[Recorded by Electronic Apparatus]

Tuesday, August 15, 1995

.1303

[English]

The Chair: Order.

Our first witness this afternoon is from the Canadian Bond Rating Service: Brian Neysmith, president, along with Maria Berlettano, manager, financial services group.

We look forward to your presentation. Thank you for being with us.

Mr. Brian Neysmith (President, Canadian Bond Rating Service): Thank you very much, Mr. Chairman. I would like to express our gratitude for being given the opportunity to address the committee today on the various issues in Bill C-100.

I would like to begin by giving a little bit of background to the Canadian Bond Rating Service so you can put our remarks in a certain frame of mind.

The Canadian Bond Rating Service was founded by me in 1972. Canada has the distinction of having established the first bond rating service in the world outside of the U.S. services.

Over the years we have been instrumental in either a direct advisory role or a consultative role in the establishing of rating services throughout the rest of the world. Today we rate some 300 Canadian corporations and about 120 governments - municipal and provincial - and various crown corporations. We have 24 analysts on staff and all our publications are read and taken by over 2,000 investment professionals throughout Canada.

We have access through our Bloomberg and Reuters services to about 270,000 terminals throughout the world. All of these terminals directly address the whole issue of what essentially is going on in Canada.

The interesting thing from this committee's point of view is that the role of the ratings has changed materially over the years. When we first started the service about 24 years ago, we essentially supplied our information to the institutional market. That was pension funds, life insurance companies, banks, trust companies - anybody who was responsible for institutional money management. Today the major effort of our service is at the retail level.

Today not only do the institutions continue to take our services, but we are seen by most of the retail investors throughout Canada as their sort of arm for the judgment of credit quality. As a result, we are very much a public rating service today, as opposed to a private consultative financial analysis group, as we started. This has changed, in a sense, the emphasis and the way in which we do a lot of our analysis, and also how we initiate it or we aim it at the end investor.

For a rating service really to be credible, it has to base most of its analysis on what it believes to be highly qualitative information and information that is given on a very timely basis.

From our point of view, a lot of the thrust that has been taken in Bill C-100 essentially fosters a far greater amount of information flowing from financial institutions.

I would like to contrast this to a lot of the utility and industrial companies we cover and say that, by and large, the financial disclosure of non-financial companies over the years has been fairly extensive.

One only has to participate in a CRTC hearing or an NEB hearing that the various utilities have to go before in order to realize the type and the extent of financial information that is required by these corporations. All of it, of course, is set out in the public eye.

For many years financial institutions resisted significant disclosure of financial information. When we first started to rate the Canadian banks some 18 years ago, most of them were sort of miffed by the idea that anybody would attempt to opine on the credit quality of the Canadian chartered banks. Today there are still a lot of companies in the smaller trust company and the life insurance company areas that resist the idea of giving extensive financial disclosure.

I can say that the Canadian chartered banks as a group, especially the big six, probably bend over backwards and are probably the best examples we have today of extensive financial disclosure.

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This is very important to us because the quality and the extent of our ratings are directly related to the amount of information we get. It is possible for a rating service not to have 100% information on any particular subject. In other words, we can do a rating on less than a perfect set of information. However, in most of these cases the rating is discounted for the fact that, in our view, not every box has been filled. So a lot of the thrust of the information disclosure that is set out in the bill would go a long way toward basically redressing what we have thought has been for many years an imbalance between the type of disclosure that is required by other regulated entities, essentially in the utility area, and that which has been regulated in the financial area.

The other thing that rating services have to be very careful about is that we are very sensitive in the rating of financial institutions to not creating the thing we fear the most about any financial institutions in the sense that we have a run on deposits. As a result, whether it is ourselves or Moody's or Standard & Poor's, we generally go to some great length to give a financial institution a reasonable degree of leeway in coming to grips with the problem, whereas in most of the industrial companies or utility companies, because they would not normally deteriorate as quickly as a financial institution would, you can adjust the ratings more gradually.

So the additional roles that you propose for either OSFI or CDIC in early intervention into a potential problem in the financial institutions are in our view highly desirable, because for anybody who owns a bond or a deposit in a financial institution that is experiencing a fair degree of financial difficulty, the last thing you ever want - and nobody ever wins - is a situation in which the financial institution declares bankruptcy. There are no winners even in predicting a financial institution that goes down the tube.

So from our point of view, we like to see early intervention into any financial institution that may be experiencing problems. So we are very strongly in favour of a lot of the bill that deals with those two points, at both the OSFI and the CDIC levels.

The other thing that is probably interesting is that over the past 24 years we've had a number of financial institutions that have gone into financial difficulty. When we do post-mortems, as we do on every company that gets into a problem, and we ask ourselves what we could have done better, what we could have seen earlier, what in a sense we actually missed, in a lot of cases when we come down to do the final study on these organizations, we find that the financial information that was given to us initially about the financial condition of the company was either outright erroneous or was slanted in some way to give a far better picture of the financial institution's health than what in fact it was.

We are also very aware that where we look at the audited financial statements one full year before the institution went into difficulty, very often there is either no information or very little indication that the institution was experiencing a severe crisis someplace within the organization. Therefore the enhanced disclosure requirements you are proposing in this bill would go a long way toward being able to get into an organization, at least look at some of the supplementary financial data, and try to get a clue as to exactly what that information or where that company is actually going.

By their nature, rating services have certain handicaps. We have no legislative power. We are not auditors. We are not lawyers. All our analysis is derived from the interpretation of what we believe to be the facts about a particular company's situation. As a result, we are completely dependent on financial disclosure.

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There is another point in the article that I want to bring to the committee's attention.

A lot has been made of CDIC and OSFI monitoring the role or the activities of financial institutions. From very long experience we know that in some cases there is very little you can do to prevent bad loans from being put on the books or an inappropriate investment strategy, but we also know that for all the financial institutions that have had a very broad base of asset classifications - in other words, they are very well diversified - this is probably the best protection against any kind of financial difficulty that any financial institution can take on.

When you look at the asset structure of the balance-sheet of most of the institutions that have got into a problem, you find that they were very heavily invested in or had loans to one category or one industry or one geographic location. When that particular industry or area went into difficulty, the institution had absolutely no way to shield itself against the magnitude of the hit it would take.

The institutions that have normally kept extensive asset diversification by industry type and by geographic and asset class have normally lived to fight another day.

Because most financial institutions operate on a very highly leveraged basis, generally 15:1 or 20:1 as a debt-to-equity ratio, there is very little scope for any major error in any institution.

If you have a significant part of your assets wrapped up in one area and it gets into difficulty, generally you do not have any equity left.

That brings me into my third point to make on this issue, that we would certainly like to see within the financial institutions the ability to raise true equity capital. I mean true equity capital, not the quasi-equity capital that a lot of them sometimes raise. This is because in the end it is only the equity capital of a financial institution that basically is the shock absorber against taking various types of financial loss.

I know there has been a proposal in this document that CDIC should develop risk premium-setting based on the capital adequacy of the various corporations, and we strongly recommend this. It is done in a number of other areas throughout the world and from our point of view would be a very strong reinforcement of any type of financial institution.

Mr. Chairman, I have run through this at a breakneck speed to stay within my 10-minute limitation. We have my remarks spelled out in a document that we have left with the clerk.

At this time we shall be happy to entertain any questions on either the areas we have talked on or any area ancillary to this.

The Chair: Thank you very much, Mr. Neysmith.

[Translation]

Mr. Loubier, you don't have any more questions?

[English]

Mrs. Stewart.

Mrs. Stewart (Brant): I will comment on one of your remarks at the outset and then ask a question.

We are constantly being hit, particularly by our colleagues in the Reform Party, with the need for government to get out of the face of business - that the market economy can manage itself quite effectively, thank you very much. As you talk about the lack of information provided to you in disclosure, it seems to me that in this area government plays a key role in making sure the marketplace works effectively and efficiently. Is that what you are asking for here?

