upon. We looked at the U.S. market where there is a very good source of data; it is with insurance brokers. In the U.S., they compile and publish their data by sector, with good break-outs so that you can see what is happening, the trends over time, and for various types of insurance they take average policies. It is not impossible to do this. Other jurisdictions are doing it.
We feel, however, that we can never get a grip on how we can better deal with cycles in insurance, which are never going away. We are realistic and always looking for market-driven solutions, but by no means more regulatory involvement because we do not feel that that is necessary at all. That being said, if we can get a grip on that issue, we feel that is a very good first step that will produce the kind of good policy that will work for all players down the road.
We feel a voluntary code of conduct coming out of the insurance industry would be a very good move at this point in time, not unlike when the banks did it for themselves. We have discussed this with groups such as the Insurance Bureau of Canada and others. One of the things we kept finding was that not only were our members' premiums increasing dramatically over the last number of years, and other changes happening with their accounts but they were not notified. We found that over a quarter of our members were not notified the all. It is one thing if your premiums increase, you can say, very well, I will hunker down and see what we can do here, but over 27 per cent got no notification of even, basically, a phone call. About half were notified 30 days or more in advance. We feel that that is not an unreasonable time frame, something we can discuss. Another chunk, 22 per cent were notified less than 30 days in advance, but they did get some notification.
These are the issues that the insurance industry can think about. They have agreed with us in meetings that this kind of thing, where they can give notice, means that they can make a much more manageable situation for the ultimate consumer.
To conclude, I do want to emphasize that we are not asking for more regulation. Small businesses typically prefer much less regulation, if at all possible. There are roles for regulation, we agree; I do not want to be misconstrued, but we do feel that market-driven solutions with good data are best because good information is the essence of having a healthy competitive market. Consumers do need to be better informed on what is out there, what they can achieve. Policy analysts need to have a better handle on this black hole that seems to exist in the business insurance area in terms of information.
We have three recommendations on the banking side and three on the business insurance side. I have not mentioned bank mergers yet, but I did earlier allude to the state of competition. Not surprisingly, our members have consistently opposed mergers, not simply on a knee-jerk basis but because they believe we already have insufficient competition and there is no question that mergers would lessen it more. The last time mergers were considered, back in 1998, they were rejected on the basis that there was insufficient competition. One of the bases was insufficient competition in the small business area. Since then, we have had the loss of Canada Trust in the sense of a separate institution. If anything, we have a less competitive market today than back in 1998. How can we justify mergers unless we come up with new criteria? I cannot fathom that one.
Our second recommendation is that there should be collection and public reporting of additional information specific to the banking sector's competitiveness status. We have some data out of Statistics Canada. There is a group within Industry Canada that is tasked with compiling and retaining data in this area. Notably, we would like to see the collection of information on such things as branch locations because when you are trying to get at competition issues, it is essential that you factor in the geography. We see such a rural/urban split in our data consistently that that is one type of area in which we need more information. Also I would include here the types of services that are available at the banks. It is one thing to have a so-called branch, but when you find that it is just two ATMs, that is not a branch like any other branch would be defined. Those are examples of the areas on which we need better information.
Finally, the code of conduct should be consistently enforced. We think it is very good, but naturally it is pretty useless if it is not being effectively enforced. On the insurance side, we have been asking the federal government take a review of P and C insurance issues affecting small business. The main purpose is to identify the problems facing the sector and try to devise ways of ameliorating it in future. I know from meeting with the insurance industry reps on a regular basis that the latest crisis is over, but this is a highly cyclical sector, and we will have another crisis down the road. Can we do something now to help at least reduce the severity of any rapid run-ups in costs in the future?
The statistical issue I have done to death. That is also a major recommendation, to obtain better data so that we know what we are dealing with here. Finally, we do believe that the P and C insurance industry should work with the government and ourselves, and any others that may have a stake in this area, to put together its own voluntary code of conduct so that they can offer better terms and better treatment to their small business clientele.
That is the essence of our presentation today, and we would be delighted to hear any questions or comments that you have.
The Chairman: The first questioner will be Senator Angus. First, would you point us to the statistics you say are available in the United States and that are not available here? You could refer that to our staff.
Ms. Swift: Could I get them to you? I did not bring them today, but we have them in our office, so we can easily get those statistics to you.
The Chairman: You have not identified them precisely but if you could send them to us, that would be useful because we are very interested in statistical analysis.
Ms. Swift: That would be no problem.
Senator Angus: Welcome, Ms. Swift and Mr. Piché. It is enlightening when you come before our committee. You have raised a number of topical points. I will focus in on one of them, although I am tempted to go for the insurance one but I will leave that for somebody else. We will have to come back on that; it sounds as though it might deserve another study.
In any event, figure 5 and your comments about the dramatic reduction in recourse experienced by SMEs, small and medium-sized businesses, for financing in the early part of this century. We did a study on the availability of not only start-up financing but also second, third and fourth-tier financing, or venture capital for small and medium-sized business in Canada. We issued a report a couple of years ago. We were very shocked at the time at how sparse the funds were for small business in Canada. There is always reason for these things. I am amazed at this number. Where are they getting their money here? You show this decline over the period from 1987 to 2003, figure 5. Could you elaborate on that and where are they going if not to the banks?
Ms. Swift: It is a good question, and there are a number of answers, but there is no one simple one. Leasing has become huge among the small business area. Instead of taking out a term loan, they will lease their piece of equipment or whatever. There is no question that there has been major growth in leasing, which is good; that is a competitive factor. However, many more businesses are also seeking non-traditional sources of financing. Small business has grown to being almost half the economy. In 1970, it was about a quarter. That is huge growth, and naturally people will see opportunities that did not exist previously with growth in that sector. Today we have many more informal capital providers in the marketplace.
Senator Angus: I noted a year ago, or maybe two, that you were at 105,000 memberships.
Ms. Swift: We are at 105,000 now. We were at 100,000 about three years ago. It is a growing sector, when we look at the overall economy — my background is economics, which I admit is useful from time to time. However, the stability that we have seen in the Canadian economy over the last number of years, despite wild swings in the stock market and in large corporate major layoffs, has come from this sector. Nurturing it has been a good prescription for the overall economic situation. We see other types of financing. Businesses are doing things with a bit more variety of items, such as credit instruments. Some of the financial institutions have come up with something like a credit card, but that are tailored to the independent business situation. The problem is that it is costly in relation to a term loan kind of situation. There are a number of growing ideas. Informal capital has always existed. With a couple of new things, like the credit card, where the business actually starts up by maxing out two or three credit cards. We hear that more than we would like. The interest rates are prohibitive. This will certainly not help the growth as well as could be done with a more reasonably priced credit instrument.
