On several occasions during his career as an actuary, Claude Garcia sounded the alarm about capital problems in segregated funds. In 2012, it must be acknowledged that the strict rules governing this area have ensured the health of the Canadian insurance industry. But this does not prevent one from being alarmed by the current challenges.

President at Standard Life Canada between 1983 and 2004, Mr. Garcia is also known for the commentaries he writes for the Montreal Economic Institute (MEI), particularly on the government’s role in the economy. In 1996, he launched a bitter attack on what threatened to “become the scourge of the next decade”: segregated funds.

Poor market returns

In a recent interview with The Insurance and Investment Journal he said that too many insurers had underestimated the negative impact of poor market returns combined with a long period of very low interest rates; even lower than in the 1930s. Combined with a sluggish stock market, this situation weighs heavily on insurers’ liabilities.

In Mr. Garcia’s opinion, there is a clear need to strengthen the rules dealing with the capitalization of segregated funds because of the stock market’s poor performance since 2000. “I remember seeing an article where it was said that, over a period of 10 years, the dividend yield of segregated funds had always been positive. The authors had forgotten to look at what had happened before the Second World War. If you look at what happened in 1929, the New York Stock Exchange fell by 91% between its peak in 1929 and the bottom in 1932. And it took 25 years to return to 1929 levels,” he comments.
At the height of the Internet bubble in 2000, the Nasdaq index reached about 5200 points. Twelve years later, it sunk to the 2800 points, a drop of nearly 50%. “People in the industry sold products where they guaranteed the performance of the Nasdaq over 10 years. That must have cost them quite a bit.”

Mr. Garcia notes, however, that Canada’s regulatory system is very effective and requires insurers to comply with capitalization rules, and this protects customers.

“This proves that the Canadian system works. And capitalization rules are made in such a way that, even if you make a call for capital, you are always very solvent. If the insurer, for one reason or another, is not able to raise capital, there is cause for concern. The fact that it is able to do so demonstrates that the regulator is doing its job. For shareholders, it is certainly not so appealing.”

Coming through the crisis

Canadian insurers have experienced difficulties, says Mr. Garcia, but they are coming through the crisis, which is good news. After years of poor returns, he says that financial institutions’ newer customers will end up paying more to bring things back to normal.

Nevertheless, Mr. Garcia says he is very concerned about the economic crisis in Europe and its impact on both financial markets and insurers’ results. “Financial institutions are based on trust. We must never forget that our raw material is public money and customers. When people lend us their money, they want to be certain that they will get it back when they need it later on.”

He attributes a large part of Europe’s problems to the implementation of the euro. According to Mr. Garcia, its creation has had the effect of lowering interest rates in countries where inflation was high, including Spain and Italy.

“This facilitated the acquisition of real estate in these countries. Today, however, 7% of the mortgages held by Spanish banks are non-performing, which is considerable. The housing bubble resulted from the creation of the single currency, but it has left the Spaniards with the problem, instead of spreading it across the EU.” It is therefore important to create a federal banking system quickly in order to prevent the breakup of the euro zone, he says.

Mr. Garcia points out that at the worst point of the financial crisis in 2008, people did not tell New York State to only help the banks on Wall Street. “All of the U.S. federal government’s resources have been involved in supporting the Wall Street banks,” he says.

If nothing is done, he warns that investors will withdraw their deposits from financial institutions. “No bank can withstand a prolonged period of massive withdrawals. Depository institutions must hold a certain amount of cash savings, but there is a limit, because if everything is liquid, you cannot be competitive with the rates that you offer to savers,” he comments.

In Canada, Mr. Garcia says he is opposed to any change that would allow banks to offer insurance in branches or online. “Banks will not give up so easily on selling insurance in branches,” he says. “Today, you have to look at how they use mortgages to gain clients, along with other products.”

Banks do not woo customers with insurance premiums but with mortgage rates, he adds. The margins are very good for the banks when they sell insurance…The current legislation does not prevent Canadian banks from doing good business, he says.