Mr. Neysmith: I think that is correct. The marketplace might not be perfect in an overall analysis, but it certainly is a very effective means of screening and digesting financial information. The government's role, especially from the regulatory point of view, where it can insist on institutions in a sense baring their souls, would be a tremendous advantage.

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If the government provides deposit insurance, then basically the retail investor doesn't particularly care about which institution he is lending the money to. He will generally lend the money where he gets the highest rate, and as long as the door has the red and white CDIC sticker, he will not do any type of analysis.

If it was an institution that relied on what we would call wholesale money or large volumes of money from other institutional accounts, then they would have to conduct themselves in a very different manner with regard to the disclosure of financial information.

Because the government has instituted CDIC and the deposit insurance, a lot of financial institutions, particularly smaller ones, would simply say to a retail account either, ``We're a private company'', or, ``What are you worried about? All you've got to make sure of is that you don't go over the $60,000. What do you care as to what we do with the money or what our balance-sheet actually looks like?''

By having the CDIC type of insurance, the government sometimes sets up the opposite reaction, where an institution can say, ``It's not necessary for us to divulge financial information.''

From our point of view - and we do the credit ratings - the thing that has changed in the last 15 to 20 years is the whole area of wealth management, wherein now individuals generally have considerable amounts of money in excess of the $60,000 limit. They now are more concerned about the potential for having over $60,000 with one particular institution, so they ask how safe their deposits are.

Mrs. Stewart: I am assuming you charge for your services. I look at your documentation and see your request to make the information gathered by surveys conducted by OSFI and other governmental agencies available to you. Is that something you are willing to pay for?

Mr. Neysmith: We have a very large budget that we spend. I believe we spend about $50,000 a year in gathering information from publications, all types of sources. Information is our key input into our business, so we have always paid for it.

Mrs. Stewart: Should you pay for it from the government?

Mr. Neysmith: I see no reason why we shouldn't. We make you pay for our services, so why not the other way around?

Mrs. Stewart: Precisely. Thank you.

Ms Maria T. Berlettano (Manager, Financial Services Group, Canadian Bond Rating Service): I would like to add to that. Currently we subscribe to OSFI's electronic service, Ivation. The Canada Gazette is also something to which we subscribe. So we are willing to pay for information if it is useful for our purposes.

The Chair: I am sure you spend a lot of time reading the Canada Gazette, just as we all do.

Mrs. Stewart: Looking for appointments.

Ms Berlettano: It is very interesting - good bed reading.

The Chair: It is certainly one of my favourite publications.

Mr. Walker (Winnipeg North Centre): Am I to read from your submission that financial institutions regularly turn down your requests for information?

Mr. Neysmith: Not regularly. Financial institutions will give us what is publicly available.

Our complaints are, one, that what is publicly available in some cases is very much untimely, and two, what is publicly available in the case of a financial institution is sometimes not sufficient to do a complete due diligence on that organization. They will certainly give us what they publish, but if they can withhold, a lot of them do. They simply say, ``This is privileged information. We are not required. Therefore you will not get the information.''

In most of those cases we cannot do a full due diligence, so we don't rate.

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Mr. Walker: Do you ever report these turndowns as part of your report?

Mr. Neysmith: No, we don't report them, because simply we don't cover the company. From our point of view, the 420 borrowers we cover are our stable that we recommend people should look at from an investment viewpoint. If there are 10 or 15 or 20 companies that we don't report on, it is not always because we don't have financial information. Sometimes we may simply find that the organization is so high-risk that it is inappropriate to be in the public domain as far as investments are concerned. There can be dual reasons why we wouldn't cover a particular company.

Mr. Walker: I am struck by this issue, because the request that you obviously are making to us, although I am not sure it is explicit, is that we somehow or another should legislate more public filings of these companies. This is what my colleague was suggesting to us. I am not exactly sure why corporations who seek public approval and public support from consumers don't report at great length. Your comments on this would be appreciated.

I was reading in The New York Times on Sunday that one of the major American companies, Fidelity, is a $22 billion fund. They outlined all their major investments, their percentages of investments, the specific companies they were investing in, how much of their portfolio was in them. I was struck by the fact that you don't very often see that written up in Canada.

Is there something in the corporate culture here on which you'd like to elaborate regarding what is available publicly? Do you think it's the responsibility of the federal government to legislate reporting procedures?

Mr. Neysmith: The Canadian financial markets came late to the conclusion that information should be free and accessible by everybody. The United States has a slightly different culture. There you cannot issue a security of any type whatsoever unless it carries at least two ratings. In Canada that is still possible, simply because a lot of the mechanisms within the Canadian financial community will still allow that to happen.

So a lot of companies today feel they're their own best judge of how good they are. This is slowly changing. At one time the Canadian banks were quite reluctant to divulge. If with all trust and all life insurance companies we had the same type of disclosure as the major Canadian chartered banks have, then we wouldn't be here today. We'd be very happy.

The market is slowly coming to that. It is not there yet. We would certainly like and we would certainly support any attempt by any organization or any government that would foster or increase that.

This will not, by itself, stop failure. There will still be companies that will fail, no matter how much information there is. But it will probably bring greater scrutiny to the companies that are not the largest ones, not major ones, but the next tier of companies that have very good credit quality by themselves except that they are not household names. Today, in one way or another, they will simply say this is not required, so they will not do it.

It takes time for people to get into the mode of, in a sense, opening their soul to anybody who comes to the door claiming to be an analyst representing some constituency and wanting to know the information.

Mr. Walker: Are you suggesting we should consider amendments to Bill C-100 to provide for better information to the public?

Mr. Neysmith: As I understand it, today you have the possibility, if the Superintendent of Financial Institutions so desires, to force - maybe ``force'' is the wrong word - to ask companies to comply with a substantial increase in financial information that maybe the superintendent has today but is not given out to the public. We want more information. We would like more information to be given out to the public.

Maria mentioned Ivation. If you go through their financial data, a lot of information is suppressed. Some of it is not necessarily germane to our analysis, but we don't know that. As financial analysts, we are basically scrounging for every piece of data we can possibly get and we will make a determination as to whether it's germane to our analysis or it's not.

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The rule in the rating world is that if you can't get a piece of information, you must assume it is negative. Even though it may be very positive if we knew it, you must assume that information is negative and the rating has to reflect that accordingly. We do not always like to do that, but we feel that what you have put forward here would go a long way.

Ms Berlettano: I would like to address that question about whether CBRS feels that legislation of additional disclosure requirements is important. CBRS is of the opinion that it is in the national public interest that Canada's financial system should be stable, that there should be no disruptions, in order to ensure that in going forward Canada is a strong player in the financial services industry, which is becoming a very global one.

The marketplace in the capital markets - that's both the money markets and the long-term capital markets - has established the discipline that if a financial institution wants to participate in the capital markets, it has to acquire a rating. In the United States the requirement is that there have to be at least two ratings by two independent rating services. In Canada, more often than not, only one rating is acceptable to investors.

Institutional investors have the clout and the power to demand that an institution be rated if it wants to access the capital markets. On the other hand, retail investors, simple depositors like my grandmother or your mother or father, unfortunately don't have that clout. Because the Government of Canada has taken it upon itself to consider the interests of the retail public, it has introduced what we call deposit insurance. I guess that by introducing CDIC the government is representing the retail investor.

As we all know, CDIC has had the problem of having to deal with quite a number of financial failures over the last decade. Tables in some of the policy papers that have been put forward have indicated that it might be in the best interests of CDIC to educate not only the institutional investing public but also the retail investing public about the different risks that are out there in investing possibilities for the retail investor.

The rating agency plays an important role in sensitizing and educating the retail investment community about the different calibres of financial institutions that are out there, about the choices that can be made.