A number of different things are happening. We heard many stories after the last recession that we had in Canada in 1990-91 that was very deep. A lot of the bankers overreacted to the situation. It was serious, but many viable businesses had their line of credit cut in half because they were in a particular sector that the bank decided they did not like, or a region, and so everyone was cut off. Interestingly enough, the bankers admitted that this had happened. However, in central Canada, in particular, we had not seen a recession so serious for quite some time. It was interesting. Our members out West did better because they had problems back in the early 1980s with the energy crisis. Ontario, and more of the central Canadian bankers, and half of the economy, reacted much more severely and negatively. That burned a lot of businesses and they turned away from banks.
There are many reasons here, and we believe the lack of competition we have always had in Canada for the small business market is one. I know the banks compete aggressively in other areas, but for small businesses we do not believe it is as healthy a market as possible. We do not deny that it is a tough market to serve. It is a lot easier to lend out a few million dollars once than to lend out in parcels of many hundreds of thousands.
Another document that we tabled with your committee was the credit-scoring model which many banks have now adopted. It is a system that lowers the cost. If you have enough of your basic ratios and your data fits, yes, you get the loan or line of credit. We do not take issue with it, except that it is a bit mechanistic. However, what we found is that if the banker knows that the business owner is honest, he or she might say ``That ratio is off, but this guy is okay, so I will give him the loan.'' The credit=scoring model takes the subjective element right out of the equation. It was not well explained at all, and we feel that financial institutions are doing a disservice to their customers because if a business does not know how it is being evaluated, then obviously it will be in dire straits when it is putting its business plan together. We worked with the industry to do a comprehensive piece. Credit-scoring is what we tabled: As a small business, you must know how you are being evaluated or you are being put at a disadvantage.
The Chairman: Many senators want to ask you questions. I hope you could curb your answers a bit so we can cover more topics.
Senator Angus: In answering that question, you said so many interesting things. One of them that you slipped in is the percentage of the Canadian economy that is made up of small and medium-sized businesses, grown from 25 per cent to 50 per cent. You have probably seen in this committee's reports that we say the foundation of the Canadian economy is not built on fortune 500 companies, but rather the foundation is that of small and medium-sized businesses. That is the foundation of our economy. When you say that it has grown from 25 to 50, what are you measuring as a small business?
Ms. Swift: For Statistics Canada's definition purposes, small is less than 50 employees, and medium is 50 to 500. The vast majority are smaller.
Senator Angus: You are including medium?
Ms. Swift: Yes, that is the small and medium. Five hundred, but when you look at the Canadian economy, 99 per cent of the number of businesses in Canada have less than 20 employees. That is a research definition.
Senator Angus: Your anecdotes on the availability or utilization of bank credit by small and medium-sized businesses is about the changeover of managers, and therefore the personal touch. The question that jumps off the page to me is that because we only have these five or six chartered banks — and I am assuming you are referring to them — have you noticed any kind of collusion or acting together? We notice that there is a new industry out there called payday loan lending, and we find that the big banks are all not in it. I listen to you and I hear that they are all acting in a similar way so that credit is no longer available from any of the banks. Is there some kind of concerted kind of squeezing out?
Ms. Swift: I would not say there is a concerted squeezing out, and some institutions are more responsive to the small business market than others. To our way of thinking, that proves that it can be done if the will is there to do it. The banks over history, like most entities, tend to have a herd mentality. We can look back several decades and find that it was real estate in the early 1980s, and the bottom fell out of that market so everyone was up the creek. One of the banks nearly went under. In the late 80s, we had junk bonds. We had Latin American debt. You will see the herd mentality, and all of a sudden the bottom gets pulled out from under them because they input too many assets. It is consistent over time. It is a base for the banks, and so we often feel really underappreciated perhaps because, when the Reichmans go down or Dome goes down or whatever you want to cite, everyone else's costs go out and it is our guys who absorb much of that.
To be fair, we rank the different institutions, not just banks but credit unions and all the other players out there. There is movement over time. We have data going back 30 years, so we can show you that, years ago, institution X was serving the small business market better than Y, and now perhaps Y is better.
The Chairman: Do you have those statistics? I think it is very important if it is as Senator Angus alluded to. We would be interested in looking at that.
Ms. Swift: We have reams of data.
The Chairman: Do not give us reams of data. Give us pertinent data.
Ms. Swift: We can compile the historical comparisons of that kind of stuff.
Senator Fitzpatrick: Actually, it is very hard to restrain yourself on this subject, and pardon the pun, but your testimony was very swift but also very informative.
I want to compliment you on the work that you do with respect to small and medium-sized businesses because, as we have just heard, it is a very large sector of our economy and the growth is extraordinary, despite these obstacles that you talked about. I must say — and this is not a criticism; your comments are very helpful in identifying the problems — like us, you have to search for the solutions because it is not that easy. I think Senator Angus's comment that maybe this would be the subject of another study is pertinent, because I assume you could do with some help in your mission.
I have a lot of questions. I will try and keep them brief but that just might not do justice to the subject. You talked, first of all, about contact declingin within the banks, and that that had an impact on small and medium-sized businesses. I am not sure that personal contact is a real problem for small and medium-sized businesses. I think it is for the consumer, and maybe that is what you were directing your comments to. Businesses usually have access to talking to banks, but they do not necessarily get the financing they are looking for, so I would like to hear a little more about that.
Again, Senator Angus talked about other forms of financing that would be available, and you responded to that with the leasing possibility — I do not know what else there is. Is there room for small and medium-sized banks, and how can they get started in Canada? I know the history of that idea in Canada has not been great, but I would like to have your thoughts on it. In terms of economic development and increased employment, this sector is so important.
I have a comment on insurance and insurance costs. I have just gone through the experience in my community, which is in British Columbia in the Okanagan Valley, of the fire storm that hit the area. I can tell you that the cost of insurance has skyrocketed there. I am not sure that it relates to what the real losses were that had to be paid out, but the insurance companies sure jacked up the premiums. Have you done any analysis on how this comes about? That would be interesting to know. It is not just loss of assets, but it is loss of business and other things. Businesses were shut down for a period of time. How do we deal with that in the future?
Another area that you did not mention — and perhaps it is not pertinent to this discussion — is directors' and officers' liability insurance. For small and medium-sized businesses, particularly if it is a small public company that is developing, it is practically impossible to get that kind of insurance. That makes it more difficult to attract the level of directors and officers that these companies might need for their development.
I will stop there, Chairman, but this is a very important subject to us.
The Chairman: Could I ask you to hit the headlines, and then perhaps if you read Senator Fitzpatrick's questions, you could come back with fuller answers? I want to be fair to all senators. You have opened up a wide area of consideration. I do not mean to be impolite but we want to be fair to other senators, and the time is running. If you could hit the headlines in responding, it will give other senators a chance to get their views across, and then you can respond in writing.