CDIC gets a lot of information, as does OSFI, but it does not have the mandate and it is not appropriate for CDIC nor OSFI to educate or provide a rating to the investment public. Rating services have the ability to do so. We feel that if additional disclosure were to be legislated, then it would go to great lengths in providing rating services with information that they could use to classify institutions according to different risk categories, which can then be used by the retailing public, who would make informed choices about their investments and perhaps would rely less on the comfort and security provided by CDIC.

The Chair: Do you rate any Canadian companies whose ratings are affected by the forthcoming referendum in Quebec?

Ms Berlettano: We currently carry ratings on the National Bank of Canada. We carry ratings on Laurentian Bank of Canada. We carry ratings on la Société Générale, which has a large business operation in Quebec.

The Chair: Do you think the referendum has an impact on a company's rating?

Ms Berlettano: Yes. The National Bank of Canada - and this information is available in our latest report on the National Bank - are a chartered bank and they represent themselves as a national one. Over the past five years they have tried to diversify their operations to expand outside of Quebec to the United States and Ontario. Just last year, their U.S.-based operations, which represent probably about 10% of overall assets, have become profitable. In Ontario they have 30 or so branches; currently they are not making a positive contribution to National Bank's profitability.

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We feel that National Bank's earnings are very dependent on their Quebec-based operations. We've made that point in our investment research report, and that information is publicly available to our subscribers. That of course is a major consideration in their rating, which is slightly lower than those of the other Canadian schedule I domestic banks.

[Translation]

The Chair: Mr. Loubier, I know that you would like to ask one small question.

Mr. Loubier (Saint-Hyacinthe - Bagot): No, because I don't want you to end on that note.

The Chair: I knew it.

Mr. Loubier: I know that the latest ratings that have been announced, be it here or elsewhere, have been primarily based on performance, on the efficiency of the various levels of government for example, and on their ability to control the evolution of medium-term debt.

When you look at the analyses done by Standard & Poor's Corporation or Moody's Investors Service, you see that they have taken into account the evolution of the medium-term, not that of the constitutional debate, which is perceived as an event that will have no impact on the viability of companies or the performance of governments. They tend to dwell more on the evolution of the debt or on mismanagement of public finance.

The only two rating agencies that have given importance to the constitutional debate are Dominion Bond Rating Service Limited and your service. I believe that if you are Canadian and if you have been following the referendum debate, it is obvious that your motions will play a much greater role compared to the objective evaluations handed out by the large American rating agencies. My advice is that you should pay more attention to that, because otherwise, it could hurt your credibility.

[English]

Mr. Neysmith: I participated in a panel with both Moody's and Standard & Poor's where this question was asked. Their response, in camera to a certain degree - it never really got published in the papers - was that they found it inconceivable that any Canadian province would, in a sense, break up. So from their point of view, they took the point that the referendum would be negative, in the sense that Quebec would still maintain its provincial status, and therefore would be essentially a non-event from the market point of view.

You are correct in stating that both we and DBRS have not been that categorical. We have stated that there is the possibility that Quebec can separate and that if this happens it will have a very significant impact on financial institutions, on provincial debt, even on the debt of the Canadian government.

[Translation]

Mr. Loubier: Mr. Neysmith, let me say that every time we receive information such as this, given in camera... You say that this was told to you in camera. We prefer to use information that is in the public domain.

There was a meeting of the governors of the New England State and of the premiers of Quebec and the Maritime provinces, and the governors were nearly unanimous in saying that a sovereign Quebec would continue to do business with the United States and in particular with the New England States. My answer to you is that information obtain in camera such as that which you have just relayed to us, and arguments that are not verifiable are things to which I attach no importance whatsoever.

Other public meetings come to mind as well. We met with finance ministers of other countries, envoys, etc., and these people didn't seem to be at all worried about the democratic vote that Quebec will be holding in the very near future.

I would say that the problem isn't purely a Quebec problem, it is also Canadian. When you say that Quebec has been fighting for 35 years now to hold its proper place in accordance with the agreement signed by the two founding people in 1867... Quebec isn't solely responsible for the current constitutional debate; Canadians have a responsibility too since they weren't prepared to resolve this matter once and for all. So let's do away with unilateral analyses based upon conversations held in camera and the primary objective which is to tarnish the reputation of sovereignists. Stop throwing the ball to just us, since you too, as Canadians, are also responsible for the disagreements we've had over the past 35 years.

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The Chair: Thank you, Mr. Loubier.

Mr. Loubier: Thank you.

The Chair: A few words, Mr. Neysmith.

[English]

Mr. Neysmith: Our analysis of course is not in camera. We have been very specific in our analysis of Quebec and what potentially may happen; therefore I think we've met your criteria to be open and above-board as to what we feel the conditions of the province would be should it actually separate.

What the governors of the New England states said is absolutely true. We have no objection to what they said. There is a difference between doing business in goods and services and lending money. Depending upon whether you are a lender or you're just doing goods and services, you might have particular viewpoints on that. I think that's what you would want to do.

Without turning it into a hot debate on whether we have a situation like this, from the point of view of the Canadian Bond Rating Service the thrust of this legislation - the early intervention that OSFI now potentially can have, additional financial disclosure.... All of these events, from a bond rating point of view, are very positive developments and we would certainly encourage the bill to be expeditiously passed and, of course, put into effect.

The Chair: From your point of view, the ratings will be higher. This means that the costs of borrowing will be lower and we will be more competitive and all of us will benefit from these trends.

All of us appreciate your intervention here today. It is always good for us to hear about how the private sector is going to react in terms of the credit ratings based on what we are proposing to do here to our financial institutions. Institutions that are very important to us are strong, not only within our country but also on an international basis.

On behalf of all members, I thank you for your excellent intervention here today.

Our next witness is Jack Carr, professor of economics, from the Canadian Institute for Policy Analysis, University of Toronto.

Professor Jack Carr (Canadian Institute for Policy Analysis, University of Toronto): I apologize to the committee for not having prepared notes. If I did, I wouldn't follow them anyway. It is an occupational hazard. Lecturing in the university, I tend to go off in all directions, although I'll try to concentrate on Bill C-100.

I thank the committee for inviting me here this afternoon.

Bill C-100 implements many of the measures outlined in the white paper entitled ``Enhancing the Safety and Soundness of the Canadian Financial System''. Bill C-100 essentially makes two changes to that white paper. The government has decided not to proceed with restrictions on stacking of deposits in affiliated deposit-taking institutions and it has decided to give further study to its proposal concerning the policyholder protection board.

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Both of these changes are desirable, and I commend the government for responding to concerns about these white paper proposals.

However, I personally still have basic concerns about Bill C-100. I do not believe that on balance this bill will achieve its stated goal, that it will enhance the safety and soundness of the Canadian financial system.

Bill C-100 proposes that premiums charged to members of CDIC be risk-rated. It suggests modest increases in the disclosure of data obtained by OSFI and makes both the general mandate of OSFI and its powers of intervention in weak institutions more explicit.

However, it represents a rejection of calls for fundamental reform to regulation and consumer protection in the Canadian financial sector.

It fails to endorse some form of co-insurance or other means of providing incentives for monitoring and market discipline by depositors and policyholders.

It asserts that because the existing regulatory system is appropriate in the Canadian context and fundamentally sound, it need only be fine-tuned. I am going to argue that the current Canadian system is not fundamentally sound.

In practice, fine-tuning means providing the regulators with more power, specifying more precisely the criteria for regulatory intervention and hiring more regulators.

I believe the problems of the Canadian financial system have to a significant extent been created by excessive emphasis on public regulation and consumer protection schemes that remove market discipline from retail financial institutions. Increasing the scope and intensity of regulation in the ways proposed in Bill C-100 is unlikely to solve the problem.

Let me temporarily digress from the specifics of Bill C-100 and give a summary of the last 70 or 80 years of Canadian financial history - very briefly, given the time allotted.

My main message is that prior to 1967, prior to the introduction of Canadian deposit insurance, the Canadian financial system worked well. I think it was the envy of the rest of the world.

When I lecture at the University of Toronto and tell my students that there was a world before deposit insurance, they can't believe it. Most of them were born since 1967, and they can't believe that a financial system could have been run without deposit insurance and that deposit insurance is a relatively recent innovation, that it came into being only in 1967.

From 1890 to 1967 there were only 12 failures in Canadian banks. All of them occurred prior to 1923, and in only six of those failures did any Canadian depositors lose any money. Our system went through the Great Depression without a single bank failure. In the United States during the Great Depression there were bank runs and over 4,000 banks failed. We had a system prior to 1967 that was operating fine, that worked well.

Not only were there bank failures; if you take a look at trust company failures and look in the post-World War II period, the 18 years before the introduction of deposit insurance, and ask about federally incorporated trust companies or Ontario-incorporated trust companies, there were no failures in that 18-year period from 1949 to 1966. The system worked well.

Depositors could tell the good risks from the bad ones. Financial institutions had incentives to provide information.

Your previous witness talked about utilization of information, saying that in a system without deposit insurance depositors cared where they put their money, and because institutions invested a lot in providing depositors with information, you didn't have to be sophisticated.

I can remember - and some members of this committee may also - when banks used to advertise their financial positions in the papers. They published their financial statements. In the old days they put every quarterly financial statement on the door of every branch. So people knew weak institutions from good ones. They took their money out of weak and put it into good, and in that system a lot of institutions closed down prior to any bankruptcy.

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Deposit insurance was introduced in 1967. At the time, the Canadian economy was growing dramatically. The financial system was stable and things were doing well. There were no bank runs. There was no financial crisis. We introduced deposit insurance.

I can get into the reasons why. I think it was a political decision to help a few weak trust companies out, but at the time most of the financial institutions were against the introduction of deposit insurance.

The introduction of deposit insurance in 1967 encouraged new entry. There was a slew of new entry, mostly at the trust company level, but also at the banking level.

It encouraged institutions to take excessive risks. Why?

How do markets normally work when you don't have deposit insurance? Institutions that take depositors' money and invest it in risky real estate or risky loans find that depositors don't want to put their money there and that they have to pay a substantial premium for those funds. In a world in which deposit insurance exists, you find that depositors don't care about what happens with their money. All they care is that there is the decal that says ``CDIC''. As long as their deposits are under the limit of insurance, which is now $60,000, they don't care what happens, because they know they're going to be paid back regardless. All they care about is the interest rate they're going to earn. If ABC trust company, which just started out and no one every heard of, offers a quarter of a point more than anybody else, people will put their funds there.

So deposit insurance caused a large number of new entrants and caused institutions to take excessive risk.

I mentioned that 18-year period before the introduction of deposit insurance. If you take an equivalent 18-year period after the introduction of deposit insurance, what do you find? You find that if you look at federally regulated trust companies, banks, and Ontario provincial trust companies, 17 of them failed in that 18-year period after deposit insurance. There were no failures in the 17-year period before, and 14 of those failed institutions were incorporated after 1967.

Since that 18-year period, since 1985, there have been even more trust company failures.

I argue that deposit insurance has created the problem. It has created the instability. It caused financial institutions to take risks that they never would have taken before.

Deposit insurance is not a new thing. I was introduced in the United States in 1934 and didn't have a disastrous consequence. I claim that the difference, why it had a disastrous consequence in Canada when it was introduced in 1967, was because it came when deregulation was also occurring. You had deregulation and deposit insurance, and that was a potent combination. This was because once you had the market not caring, as happens with deposit insurance, and deregulation regulators not solving the problem, you had unnecessary risk-taking and a major problem.

There are two ways to go. You can try to correct the problem by fundamental reform to deposit insurance or by more regulation. I believe the way to correct the problem is through fundamental reform of deposit insurance. In fact, if I had my druthers, I would eliminate it altogether.

I come from the department of economics at the University of Toronto, which used to be called the department of political economy. Politically, I would view that as a non-starter. You're not going to get rid of deposit insurance, and therefore I would recommend some fundamental reform to deposit insurance, some substantial amount of co-insurance.

I am going to argue that the reforms proposed here, particularly risk-based premiums, are not sufficient and are a stop-gap measure and won't solve the problem.

I do not believe that increased regulation is going to solve the problem. I would like to see deregulation, but you can't have both deregulation and deposit insurance. That is a potent combination for disaster.

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The white paper argued why there shouldn't be fundamental reform of deposit insurance and why there shouldn't be co-insurance. It gave three basic arguments.

One, it said that there's opposition to the introduction of co-insurance and as a result there's no consensus.

Of course there's opposition. The people who gained from deposit insurance were the risky, regionally based trust companies. The large national-based trust companies, such as Canada Trust, were opposed to it. Large banks were opposed to it. High-risk institutions now could compete on a level playing field with low-risk institutions, and that never should be. Companies of the same risk class should be able to compete equally, but high-risk institutions should not be able to compete equally with low-risk ones.

So you had those people objecting, and you would expect them to object. They were the main gainers from deposit insurance.

The Chair: How many of them still exist?

Prof. Carr: Not a lot.

That's an interesting point. When deposit insurance came in, it was argued that this was going to increase competition. Initially, it did. It brought a large number of them in - and a large number of them have disappeared.

The companies that remained were largely the companies that existed prior to 1967, that essentially had low-risk loans, low-risk portfolios, and have maintained them.

What we did by deposit insurance was encourage a large number of risky companies to enter and to go under, and that caused instability in our financial system. What we have now is a system that in some sense is more concentrated than it was in 1967.

When you look at the sum total, deposit insurance has done more harm than good.

It was to prevent runs. We've never had a run in Canada. There were runs in the United States. If by ``run'' you mean that people take their money out of banks and put it under their mattresses, that they are afraid of banks and financial institutions, that never occurred in Canada.

What did occur in Canada was people taking their money out of bad companies and putting it into good ones. In 1967 people were taking their money out of York Trust and putting it into safer trust companies. Trust companies grew in 1967.

It was the riskier trust companies that first lobbied the provincial government in Ontario and then lobbied the federal government. These trust companies were based all across Canada. They were regionally based and they had a large amount of political power.

It was not the first time they tried to introduce deposit insurance. There had been pushes for deposit insurance in the early 1900s, in the 1920s, but they weren't large enough. The trust industry grew by leaps and bounds in the post-World War II period. That gave them the political power to bring in deposit insurance, at a time when things were doing very well.

The Chair: Professor Carr, it seems as if your thesis is that although the banks originally opposed deposit insurance, it has been incredibly to their benefit because it resulted in a lot of the trust companies going bankrupt and today we have very few trust companies, which were the deposit-taking competitors to our chartered banks, left in this country.

Prof. Carr: I don't think it has benefited them, and I think if you asked them, they would still ask for fundamental reform. It hasn't benefited them because the banks have paid for the problems in the trust industry.

People misunderstand deposit insurance. They think that it is paid for by Canadian taxpayers. That's not the case. It's paid for by CDIC assessing premiums on financial institutions.

When you have had more bank failures, the premium rates have gone up dramatically on insured deposits, and that was paid for by the safe institutions. The safe institutions subsidized the risky ones. It came out of their bottom line.

If you asked the banks if they would have preferred not to go through this experience, I think they would say yes. They would much rather still have had a little bit more competition from the trust companies and not have had to pay.

In fact, the banks' position today is that they want substantial co-insurance. If you pushed them and asked if they would want to be in a position where there was no insurance, as opposed to the current scheme, I think they would take no insurance. The reason is that the banks are substantially in a position different from that of the trust companies. About 40% to 43% of bank deposits are insured deposits. They're in the wholesale market. A large amount of their deposits are over $60,000. They are not insured. They can't take unnecessary risks because they'll lose this business.