Ms. Swift: First, you mentioned at the outset recommendations. We tried not to burden you today. We have a lot of information going back full of recommendations as to what can be done in all these areas. We do have that on both banking and insurance, and I would be happy to provide it to you at any time. We just highlighted key things today, but we have all manner of information as well.
When you mention small business being able to speak to a bank, by and large they can, but that turnover issue is huge. That is shocking, that suddenly it triples the likelihood of a loan rejection because you have bank manager turnover. The banks do that because they want to move their people around. You can understand why they are doing it, but we wonder whether there is not a way to have a couple of people knowledgeable about that file so that when someone leaves the branch, the small business person is not left holding the bag? There are things that can be done, and we have made those recommendations in other reports.
We do not have anything specifically about regional issues on the insurance side. We have done two surveys on insurance issues so far, and we could break the data out regionally. There might be some solution there for you. We have asked questions of our members — things such as how much did your premiums increase, et cetera — and we showed you some of that data. If we can get at the database, this would be the answer.
In terms of directors' and officers' liability insurance, we included that in the rubric ``business insurance.'' P & C is the biggest chunk of it, but you are absolutely right — there are other types of business insurance, and officers' and directors' insurance is a big problem as well. With the increasing scrutiny from a corporate governance standpoint that has arisen out of all the crises we have seen in that department, that is affecting small businesses too. They have to pay higher audit fees; they have to obtain different kinds of insurance. There is no doubt that these are all issues as well. Today, however, we tried to focus in on the biggest items. If we could get a good database of insurance data, or at least start it, then it will help us point to the answers.
Senator Fitzpatrick: It would be very helpful if you could provide us with some of the information you spoke about.
Despite all of these obstacles, small and medium-sized businesses continue to grow. I would like to have your comments on that. How much more would they grow if they did not have these obstacles?
Ms. Swift: Those are actually questions we have asked our members. If ``X'' happened, what would that mean to your business? The focus is usually on increased hiring, increased benefits and pay to their staff, increased expansion of the business and so on. It is hard to measure opportunity cost — what is foregone — because you do not go there.
I have a bias, but I have always said that we underestimate how entrepreneurial the Canadian economy is. We have a very vibrant entrepreneurial sector. Our mission is to ensure that it is as well treated as possible — not simply for the individual businesses, which is important, but I believe the spin-off effects of helping small business are bigger than helping any other single group in the economy.
The Chairman: If you could read the transcript, and if there are other questions that Senator Fitzpatrick asked that have not been answered, you might respond to them. He raised a number of issues and all of them are relevant and important.
[Translation]
Senator Massicotte: The regulations are always very important, but there is no better solution than real competition. It is more flexible and more effective, and does a better job of serving consumers and users. To better understand the sectors involved, in Table No. 5, Senator Angus asked why the trend was downward. You explained the consequences and other forms of financing, including leases.
Accordingly, in Table No. 4, we noted the stability in the number of loans under $200,000. But the impact of leases — when you think of financing more generally — will perhaps increase financing as a result. It may not be stable. This indicator is somewhat awkward. Having said that, from the standpoint of the banks, I have the impression that there is a great deal of lease financing; you imply that there is a lack of competition, a lack of players. Can you give more details? There is no shortage of competition; some U.S. banks are giving us a great deal of competition. I assume that more sophisticated financial services are not really of interest to your members. Would it be mainly in the straightforward loans and bank services where there is no competition?
[English]
Ms. Swift: Again, the regional issue comes in in a big way. Although in an urban market you will have many of these players, when you get into rural markets you do not. There is competition to a certain extent in some areas but less in others. I believe we should throw our market open to U.S. institutions completely, and that is not the case now. They have a limited ability to come into Canada, which has been good. I believe that it was Wells Fargo, a small player, who levered the banks to offer a similar product. That is high-cost money at a rate of prime plus 6 per cent, but it serves a certain niche. It is interesting, however, that it went beyond the niche. I cannot remember the amount that Wells Fargo was lending out relative to the big picture, but the banks all followed suit by offering a similar product. Suddenly the impact was more broad. Thus, we believe that the ultimate answer is competition, as robust as it can possibly be.
Our financial institutions, despite all their moaning and groaning over the years about mergers and not doing well, consistently do extremely well according to the profitability statements and stock market returns. I tend to think that we have a highly protected financial sector and it is important that it be stable, so I am not suggesting that. However, we could have a more competitive environment if we truly open the Canadian market more than it is open now.
We have seen a stable level of lending since 1988 but we have many more small businesses now and so the money has stayed roughly the same with more players in the mix. If we factor in those influences, we can understand why the charts are as they are.
[Translation]
Senator Massicotte: It is more the SMEs in the rural regions who are suffering from competition problems, isn't it? Is that the dilemma?
[English]
Ms. Swift: That is at its worst in rural areas. We have seen branch consolidation such that a small town with only one branch was left with no branch, and the larger location with two or three branches was left with two.
[Translation]
Senator Massicotte: We assume that there ought to be more competition allowed in Canada; there is not enough. I thought that the regulations, for six or seven years, were very flexible. We have not seen many U.S. HSBC banks; there are only a few. But what would have to be changed? Some important needs have been identified, and everything has been made more flexible. Why do they not want to join? Are there barriers we do not know about?
[English]
Ms. Swift: The big obstacle is capital requirements, and that foreign institutions still have to establish a very significant capital base in Canada. They cannot say they are a U.S. bank or a European bank. They cannot offer those services backed up by reserves that are in their home jurisdiction, wherever that may be. In this day and age, when the globe is shrinking and technology is such as it is, there is more scope to open the market to foreign credit providers. It does not have to mean that they are required to set aside a certain reserve exclusively to serve the Canadian market and appear to be sound.
[Translation]
Senator Massicotte: I was recently asking myself why the banks are not interested in insurance companies. There has been discussion of mergers between life insurance companies and the banks. I believe that the reason is that on average, for two years, the return on equity for insurance has been 6 per cent. That is why ING has very few new competitors. The conclusion, according to this sector, is that it is not profitable. This also explains why, for four or five years, insurance premiums have increased significantly. They were much lower before. Do you have any comments about these conclusions if we compare them to your analysis?
[English]
Ms. Swift: The whole issue of so-called cross pillar mergers is one that should wait for another day. I do think it is an interesting concept because, even though bank-to-bank mergers in the current climate are believed to be problematic, there may be scope, but it is a complicated issue. That is an interesting question, and may well have some beneficial effects in the insurance area. It might have to stay up in the air for the moment but I do not think it is a priority on anyone's radar screen. The small business market for insurers, for banks or for anyone, is hard to serve. You can understand the individual corporate decision and public policy decision are different but with a bank there are, undoubtedly, more profitable segments that they can serve.
The same applies to the insurance industry. We have always tried to convince the banks, and some are doing it now. We have brought this point to the committee on numerous occasions. If the bankers or insurers look only at the line of credit or at one particular part of the business, they will not see it as being as profitable as the ``flavour of the day'' in the larger financial market sense. They need only add up all the different services that a small business consumes, including personal services such as RSPs. Independent business ownership, which is our membership, have their personal and business finances mixed in together, such as a home that might be listed as collateral against the business. It is a mishmash. If they look broadly across the services they offer, then they see that it is a much more profitable market than the term loan market. I would suspect that it is the same in the insurance industry, although the economics are different. We know that some banks have done that and found that it is a profitable market and look to different ways to serve it better.
Canada is a small market, generally. Many international or European based insurance businesses view Canada as not having a particularly high rate of return and so they pull out because it is a small market. These are the overarching economics of the industries that affect this sector as well.
[Translation]
Senator Plamondon: I have a question about bank charges, another about insurance and another about credit.
I will begin with insurance, because your presentation showed that consumers have approximately the same concerns as they do about home insurance. I have already conducted a study on this matter.
In a survey, we were able to isolate the reasons why people were denied insurance. It could be because they lived near a bar, or in a particular neighbourhood, or again that the person's home was in another form of high-risk neighbourhood. It could even because of the person's occupation. If someone worked in an artistic environment, that person was refused insurance. There were reasons for this.
There is a way of making complaints. I was surprised to learn that you could not get an answer when you wanted to know why an insurance company was denying you insurance. You could direct your members to the Financial Services Ombudsman Network to ask why they were denied insurance.
Before coming to the Senate, I heard insurance agents and brokers say that it was difficult to evaluate a small company. Do you think that there should be better training for brokers? Are you well served by brokers? We say a broker, but in fact, brokers have only two or three insurance companies because they receive bonuses on the volume they sell and will direct all their customers to the same insurer. Is there enough competition in this field?
[English]
The Chairman: Senator Plamondon, that is a broad question that contains several sub-questions. Perhaps you could tell us which of the major questions is most compelling for a response by Ms. Swift?
I hope you would respond to each of those questions in writing, but perhaps you could select the one question that is compelling and then we can move on to Senator Moore.
[Translation]
Senator Plamondon: The small businesses sector and the chambers of commerce paid me tribute the first time I led the battle against bank charges in the 80s. It is no mean feat to be an activist and then receive a tribute from the chambers of commerce. This homage was a big surprise to me. We came to the realization that bank charges were a common concern. Small companies were being bled dry by bank charges. Has there been any improvement on this point? As for alternative sources of credit, you have not answered the question about where the interest of your members lies.
[English]
Ms. Swift: With respect to service charges, we go through cycles with those too, and there is no question that public pressure works with service charges. Indeed, I think the banks will try to get away with what they can. We know, from looking at their financial results, that there is a much larger portion in their overall bottom-line profitability, a much bigger slice of fee-based income. That comes from all kinds of fees, not just the typical SME service charges, but all manner of fees, so fee-based income is a real, growing source of money.
The principle of charging fees is perfectly legitimate and defensible, but what we have said to banks is: be transparent. It is this communications issue again. I can remember instances where a business did not know a fee was to be charged, and found the amount had been taken off their account with no notice, and suddenly they had cheques going out NSF. That kind of situation should not happen. There should be, at least, information and also negotiation, things that we have promoted with the industry for years. Things like have a package, being able to do your banking à la carte or package things together, because every small business is different; not one method will suit everyone. Is there some kind of bundling you can do so that an individual business can go in and negotiate?
We also find intriguing service charges. It is caveat emptor. We try to urge our members to bargain; go in and say, ``What can you do for me?'' Of course, the business that does not really need the break, the well-established, profitable one, is the one that gets the break and the one that is younger or just getting growing, they are the ones that get nailed by service charges because they do not have the same bargaining power. It is a bit perverse.
The Chairman: We will pause there. I hope you will read the senator's questions and respond.
Senator Moore: You mentioned, Ms. Swift, that you have 105,000 members and that the small businesses are the ones with less than 50 employees. How many of those are there? How many are small businesses and how many are medium-sized?
Ms. Swift: Those definitions are research definitions and part of the reason we use them is that they are used all over the world and we can compare.
Senator Moore: If you have 105,000 members —
Ms. Swift: Half have less than five employees and 80 per cent less than 20 employees, and we would have probably less than one per cent that have more than 50 employees.
Senator Moore: Less than one per cent.
Ms. Swift: That is not unlike the Canadian economy. We are trying to harmonize definitions. That is the reason we use that other one, so that we can make comparisons.
Senator Moore: Like some of my colleagues, I was intrigued by figure 5, the graph there. Fewer small businesses were applying for financing through that whole period, including through the period of recession. You mentioned that they are obtaining financing from other, alternative sources. Is there any other reason for that? That is quite a dramatic trend.
Ms. Swift: Yes, it is a dramatic trend and, we feel, a worrisome trend.
Senator Moore: Have banks just got out of the business?
Ms. Swift: Some have, more or less; some have moved out of a sector or a region. We see quite different behaviour on the part of different institutions. If you collectively put it together as an industry, one thing that is horribly difficult to get right now is a commercial mortgage. If you are located in some parts of the country, you cannot get a commercial mortgage. That is the trend.
Senator Moore: Why is that?
Ms. Swift: The banks have moved out of the business. That is the problem you have when you have an established core group of players who have been in the business forever and they have just opted out. They have simply said ``We will not be lenders to that sector of the field any more. We see better opportunities elsewhere.'' I do not think those are good decisions, but I am not making them.
Senator Moore: Is there any sector of the economy of small business groupings that suffers more than the others? Is there one area, one of the groups of the small business sector that does not receive financing?
Ms. Swift: The hospitality industry always has challenges and there are changes within that industry, so institutions are loath to lend to them. Groups like construction are also a challenge because of the volatility and the changing nature of that industry. We have also found that start-up technology businesses, for the longest time — things have improved somewhat now, but because they were actually rapid growth, they scared the lenders. They thought ``Something is wrong here. This guy is growing like mad, so we will not lend to them.'' We did a study and found high- growth businesses were treated as badly as low-growth businesses, and worse than the average moving-along businesses.
The Chairman: Thank you very much to your organization. You have provoked us to take a careful look at some of the issue, and there will be a trail of your material for other witnesses.
Could you respond again, in writing, about rates of return? It would be very interesting for us to have a look at rates of return in the insurance industry in the last five years, and the rates of return in the banking business in the last five years; rates of return on invested capital. You can do the model however you choose to do it, but I think costs and relationships have a lot to do with rates of return. It would be interesting to see if there are abnormal or subnormal rates of return, because that very much determines the costs and the fee structures of businesses, both in the insurance and in the banking area.