If you take Canada Trust out of the trust company picture, you find that about 90% to 95% of trust company business is in insured deposits. So they depend entirely on that.

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What deposit insurance has done is allow these riskier companies to gain, at least initially, at the expense of the safer companies. Eventually, a large number of the risky companies went under, causing a large amount of turmoil in the Canadian system. Unless we have fundamental reform of the deposit insurance system, that potential still exists.

People claim that with fundamental reform, with co-insurance, you'll find that consumers won't be able to tell good banks from bad ones. Well, they did up until 1967. Consumers, depositors, never lost a cent from 1923 to 1967. This is a fact that people don't understand.

Institutions in that period invested in brand-name capital. People cared about what the good and solid institutions were. You didn't need much financial sophistication.

I don't have to know how a refrigerator or a car works to know that when I see the name of Toyota or General Motors on the car it's a high-quality car. I'm not a mechanic and I don't understand how the car works, but those companies have invested in brand names.

Financial institutions used to, but with deposit insurance they don't have the incentive to do so.

People claim that deposit insurance or co-insurance would introduce instability into the system. I claim that misunderstands what went on. The instability has been caused by deposit insurance, by this particular institutional set-up.

As long as the government holds the view that the operation of the market, transfers of deposits from banks that are perceived as having low quality to high quality ones, is destabilizing and should be eliminated, deposit insurance will be necessary - not because of the threat of bank runs but because of the use of the deposit insurance system to protect and promote weak institutions.

Risk-based premiums are being proposed in this bill. The power to have risk-based premiums already exists with CDIC. The bill and the white paper say that the purpose of this risk-based premium is to provide a signal with financial consequences to boards of directors and managements of member institutions concerning the risk rating of their institutions.

The high-risk institutions already know that they're high-risk - they don't need any signal - and it's implausible that OSFI and CDIC are better informed.

What is needed is punishment for being high-risk. You need to give them incentives to behave in the appropriate fashion.

What deposit insurance does is distort normal market incentives, and the type of risk premium that's being proposed, the range that's being proposed, is very small and comes in after the fact and is unlikely to do the job.

If you were serious about having actuarially based risk-based premiums, I think it would do the job. But, politically, governments have shown a lack of desire to have fully actuarially based premiums. In fact, the legislation says that to have actuarially based premiums is not the aim. It is not the aim because that will punish the people who push for this legislation, who push for deposit insurance and want it maintained.

As long as that exists, we're going to have deposit insurance and we're not going to have any solution via a risk-based system.

You can see the logic of the increased role of the regulator. Because one is not willing to make a fundamental reform of the system, now one really has to regulate these institutions so they won't take excessive risks.

The problem with the regulation is twofold.

One is the incentives the regulator has. The regulator is subject to all sorts of political pressure and doesn't have the appropriate incentives, and the problem is with the information the regulator has. For regulation to be effective, it would have almost to duplicate management, and if it did that, the system would be very inefficient, with dual management instead of sole management.

So all of this tinkering with regulation to improve information, even though it is commendable, is just tinkering with the system and is unlikely to do very much.

Let me conclude.

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While the development of an explicit mandate for OSFI and increased exposure represents improvement to the regulator system in Canada, the major proposals contained in Bill C-100 are unhelpful at best. The CDIC escapes major reform despite the overwhelming evidence of the need for it, and risk-rated premiums of the type adopted in the U.S. will quickly be recognized as a means of avoiding rather than providing discipline for managers of financial institutions. In explicitly setting out the principles on which proposed reforms are based, Bill C-100 makes clear the contradictions and inconsistencies underlying the current policy on prudential regulation and consumer protection in the Canadian financial service sector.

Increased public intervention in the management of financial institutions is justified in this legislation by a grab-bag of market failures: bank runs, consumers who are unable to assess the quality of financial institutions, and managers of financial institutions who require regulators with no pecuniary interest in the firms to inform them about their risk portfolio and business practices more generally, none of which have any credible evidentiary or intellectual foundations.

While the principle that the Canadian financial market should be competitive and efficient is espoused in Bill C-100, the regulators remain committed to protecting weak firms from market scrutiny and inhibiting the flow of deposits from weak to strong institutions. They appear to view the results of competition as evidence of market failure and use this, in turn, to justify their ambivalence about increasing market discipline as a means of enhancing the safety and soundness of the financial system. Enlightened public regulation may supplant and enhance market discipline, but all should recognize that it can never replace it.

The fundamental weakness in the Canadian financial system in the 1990s is the inappropriate incentives for depositors and managers of financial institutions created by the existence of insurance for deposits.

The Chair: Mrs. Stewart.

Mrs. Stewart: Mr. Carr, your historical background is very interesting, and I'm just trying to figure out some of the logic that might come as a result of this legislation.

I believe what you're saying is that if we didn't have deposit insurance the deposit-taking institutions would be less likely to invest in risky ventures and more likely to invest in brand-name capital. As a member of Parliament, I'm having a heck of a time these days with the banks, trying to get them to invest in risky things as the economy changes, so I have a problem with that.

Having said that, then I hear you say that now that we're going to increase the regulation, we're going to make it more difficult for the banks to invest in riskier things. So are we in fact going to make it more difficult for ourselves to get capital for our new economy, our knowledge-based economy, our non-asset-based economy, and all of that stuff?

Prof. Carr: There is a certain inconsistency in this legislation with other attempts of the government to push the banks in certain directions - say, lending to small business. If we talk about legislation, I don't view that as the appropriate role of the government. I believe the way you get the banks to take the appropriate amount of risk is to ensure competition in the banking system. As long as there is competition, the banks will lend to whomever they can make a profit from and they'll take the appropriate risks.

You have to remember that the banks operate the payment system -

Mrs. Stewart: What does that do to the transition economy, though? Who pays? Who's going to support a transition economy?

Prof. Carr: I don't know what you mean by ``transition economy''. We are in fact going through major technological change. With that major technological change, we need to have a safe and sound financial system.

In the 1980s the cry from governments was that the banks took too much risk - they loaned to Dome Petroleum and they loaned to the Latin American countries, and they made loans to the Reichmanns - that the banks suffered substantial losses and that threatened the stability of the financial system. In the 1990s the government is arguing that the banks aren't taking enough risks.

The banks learned their lesson. Their deposits are payable on demand. That means that any depositor can walk in and say, give me my money now. Depositors can line up, and it's a first-come first-served basis. Under that system, banks have to take depositors' money and invest it in safe and sound securities.

Do I know what safe and sound securities are? No. It's not my expertise. But I know that as long as you have competition in the banking system, and you ensure competition, that will guarantee it.

Now, if you have a system with competition and have a system of deposit insurance, you're going to have some financial institutions that will say, look, we can really take big risks.

Let me give you a prime example: the Canadian Commercial Bank and the Northland Bank. They essentially lent everything on the basis of the oil industry. They lent on real estate in western Canada, which was based on the economy of oil. They diversified in the United States to Weston U.S., which was based on oil. If the price of oil went up they would have made a killing. They would have gained. The price of oil fell, and what happened? Well, their loan base fell, they went under, and CDIC picked up the bill. That means all the other banks picked up the bill.

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So a system that says ``Heads, I win, tails, somebody else loses'' is going to encourage me to take gambles, and that is what deposit insurance did. It had banks fail when banks never failed, and these were banks that entered primarily after 1967.

So you can have too little risk-taking or you can have too much risk-taking. What you need is the appropriate amount of risk, and the way to guarantee that is to guarantee competition.

If you have deregulation, as is taking place in the Canadian economy and as is taking place all over the world, allowing the banks, the insurance companies, the trust companies, all of them, to compete for your business and your constituents' business, then you will find that your constituents will be taken care of. If the banks will not handle it, then a trust company will give them a loan or an insurance company will give them a loan; or if they don't get a loan, maybe they didn't deserve that loan in the first place. Maybe it was too risky, and maybe the only people who are going to put their money in that venture is their own family, and that is as it should be.