As well, if you could give us some help in terms of the model of rates of return for your businesses, 150 to 500 and so on, so that we can take a look at that aspect. It is a question of not just competition but also rates of return. That would be helpful in terms of our analysis, to be fair.
Ms. Swift: I have to say that data are not always available. This is what we are asking for.
The Chairman: I am asking you to give us something as best you can, because there are some systemic problems that you have raised here. In order for us to examine the systemic problems, we need to look at the systemic problems facing each of the sectors including insurance and the banking structure, and a lot has to do with rates of return.
Ms. Swift: I hope you will also ask the Insurance Bureau of Canada, the Canadian Bankers Association and the people who are much closer to those numbers than we are.
Senator Fitzpatrick: I do not know if the information would be available, but it would be interesting to know what the loan failure rate is for small- and medium-sized enterprises compared to the big guys.
The Chairman: Again, if you could do that, not only in terms of size but also in terms of sector. This is not a macro study; there is a micro analysis that has to be done to come to some macro conclusion.
Our next witness is Gordon Dunning, President and Chief Executive Officer, Canadian Life and Health Insurance Compensation Corporation. We are continuing our study of the oversight in the financial sector with respect to consumer protection issues. We welcome Mr. Dunning. Mr. Dunning, please look at the clock this time. We only have literally 40 minutes for your presentation and your questions, and then we have some business to complete as a committee. I apologize, and if there are questions that senators ask you and you cannot answer them, they will be taken down in the transcript and you can answer them more fully in writing. We apologize for this, but you can see that we are very interested in this topic.
Mr. Gordon M. Dunning, President and Chief Executive Officer, Canadian Life and Health Insurance Compensation Corporation: Thank you, Mr. Chairman. I will keep my opening remarks as short as possible to allow for more questions.
Thank you for this opportunity to explain the role of CompCorp, especially in the context of your study of consumer issues and the financial services sector. We protect the Canadian policy holders if their life insurance company fails. Over 23 million Canadians have life, health or annuity benefits issued by our member companies and the total value is over $140 billion. Our mandate is it to protect policy holders. We are accountable to the government and industry to deliver on that protection. We have contractual participation agreements with the federal and each provincial and territorial government. Under those agreements, we commit to protect the policy holders in their jurisdiction. In return, each jurisdiction has agreed to ensure that companies that sell life insurance in their jurisdiction are members of CompCorp. We are also accountable to our members for providing policy holder protection that is designed to maintain consumer confidence in the industry.
Virtually all benefits promised by members are protected by CompCorp. We guarantee that policy holders' income, health and death benefits will continue at no less than 85 per cent of their original value. For the majority of policy holders, they will continue to 100 per cent of their original value. Policy holder cash values and accumulated values are 100 per cent guaranteed up to $60,000. CompCorp protects policy holders by continuing their covered benefits under the original terms of their policies. This is as opposed to rather than cancelling the policy and paying cash compensation. This continuity is particularly important to policy holders who are receiving disability or retirement income benefits, as it avoids the hardship which would arise from an interruption in their income payments. It is also important for life and disability insurance policy holders as it ensures that those of they who are no longer insurable because of deterioration in health retain their benefits.
CompCorp's governance reflects our public-private partnership. We have a board of directors that is elected by the members but is fully independent of them. This independence allows the board to fully collaborate and exchange confidential information with the regulators. The directors have a diversity of experience, which is required to oversee our unique role. The participation agreements with the federal, provincial and territorial jurisdictions require us to obtain their approval for any changes to our bylaws. This gives the regulators approval authority over any changes to our policy holder protection or to our assessment rules, which are embedded in these bylaws. All jurisdictions are members of the CCIR, the Canadian Council of Insurance Regulators, and this body has developed an effective review process to deal with any changes to our bylaws.
CompCorp is a not-for-profit organization incorporated under the Canada Corporations Act. All life insurance companies operating in Canada are member of CompCorp. We routinely report to members at our annual general meeting and if any changes are required to our by-laws, they must also be approved at those meetings. The most recent change to our by-laws introduced the new 85 per cent proportional coverage and that received 99 per cent approval rating from our members at that meeting. We are entirely funded by the membership and are not reliant on any government resources. We retain a liquidity fund in excess of $100 million to provide immediate funds to support policy holders. Our current annual assessment capacity is $138 million, and our present value of our assessment capacity is $3.5 billion that stands ready to protect policy holders.
The core of our operation is our detection of troubled companies and early intervention to protect policy holders. CompCorp's detection procedures are designed to identify systemic and company-specific risks. Our analysis is based on information directly from the member companies but it includes the company's financial statements, regulatory filings and capital adequacy tests. Because of this, we take an active role with the professions and regulators in the development of accounting and actuarial standards but with a focus on those that affect solvency. We advocate for strong, relevant disclosure and capital standards. The majority of our members are regulated federally by OSFI, Office of the Superintendent of Financial Institutions, but a significant minority are incorporated in Quebec and regulated by AMF, or Autorité des marchés financiers.
If any member deteriorates to the point where policy holder benefits are gravely at risk, and if CompCorp and the regulator, working together, are unable to find a solvent solution, the regulator will take control of the company and place it under the Winding Up and Restructuring Act. CompCorp then provides financial support to the policy holders through the liquidator to ensure a rapid transfer of the policies to a solvent company. At the time of failure, communication to policy holders is extremely important, and we supplement our own resources with those of the liquidator and the industry to communication through the media, and directly by phone, mail and email.
In response to the convergence in the financial services sector, we have been in recent cooperation with other compensation corporations and deposit insurers to improve communication to consumers. The first product of this cooperation was the launch of a joint web portal in December. In the 1990s, three life insurance companies failed, two were federal companies and one was a provincial company. We protected almost three million Canadians with policy values in excess of $4.5 billion. In all three cases, the Canadian policies were transferred to solvent life insurance companies. In two of these cases, 100 per cent of the policy holder benefits were preserved and in the third, 96 per cent of policy holders retained 100 per cent of their benefits, while the remaining four per cent retained at least 90 per cent. CompCorp has demonstrated a record of quietly protecting policy holders and we stand ready to do so again, if needed.
Thank you for this opportunity of allowing me to briefly explain our role, our governance and our successes. I would be pleased to answer any questions.
The Chairman: Thank you, Mr. Dunning. I do not think Canadian consumers are as aware as we are of the important work that your organization does to protect consumers, and in that sense your testimony is very relevant to our considerations.
Senator Moore: Mr. Dunning, I would like you to tell us more about the guaranteed coverage. You are guaranteeing the payout of every policy up to $60,000, regardless. Does that include the cash value of the policy? For example, if the policy were $200,000 with a cash value of $10,000 and the company went under, does that $60,000 include the $10,000 or is it $60,000 plus $10,000 cash surrender value?
Mr. Dunning: Part of our problem in communicating with the consumer is the complexity of the product and, therefore, the complexity of the coverage. For death benefit, we cover the greater of 85 per cent of the death benefit, or $200,000. If the death benefit is less than $200,000, they will receive 100 per cent of the death benefit transferred to another company. If the death benefit is greater than $200,000, they will receive 85 per cent transferred to a solvent company. In addition to that, we cover any cash surrender of that policy, up to $60,000, 100 per cent.
Senator Moore: The $60,000 is for the cash surrender value?
Mr. Dunning: Yes.
Senator Moore: We heard testimony from the last witnesses about increased premiums being experienced by small business owners and operators. What is the rate of premiums? Has there been a dramatic increase, or is it fairly stable? I realize it depends on the applicant but, in general, where does your industry stand?
Mr. Dunning: I would have to defer to industry representatives on general questions about the industry. Our focus is on the insolvency of financial institutions and protecting policy holders in the event that an institution becomes insolvent.
Senator Moore: Can you respond in respect of the rates in your company?
Mr. Dunning: We are a post-funded scheme, so we have on hand in excess of $100 million, and today it is about $115 million. However, we do not make regular assessments of the industry to pay for our internal costs, which are met by the investment income off that pool of funds. Should an insolvency occur, within 60 days we can raise $138 million in regular assessment and, in fact, almost 10 times that amount in terms of a loan assessment against our members. We do not regularly charge the industry for our own costs.
Senator Moore: Those costs are covered by the prudent investing of the pool of cash that you have on hand at all times?
Mr. Dunning: That is correct.
[Translation]
Senator Massicotte: Your testimony is very interesting. As our chair indicated, we appear not to know very much about your organization. That is why we have several questions to ask.
You have in fact combined insurance and consumer services to some degree. I am going to speak about the business side. Are your financial needs met by the members and the insurance companies? You say that the board of directors consists of members and insurance companies. However, you are there to meet the needs of consumers. To whom are you accountable? How can we be sure that consumers are well served by your organization?
[English]
Mr. Dunning: Our focus is very much on the consumer, and we are responsible to both the members and the regulators for protecting consumers. In terms of the membership, the members see us as having a vital role. Should a life insurance company become insolvent, it is important to the industry that policy holders are not seen to be poorly treated in such circumstances. Our protection helps the industry maintain its reputation for fair dealing with policy holders and for living up to its promises.
In terms of our reporting to the regulators, we have a participation agreement with every territorial and provincial government and with the federal government. Under that agreement, we promise to protect consumers. We have open dialogue with both the members and the regulators on the development of the plan. In particular, we meet at least annually with the Canadian Council of Insurance Regulators, CCIR, to exchange views on specific and philosophical issues about the development of the plan to protect policy holders.
[Translation]
Senator Massicotte: In insurance policies, there are often grey areas. I understand that you represent consumers and that your members want to maintain their image. Your bosses are nevertheless those who have to pay the costs of losses and damages. Are insured people the top priority or do you have to begin by pleasing the insurance companies? Let's not forget that the insurance companies have to bear the consequences of overly high benefits paid to consumers.
[English]
Mr. Dunning: My experience has been such that within the life insurance industry the benefits tend to be much clearer for policy holders. My dealings with policy holders in evaluating their claims has been during the three insolvencies. CompCorp took a very active interest in ensuring that policy holders, whose benefits were in pay or policies matured or had a death benefit to be paid, were paid fairly. We were heavily involved as a management group with the liquidator to ensure that those policy holders were paid fairly and that payments continued without interruption.
We have a proud record on the insolvencies with very few consumer complaints. When we have an insolvency, CompCorp sets up hotlines for consumers. In 1994, at the height of the crisis of those three companies, we received 15,000 phone call per year from consumers. That number is down to about 500 calls per year because the concern has lessened.
We set up a hardship committee for any consumers who believed they were not being dealt with fairly by the liquidator during the transfer of policies to a solvent company. We heard directly on those. The number of consumer complaints that we received throughout the process was exceedingly small.
[Translation]
Senator Massicotte: Does a company have to be a member of your organization to be entitled to sell life insurance in Canada?
[English]
Mr. Dunning: Yes. The regulators are responsible for approving the companies who can sell in their jurisdiction. As part of that process, they require a company to become a member of CompCorp.
[Translation]
Senator Massicotte: Is there someone in your organization who can refuse?
[English]
Mr. Dunning: No. Under our agreement with the regulators, as part of the approval to sell the business, each one has to prove that it is a member of CompCorp.
[Translation]
Senator Massicotte: My concern is when the amount of the insurance is too high. A Canadian who wants to buy a financial product looks for the best premium. He or she is not interested in knowing whether the company is solvent, because the protection is 85 per cent. Consequently, the only competition is at the service provider's level. The consumer is not concerned about profitability. So don't we have here a problem of moral hazard?
[English]
Mr. Dunning: Those questions of the moral hazard and the ultimate protection of consumers are very much on the minds of the industry, CompCorp management and the regulators in setting up our protection.
Last year, we did go through a review of our protection, because life insurance policies have been growing. With things such as disability income, the payout amounts have been growing. The scheme has been in force for almost 15 years. Therefore, we looked at increasing, for instance, our monthly income. The base level is $2,000 a month, and that is 100 per cent guaranteed by us. We looked at whether we should be increasing that 100 per cent level, or whether we should be introducing proportional coverage over that amount. The feeling was, through that task force and through the subsequent discussion with the regulators, that the advantage of the proportional coverage for the high percentage amounts is that you are giving some responsibility to the consumers in the selection of the product, because they are not 100 per cent guaranteed; they have to think about that. At the same time, should a financial institution become insolvent, they are guaranteed that they will not have a devastating loss of the benefits that they were promised.
Senator Angus: I was looking at your annual report for 2003, where you referred to the pressure on a number of life insurance companies and other international organizations to adopt common accounting standards in terms of competing for available capital and so on. I understand that there is quite a move to harmonize the accounting standards. Canada has one set, then there is the U.S. and then there are the international standards. We are hearing about this in many different domains, in terms of our work in this committee. You seem to have highlighted it in your report and I believe, as Canada is forced to change its requirements in this area, this will affect the risk detection in terms of insolvency methods or, indeed, effectiveness.
Could you comment on that, and perhaps pinpoint for us the principal changes that you foresee will take place in these standards in Canada?
Mr. Dunning: As you mentioned, there is a general move to international accounting standards as capital markets go more international. Why it is highlighted in that annual report you are referring to is that, within life insurance, this is particularly acute because accounting for life insurance is very different in different jurisdictions. It is certainly more different than in any other industry that I know of. There are the pressures to harmonize in that sphere.