The Chair: In the ideal world that you envisage for us, how would the banks get competition? Who would the competition of the banks be? They've just about been wiped out. Wouldn't we be back in the position where new financial institutions would say, you have to give us deposit insurance so that we can attract the funds to go into competition with the banks?

Prof. Carr: We hear that argument from insurance companies now, and the insurance industry says, we cannot compete against the banks because they can raise funds that are insured and we can't; we have our own local insurance but we don't have anything like CDIC.

I think the bank's answer to that - and the correct solution is to have a level playing field - will be, look, maybe as a group bank and financial institutions have a competitive advantage over insurance companies, but some banks are worse off and some banks are better off. Some trust companies are better off - these high-risk trust companies that couldn't compete before.

The Chair: Just a second, how many trust companies do we have today, apart from Canada Trust?

Prof. Carr: We don't. The situation is that when you start talking about an ideal world.... We had a world without deposit insurance.

The Chair: What about today, though?

Prof. Carr: A world existed in which there was more competition. Today I think you're going to find that there is not substantial competition, at least initially, from trust companies if you get rid of deposit insurance. Where the competition is going to come from is other sectors in the financial arena. You're going to find it from the insurance companies.

What you want to do, I think, is deregulate. In Canada traditionally we had the four-pillar system. We had financial institutions not competing with one another. We had a kind of difficult situation in becoming a bank.

If we look at Canadian financial history, we used to have many more banks. We used to have 40 or 50 banks. What you found was that this was too many banks for Canada. You found that there were great economies of scale in the banking industry, and we had a substantial number of mergers and we dropped down to eight, which probably was the right number for Canada. Those eight banks did compete. Those eight banks went through the Great Depression and survived it. Those eight banks were safe and solid. Maybe that's all you're going to get - eight banks - for countries such as Canada.

Our banks can compete all over the world. So I'm all in favour of saying let's open up the floodgates to banking. Let's make it as easy as possible for financial institutions to come into banking. Let's open up, as we did, the Canadian Payments Association. Until 1981, the Canadian Bankers Association ran the Canadian Payments Association.

The Chair: You said that the other alternative to deregulating and taking away deposit insurance is for the government to regulate. One individual who is extensively involved in the insolvencies of a number of trust companies painted exactly the same scenario as you did. They were able to attract money because of deposit insurance, and they could offer not just a quarter point higher but sometimes two and three percentage points higher in return to attract this money. And of course, when they were paying more money than the other institutions were, they had to find riskier investments to put it into.

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So this person's suggestion is that you could very easily regulate it. You could say any institution taking deposits that charges, say, 25 or 50 basis points more than a benchmark will thereafter be denied deposit insurance. That would not require a stream of regulators going about, but that is one solution.

Prof. Carr: It is, and in fact it was a solution that existed almost prior to 1967. It was a solution that existed in the United States.

In the United States, when deposit insurance came in, they had substantial regulation. They had prohibition of interest on demand deposits, so you couldn't pay anything on chequing accounts, so riskier institutions couldn't attract funds by paying a higher rate. And they had regulation Q, which limited the rate of interest they could pay on prime deposits.

You're suggesting the same thing. In Canada we had interest rate restrictions on personal loans that could be made by chartered banks and we had all these interest rate regulations. That would help solve part of the problem.

That's why I said that deregulation and deposit insurance were a potent combination. At the time deposit insurance came in in 1967, we got rid of those regulations.

The Chair: All I wanted to do was suggest that there could be another approach.

Prof. Carr: Yes, but let me suggest that there's a cost to that other approach, the cost of reregulating in a world of international capital mobility. When we limit the interest rate that financial institutions can pay here, you will find that capital will leave Canada and go elsewhere.

The Chair: Just a second. The capital is going to leave these institutions the moment you take away the deposit insurance. Where is it going to go? Is it going to go abroad?

Prof. Carr: No, the capital will not leave -

The Chair: Just a second. You say that if you reregulate, it will go abroad as opposed to staying here.

Prof. Carr: No, if you put in interest rate regulations - because that's what you're telling me, that there's only so much you can pay on deposits - you're going to put -

The Chair: And maintain deposit insurance protection. If you want to pay more, you lose your right to grant deposit insurance on $60,000.

Prof. Carr: Oh. Why don't you simply make deposit insurance voluntary and say that any institution that wants it can have it, and you can set up whatever terms...? I would be in favour of a system where the government said we are going to have certain conditions - and I don't care what those conditions are - and those conditions are that you'll get deposit insurance and if you don't satisfy these conditions you don't have it. That's not the system we have now. The system we have now is that every federal institution is compelled.

The Chair: I understand. I simply wanted to put the argument to you of that individual, Mr. Jack Biddell, who worked as a liquidator at many of these trust companies. He said that was one of the ways we could deal with these fly-by-night operations.

Prof. Carr: I think that once you start reregulating, you're going to find there are other problems with regulation.

The Chair: Professor Carr, you've been stimulating, you've been controversial, you've challenged our conventional thinking. You've made us revisit this intellectually. I'm not sure whether we are going to march in lock-step after you to suggest that your proposal -

Prof. Carr: No one ever has yet.

The Chair: One thing I can assure you is that we will think about you when we do vote on the changes to the CDIC, and you'll be in our thoughts tomorrow when Grant Reuber from the CDIC appears before us.

Prof. Carr: Thank you for giving me the opportunity to address this committee.

The Chair: Thank you for being with us.

We'll take a one-minute break. We're going to come back in camera.

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PAUSE

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The Chair: We shall resume our hearing.

Our next witness is from TRAC Insurance Services Ltd., Mr. Don Smith.

We look forward to your presentation.

Mr. Donald G. Smith (Chairman, TRAC Insurance Services Ltd.): Thank you,Mr. Chairman. You'll be delighted to hear that I have no long treatise to solve the problems of the financial institutions in Canada.

We have some very keen interest in certain aspects of Bill C-100, and we are delighted to have been invited to present a submission to the Commons during the deliberations on the bill.

The bill before the committee was introduced to implement the measures proposed by the Department of Finance to enhance the safety and soundness of the Canadian financial system. Many of these measures were aired by the Senate banking and finance committee last fall.

We personally made written and oral submissions to the Senate committee at the time, and we are pleased that many of our recommendations are generally consistent with the key amendments currently being proposed.

I would like to provide some background on TRAC. TRAC is a 100% Canadian-owned company that has been reporting on the financial solvency of insurance companies since 1978. Our principal activity in our first decade of operations was in the property/casualty industry, in which we accurately predicted the negative trending of all the major insolvencies.

In 1991, at the invitation of the Investment Dealers Association, we expanded into the life insurance industry and were the first rating agency to identify solvency problems in both Sovereign Life and Confederation Life, in the latter case a full two years before other rating agencies and two years before the winding-up order.

Our mission is to provide financial trending analysis to our client base, which includes policyholders, brokers, financial institutions, and regulators.

Our sole source of revenue is our subscribers. Unlike other rating agencies, we do not charge the insurance company for an evaluation. As a result, some insurance companies have refused to provide voluntarily their data to TRAC and we have had to go through freedom of information and processes and appeals and so on.

I should clarify that we are the only rating agency that attempts to rate all insurance companies in Canada.

The current bill under study by your committee includes three key proposed amendments that are within our area of interest and knowledge and that we addressed in our submission to the Senate banking, trade and commerce committee.

The first key amendment would allow the Office of the Superintendent of Financial Institutions to take control of a troubled financial institution earlier than at present.

We have made public comment, including in our submission to the Senate committee, that OSFI should have intervened earlier in the case of Confederation Life. We fully support any required legislative amendments that will empower the office of the superintendent for these purposes.