Canada is fortunate in having probably the most sophisticated accounting for life insurance in the world. We are somewhat out in the lead on that. The challenge will be, as the international standards come forward, to figure out how we will harmonize the accounting for life insurance.
When you look at life insurance companies as well, there are two sides to the quesiton. There is the asset side, which is being influenced by the changes to fair value that are coming down for all financial institutions, including banks. Then the other side is how you value the policies, which is the trickiest thing to do — the actuarial side and how you account for that. We will need to harmonize our actuarial valuation standards and our accounting standards to the international standards. As in a lot of these cases, we are looking at both Europe and the United States. For Canada, it would be nice if Europe and the United States would go to the same common standard. That does not look likely at the moment on the life side; and so, how will Canada respond to that situation?
Those are some of the changes on the accounting side. From ComCorp's perspective, we are interested in two things. If you change the basis of accounting, you change the way information is disclosed. A lot of our bread-and- butter work deals with doing ratios and looking for risk by analyzing financial statements. If you change the fundamental accounting, that changes what you are looking for and what financial statements show. That is one area of interest.
Another, more vital area of interest is how you measure, for a life insurance company, how much is adequate capital. For us, capital is the thing that matters most. We do not become concerned with a high-risk organization if they are putting their own capital at stake, but when an organization is putting policy holder money at stake through high risk, we become concerned, and regulatory capital is a measure of that.
At the moment in Canada, with a combination of the sophisticated actuarial evaluation we have — the good accounting rules — plus what is called MCCSR, the capital rules for life insurance companies, we are well served. However, as the accounting rules change, we need to change the capital rules.
The Chairman: Mr. Dunning, that just means what — optimum capital?
Mr. Dunning: No; from a ComCorp perspective, we would like to see optimum capital. When we analyze companies for risk, we like to see profitability, because a profitable company will not land in our court. As you know, several of our larger members are very active internationally; it is very important that they stay competitive internationally. If we have Canadian standards of capital that are too tight for them, we will throttle their competitiveness internationally; and again, we would see that as a risk. From a ComCorp point of view, we advocate strongly for the right level of capital and a clear level of capital.
On the bank side, we do BASEL 2; and we have seen that trickle down into the Canadian system. We are following that very closely. I would like to emphasize here that ComCorp is an interested participant in this process. However, we do not control the process or set the rules. The regulators set the rules. The main federal regulator whom we deal with is OSFI, and we have a very good relationship with OSFI. As recently as last week, we had a meeting looking at some of the longer-range views on how the actuarial profession can respond in doing research, and what the regulators long-term views are for capital standards in Canada.
Senator Angus: To put a practical face on it, this is quite complex stuff, obviously, and recently we have seen one of our big flagship life insurance companies, Manulife, acquire a big American one, John Hancock. That was all over the newspapers. We know that the U.S. standards are different from the Canadians ones. By using this practical example, can you indicate how we harmonize and deal with a situation like that so that the policy holders of Manulife are reassured that their risk is not greater now that this big American company, where the standards are looser, has watered the stock, as it were?
Mr. Dunning: As a matter of policy, we never comment on an individual member company under confidentiality rules. Second, Mr. LePan is the first person you should ask about the capital standards and the issues, because he is front and centre. In generic terms, we do not have a concern about these developments. They are serious developments but, quite frankly, we are pleased to see our major members being successful players on the world stage. As long as that is profitable, we have no concerns on that front.
We have a lot of confidence in the Office of the Superintendent of Financial Institutions to deal with those issues. We have quarterly meetings between our board and the OSFI representatives, and Mr. LePan comes to our board once a year. That would be the type of discussion that goes on between the Superintendent and our board in terms of some of these major developments with major players; and how, from a regulatory point of view, he is ensuring that Canadian policy holders are being well served and well protected. That is our major focus, and the question that we asked the Superintendent is the very question you asked: With a major development, how can you reassure us that this is still positive for Canadian policy holders?
Senator Angus: Will this move to harmonization address this kind of issue?
Mr. Dunning: Yes, if we can achieve it.
Senator Angus: If you can achieve it.
Mr. Dunning: It is a worthwhile goal from our point of view to ensure that we have the right level of capital standards for our purposes and for the competitive position. I would be tempted to start on the ideas we have on that but that is too technical.
The Chairman: We do not limit your thought processes here. Senator Angus is raising an important question. We are concerned with consumer protection but we are also concerned with international competitiveness for our financial institutions. He has raised an appropriate question dealing with capital and the appropriateness of our regulation. While we want to protect the consumer, we do not want to inhibit growth if it is safe and good growth. That is the basis of his question, so please do not restrain yourself. If you have ideas that you think would be useful for our purposes, we would like to hear from you in writing on that.
Senator Angus: If you have some thoughts just along these lines, we would like to hear them. This subject comes up for us in areas other than this. In terms of prudential issues, I am concerned myself.
The Chairman: It is a question that we will be looking at in terms of productivity and competitiveness, so it is relevant to our deliberations. Please, give us your ideas on that.
[Translation]
Senator Plamondon: After the McKay Report, recommendations were made to the insurance companies about how they should draft clear contracts. Their previous contracts used hermetic and particularly difficult to understand language. If there were a class action suit against an insurance company and it threatened the solvency, or made it likely that an insurance company would become insolvent, would the Office of the Superintendent of Financial Institutions advise you that the company was being placed under supervision or whether it would simply be requesting more frequent reports than usual? Would you be advised of such a situation, or would you be surprised and simply learn about it from the newspapers like everyone else.
[English]
Mr. Dunning: You refer to class action lawsuits, and they form part of a category of risk which we refer to as optional risk. They are a very serious risk to the financial services industry worldwide. We have seen losses on that. Any company which is subject to that, we do have our own detection process and we hope that we would be aware of that. In fact, yes, in answer to your question, both with the AMF in Quebec and with the OSFI officials, we meet with them regularly and we do share the confidential information about insolvency risk to individual companies on a quarterly basis. In order to protect consumers, what is vital is that we act early. If there is one lesson we learned from the 1990s, it is that we protect policy holders the best by getting in as soon as there is a problem, as soon as the company can no longer ensure that the policy holder will be looked after. That is the time to intervene.
In 1996, the Office of the Superintendent of Financial Institutions did change its focus to more early intervention. We have a protocol agreement with them which says as a company gets into trouble, what is their role and what is our role, as the situation deteriorates. That can be simply stated as: it is the regulator's job to work with the company to correct the problem, and it is our job to start doing the contingency in case they cannot fix the problem so that we can step in at the right time to protect the policy holder.
[Translation]
Senator Plamondon: With respect to compensation, do you know if some consumers who were eligible for compensation did not receive it because they were unfamiliar with your organization?