We have reviewed the main elements of the white paper of the Department of Finance dealing with early intervention policy, and we recommend these amendments.

The second amendment would expand the role of the superintendent in the governance of troubled companies by developing a stronger prudential framework for financial institutions. The proposed bill seeks some improvements in existing supervisory standards, such as the superintendent's authority to designate whether certain directors are affiliated or unaffiliated with a financial institution. We support this aspect of the proposed amendment.

Additionally, it addresses the role of the appointed valuation actuary, designating that this person cannot be the chief executive officer, chief operating officer, or chief financial officer of the institution. We have concerns with respect to this proposal.

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In our submission to the Senate committee we made a case for tightening of the actuarial process, suggesting the need for more objectivity, and recommended that the opinion be provided by an external actuarial firm. The current proposal seems, in our opinion, to weaken the process, as most competent actuaries strive to be the top executive in their insurance company. This would appear to relegate the role of the valuation actuary to a more junior position, subordinate to senior management. We cannot perceive how such a step would strengthen the objectivity of the actuarial opinion.

Our alternative recommendation was to include the actuarial opinion in the external auditor's scope of responsibility. Since the external auditor reports to the board of directors and not to management, this alternative would guarantee objectivity and ensure that the directors are brought into the loop in this critical area.

The third key amendment, and the one that is of the greatest concern to TRAC, is the issue of greater disclosure of financial data.

The timely availability of statutory data - that is, data contained in the regulatory filings - is crucial to our fulfilling our mission of reporting on financial trends of insurance companies.

Prior to 1992, such data was available through the Department of Insurance database. However, legislation was then effected to place restriction on disclosure. Although this restriction was technically removed in 1994, in practice the current data released is neither adequate nor timely.

In point of fact, in spite of the Senate committee's recommendations and in spite of the perceived intent within the current proposed bill, in actual practice less data is available now than was available to us in 1991. For some inexplicable reason, OSFI personnel see fit to suppress data that was previously available in the public database in 1991.

We are encouraged, however, by a recent public speech given by John Palmer, the new Superintendent of Financial Institutions, presented to the annual meeting of the Canadian Life and Health Insurance Association, in which he stated that the life and health insurance companies fall short of other financial institutions when it comes to disclosure of certain types of financial information. He specifically identified the need for more disclosure on risk-based capital and actuarial presumptions.

He particularly stated that it was not sustainable, that the most important number on the life insurance company's balance-sheet, the actuarial reserve, would be provided without information on the key assumptions leading to its calculation.

He concluded that although accounting and actuarial practice has improved, there is still enough flexibility remaining that companies may be tempted to trim the reserves in order to improve their capital positions.

We at TRAC share these concerns. We recognize the crucial need for a dramatic move not just to enhance disclosure but to complete disclosure of all pertinent financial data applicable to a financial institution's solvency.

We take the position that there is nothing in the statutory filing or in supplemental documentation that must be filed with the superintendent, such as the minimum continuing capital surplus requirement, MCCSR, for life companies and the minimum asset test for property/casualty companies, that should be withheld from full public disclosure. The issue of suppressing data because it could affect competitive advantage is the usual rationalization: it may give away the trade secrets of the company. Nowhere in these financial filings is there reference to individual policyholders that might affect the competitive advantage of an individual insurer or its marketing strategy.

We recognize that the filings identify investment strategies of individual companies. However, we believe very strongly that the potential policyholder has a right to know how his or her policy premium will be invested to cover future policy obligations.

If one of us purchases one share of Canadian Tire stock on the Toronto Stock Exchange for the market rate of $16, we're entitled to full disclosure of all of that company's filings with the OSC. However, if we invest our life savings in the trust of a mutual life insurance company, we are asked to assume that the company is healthy and to trust the system. Following the failure of Confederation Life, the consumer will not accept such a rationale.

We are vitally concerned that the recommendations of the ministry that encompass the bill before this committee are insufficient to fulfil the real need for financial disclosure, and we are doubly concerned with respect to the timeliness of such release.

By comparison, in both the British and American regulatory systems, full disclosure is practised.

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In point of fact, in the U.S. the National Association of Insurance Commissioners market the statutory data information through a catalogue, using it as a profit centre. I was going to bring this catalogue, but I left it in my office. There is a catalogue. You have to take my word for that.

The Chair: Would the Canadian catalogue be one-tenth the thickness?

Mr. Smith: The Americans actually ask for more data. They ask for much more detailed data in their yellow filing, as they refer to it, or ``yellow peril'', in the U.S., which is a uniform filing in all states. But it is every piece of information and it is freely given to the public.

In the property/casualty industry, OSFI still wants to suppress data on the minimum asset test and the adequacy of loss reserve development. By this I mean the company has been in business for a number of years and has reserves by year and can see the reserves developing as the claims settle. There's a filing that must be submitted with the regulatory filing that gives detail that could be analysed to see if the company is adequately reserved. It's not available to us. In our opinion, these are two of the most critical areas in identifying financial solvency of a property/casualty company. Basically, do they have liabilities that are recorded properly and do they have sufficient assets to meet those liabilities?

In the life industry a significant area of disclosure should be enhanced that has not been proposed in these amendments.

We have mentioned the actuaries' reports; disclosure of interest rate, lapse rate, mortality rate, and other major assumptions underlying the actuary's valuation should be authorized. Of equal importance, analysis of a life company's investments of policyholders' premiums is critical and in fact was the cause of the failure of Confederation Life and Sovereign Life. Methods of valuation of real estate, mortgages, and subsidiaries should be disclosed. Such disclosure should identify the valuator and the methodology of valuation and the major assumptions underlying the same.

This point is particularly pertinent with respect to some of the larger mutual life insurance companies that have substantial investments in unregulated subsidiaries. We have concerns that the valuations placed on these subsidiaries may not reflect the real worth of the entities.

It is TRAC's recommendation to the standing committee that the proposed bill be amended to allow and require full public disclosure on a timely basis. In that context, as you all know, the companies must file, on the calendar year, by February 28 following December 31 in the year of closing. We believe a timely basis should be at the database. A full database should be available within 90 days following fiscal year-end.

I said that I would keep this brief, but we wanted to raise a few specific points in this context. I shall be happy to clarify further any points I've raised in this submission.

The Chair: Thanks, Mr. Smith. Obviously you raised these points in response to Mr. Peters' white paper.

Mr. Smith: Yes.

The Chair: Why, in your opinion, were they not dealt with? They seem to be eminently reasonable.

Mr. Smith: There has been a historic position between the regulator and the various industries, the Insurance Bureau of Canada and the Canadian Life and Health Association, that certain information within the day-to-day file is of a confidential nature and may affect the competitive advantage of one company in relation to another. They are concerned -

The Chair: Do you mean information on reserves?

Mr. Smith: I've never understood the rationale of why they should not give full disclosure on, for instance, the minimum asset test, which is a relatively simple test in the property/casualty field. Do they have sufficient assets to meet the liabilities? That's pretty fundamental and pretty basic.

Perhaps there's less concern about solvency in the property/casualty business because fundamentally you're buying a six-month or an annual policy and you might get lucky and by the time the company gets into trouble you'll be out of it and off to another insurance company. But with a life company you could be locked in for life - and literally locked in.

People in Sovereign came to us after we reported on Sovereign in 1992 and indicated that it had failed seven of our eight early warning tests. The chap had bought a $5 million partnership policy and then had a heart attack. He was no longer insurable. The guarantee fund meant nothing to him. It meant 10% of his protection, if that. He wanted to know why someone hadn't moved faster. He had bought his policy only six months before. The problem was a year or two old. It wasn't identified.

Perhaps I should have clarified that we use a series of early warning tests that test a cross-section of the company's strength in leverage of risk, movement in surplus, movement in premiums. We measure specifically their investments, the degree of their investments in subsidiaries in relation to the surplus. We measure the mortgage default ratios.