[English]
Mr. Dunning: Yes, when the institutions fail, one of the first things that policy holders ask themselves is ``What will happen to my benefits?'' Up until that point, most policy holders would not be aware of our existence. That is why we know that and we get out very quickly. First, in the media but, more important, we work with the liquidator to get a letter out to policy holders saying exactly what does this insolvency mean to them. Reading a newspaper article about, in general, CompCorp exists is important, but what they really want to know is what does it mean to my policy benefits. We work hard in the early days of the liquidation to deal with that.
[Translation]
Senator Plamondon: Have there been any cases in which people who received a letter did not request compensation for one reason or another
[English]
Mr. Dunning: I do not know of instances of that.
Senator Kelleher: If I may follow up in an area delved into by Senator Massicotte, I am just wondering, very simply and briefly, how do I become a member of your organization?
Mr. Dunning: First of all, you have to be a life insurance company. When you apply for a licence to sell business in Canada, whichever provincial jurisdiction you want to sell business in will tell you that you must become a member of ComCorp. If you become federally incorporated, the federal regulator will tell you that you must become a member of ComCorp. They then write to us. It is a chicken-and-egg situation in that we say anyone who is authorized to sell business is eligible to become a member; the provinces say that you must be a member in order to sell business. As soon as they are authorized to sell business, it is automatic to become a member of ComCorp. They do have to sign a contractual agreement with us.
Senator Kelleher: I am assuming that I am a life insurance company, licensed to practice. Is it possible that I could, for some reason, be disqualified?
Mr. Dunning: No, not by ComCorp. If a regulator has said a life insurance company is fit to operate, that is the only requirement we have for them to be a member. Equally important, we cannot discontinue membership of a member company. Only the regulator can step in and close a company down. While they are selling business, we have to keep them as a member. The trigger for both entry and exit is with the regulators, not with us.
Senator Kelleher: If I have a policy personally with a company that has become insolvent and you have arranged that that policy be transferred to a new company — when that happens is there any change in the premium that I have to pay?
Mr. Dunning: No, the policy would be continued. If it is 100 per cent protected by us, the policy premiums and all the policy terms will stay exactly the same as they were with the previous company. If there is a reduction, if it is one of the larger policies and was reduced down to the 85 per cent level, your premiums would be reduced by 85 per cent because you only have 85 per cent of the continuing benefits.
The Chairman: By 15 per cent.
Senator Kelleher: By 15 per cent.
The Chairman: We are awake, Mr. Dunning. We are listening carefully to your numbers. Senator Plamondon has a short and final question for you.
[Translation]
Senator Plamondon: What are the problems that threaten insurance companies at the moment
[English]
Mr. Dunning: We are, in fact, in a very fortunate period where the financial health of the life insurance sector is very strong. We do monitor for systemic risks and there are no particular ones. The operational risk has become much more of a factor worldwide. Companies are not required at the moment to hold capital for operational risk partly because it is difficult to measure. That is one thing that we do look at.
Will there come a time when the economy turns down and we will have more risks emerge again? I am sure that they will, and that is when we will become operational again.
[Translation]
Senator Plamondon: Would you agree to have consumers notified when an insurance company was being supervised? Your agency is a federation of insurance companies, and you are for that reason aware of everything that affects this sector. However, the consumer does not know whether his insurance company is suddenly at risk.
[English]
Mr. Dunning: This is a very difficult area because, although many are in favour of full disclosure to a consumer, you cannot disclose that a company is in trouble until you are really ready to close it down. If you just say that a company is in trouble, that will be sufficient to close the institution down.
When I mentioned earlier that there are a number of companies, and issues in companies, that we were concerned with and the regulators are concerned with, the key thing is that the regulator deals with those issues before they are at a level where policy holders should be concerned. The very difficult job that the regulator has is to know when to intervene. The correct time to intervene is when there is still sufficient money there for the policy holders, but it is really after there is insufficient capital but still enough assets to cover the liabilities. That is the ideal time to intervene. Doing it right is an art and not a science and we have a lot of respect both for the officials in the AMF and the officials of OSFI who are charged with that task.
Senator Plamondon: The consumers are the last to know.
The Chairman: What we have heard is from OSFI and others about the early warning system, so the evidence is interesting.
I have one question. It relates back to your final statement and to the same discussion that we had with the Canadian Deposit Insurance Corporation. I think the $60,000 is as much a term of art as it is a term of science. Am I correct in saying that that was established some 14 or 15 years ago when your corporation was first established? We had that same period with respect to the coverage for the Canadian Deposit Insurance Corporation of $60,000. It is a question for us, from a consumer protection standpoint, as to whether or not we would consider increasing that coverage from $60,000 to $100,000. That was among a number of issued that we discussed with CDIC and we asked them to give us a cost benefit analysis of recommending an increase of that amout.
Could you give us, briefly, the benefit of your views on that? If you want to take a longer period of time to get us a mathematical equation, we can look at that as well. This is an issue for consumers, of the level of protection, and you have done a great job in protecting consumers at the levels you state in your documents. However, it is now 14 years later, and we are an oversight committee. Is this the appropriate level of protection, keeping in mind the inflationary impact of that level over the last 14 years?
Mr. Dunning: I have no official comment from the organization on increasing the $60,000, but last year we did look at increasing the levels on all our benefits. We decided not to increase any of the levels but, rather, introduce the 85 per cent coverage on amounts in excess of that amount. The industry in a task force also considered that same approach to the $60,000 and the cash values, so it considered guaranteeing 100 per cent on 60, and 85 per cent on larger amounts. I think that was the favoured viewpoint.
If we felt that an increase in consumer protection was required, that approach would be favoured by our industry. There are two reasons why we did not go with that: one of them is that we think it is very important that many of the products which are covered by the $60,000 in our industry are very similar to those of the deposit-taking institutions. From a consumer point of view, it makes sense if we move in harmony on those and not have different coverage on the different levels.
The Chairman: If, in fact, CDIC is convinced, or we have become convinced. based on very careful analysis of the evidence, that we would recommend an increase, this would be something that you would need to consider because it is appropriate for the consumer to have a clear understanding of what the monies available them would be, whether it is a banking question or an insurance question. In that sense, it is a term of art and not a term of science.
Mr. Dunning: What we would like to see happen is that our industry would be involved with the deposit-taking industry, ComCorp involved with CDIC, in joint discussions about what would be good in terms of the consumer, in terms of changes.
The Chairman: I do not want to speak for this committee, but please start your discussions. I welcome your evidence; it has been very helpful and very useful. It is one of these items in our economy that people are not aware of and your work is a very valuable and important part of consumer protection in this area. We thank you for your work and diligence.
The committee continued, in camera.