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I found it amazing.

We got considerable support and interest from our friends at the Department of Finance and they had discussions with us last fall to talk about what areas should be disclosed and what shouldn't. Our position was full disclosure. OSFI's position seems to be to go back and rethink every single item on the balance-sheet and what should be and what shouldn't be disclosed. We believe we need sufficient information to evaluate companies.

The Chair: Has the insurance industry indicated that it doesn't want to make full disclosure? Are there good reasons not to do so? Do they want to be hard on this?

Mr. Smith: I understand that Mr. Daniels and his people will be addressing you tomorrow. I've even suggested to his people this afternoon, while you were in camera, that he should make a comment on disclosure. CLHA has never made a position either way on disclosure. The Insurance Bureau of Canada has taken the position that it believes in expanded exposure on the property/casualty field. I'd be very curious to have one of your members ask for the position of the life industry on disclosure.

The Chair: Does the IBC support you on these proposals?

Mr. Smith: Yes, they do.

Our position, as I mentioned, was that we do not charge the insurance companies for the data. For instance, if a major U.S. rating agency such as Standard & Poor's, Duff & Phelps, or Moody's comes in to rate the data or the paper of a company, it charges it a fee. Therefore, they get full disclosure of the data.

We don't solicit the company. We secure our total revenue from the subscriber or the broker or his client and so on. Then we are at the mercy of the database availability or the companies, or through our own pressures and so on, to force or coerce companies into providing us with the data. So without the disclosure from the OSFI database, which was readily available for many decades prior to this technicality change in the creation of OSFI, we are totally at the mercy of the goodness of the individual company to decide whether or not to give us the data.

It isn't just the fundamental data. We have some real concerns about how these companies evaluate some of their subsidiaries, and we want the details on how they evaluate the reserves and so on.

I intend no disrespect to this company. I think it's a fine company. But I didn't know that ManuLife owns a piece of a brewery in British Columbia. I'd like to know that. If I was a policyholder of ManuLife and had my life savings and my RRSPs in it, then I'd like to know what is on the balance-sheet, what their share is, whether it's a good investment.

The Chair: Mr. St. Denis.

Mr. St. Denis (Algoma): With reference to your comments on page 4 about the valuation actuary in the firm, I'm assuming that even in a world where the valuation actuary could not be one of the senior officers, as listed, that would not prevent those persons from being an actuary, that they could still be an actuary and provide a kind of management oversight of the valuation actuary.

I would be concerned about requiring an independent actuary through the auditor, say. Maybe cost isn't a big factor, but there also is adding time. You made a point about the timeliness of reporting. Do you see that as being a problem? Would it add much time and effort and cost to the actuarial audit process?

Mr. Smith: I suggest that, as an offset, in many companies the rating actuary is also the valuation actuary. In short, the actuary who has been asked to design a policy and to presume lapsations and to presume rates then has to put another hat on and evaluate his performance in evaluating the lapse and the rate of that product that he designed. Obviously, there's a bit of difficulty in being objective in that area.

I think there's a major concern. Certainly, the issue of whether the actuary had drawn the right presumptions was a major concern in the failure of Sovereign Life. The same actuary was the one who made the product and then evaluated his performance in the decision on that product.

The actuary, again, then reports to the management of the company. You would be much better off if it was under the sole external evaluation of the auditor. Therefore, the methodology and the rationale would be presented to the board of directors and it would bring them into the loop in corporate governance.

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Mr. St. Denis: You wouldn't be concerned about the extra time it would take to produce?

Mr. Smith: It should not take any extra time, and the cost is minimal compared to the cost of the failure of an insurance company.

The Chair: In terms of assessing the viability of an insurance company, is your main concern to protect the policyholders or to protect the shareholders?

Mr. Smith: Our concern is the policyholders. The shareholders are taking their risk. But you must appreciate that ten of the twelve major life insurance companies, which control 75% of the asset base in Canada, are mutual insurance companies who don't have shareholders. Most of them don't even know that they own the companies.

Confederation Life was a classic example. I had policyholders phone me and ask what they could do. I said, ``You own the company. Do something''. They would answer, ``I do?''

The Chair: Does the same consideration apply in terms of general insurance?

Mr. Smith: The consideration from a disclosure standpoint, yes. We're certainly interested in the same context.

I don't think it's as critical. The property/casualty companies historically have given us their data. Their reporting concepts are far better. They're all on electronic reporting. The life industry started just this year. Virtually 100% of the property/casualty companies give us their electronic disk that they send to OSFI. We download it and we have it.

So we've had good long-term support. This is our fourteenth year in reporting P and C companies. They've been totally cooperative. We have their data.

They still don't want us to report on the minimum asset test and loss development. We're hamstrung in reporting on that unless the Department of Finance authorizes the release of that data publicly, and then we would provide it. So we use other criteria to measure it. But they're not nearly as complicated to evaluate as a life insurance company is.

The Chair: Do you know of any situations in the general insurance field where a shareholder can directly or indirectly write business with his or her own company?

Mr. Smith: Where they can write business with their own company?

The Chair: Yes, and take commissions.

Mr. Smith: Oh yes. It has been a classic example of some of the major failures. Northumberland was probably a classic in that area. The principal wholesaler was the owner of the company. There was far less than arm's length dealing.

I have some knowledge of insolvency, because I wound up two of the insurance companies for OSFI, Pitts and Cardinal.

Over the years, OSFI has learned from its mistakes: items such as less than arm's length dealing, unregistered reinsurance, problems with subsidiaries, etc. So this has been a learning process over20 years.

We didn't have an insolvency in the insurance industries prior to 1981. I think the first was Strathcona, an Ottawa-based company, and then there was Pitts. Prior to that there had been maybe one or two minor provincial insolvencies in 100 years.

The Chair: Is there anything in the law that prevents this type of self-dealing?

Mr. Smith: With respect to the regulations, there are measures now whereby OSFI can scrutinize any areas of self-dealing. However, self-dealing has not really been the major problem on the life side. The problem on the life side has been outside investments.

The Chair: I'm talking about the general side now.

Mr. Smith: There was a problem in the property/casualty side in Pitts. The owner of the insurance company also owned the offshore defunct reinsurance company. There was a problem in Cardinal. He was the managing general agent as well as the insurance company. There was the same problem with Strathcona. It was a classic problem in the property/casualty side.

The Chair: Does the current law or will Bill C-100 prevent this type of self-dealing or regulate it in any way?

Mr. Smith: The regulations prescribe the limit of self-dealing and any self-dealing has to be approved. Any self-dealings with associate reinsurance companies have to be approved by the superintendent before they can proceed. So he has power and controls.

The Chair: This is a new power given to the superintendent under Bill C-100.

Mr. Smith: He has had that power. That has been existing for many years, since the early eighties.

The Chair: So if the superintendent sees that there's self-dealing, all he has to do is say whether he likes it or not?

Mr. Smith: That's right. As a matter of fact, in certain self-dealing, for instance, if you own an insurance company and you also own a Cayman Island reinsurance company or a Bermuda reinsurance company, you cannot use that reinsurance company without the prior approval of the superintendent. That has been in effect for several years.

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The Chair: Okay.

Mr. Smith: That has not been the problem on the life side. On the life side, the traditional problem has been in the area of investment.

The Chair: In the area of investment?

Mr. Smith: That's right.

The Chair: Real estate?

Mr. Smith: Basically, real estate and subsidiaries.

I think it was the thrust of many of the life companies to get in and compete in the four-pillar environment and to get into areas they didn't understand. We have never seen a single successful trust operation by a life insurance company since they got into it, not one as an example, because they got into areas they didn't understand in racing to compete with the banks.

The Chair: You've made some suggestions here for greater disclosure.

Mr. Smith: With respect, full disclosure.

The Chair: For full disclosure. Could you bring us up to speed? Who is going to argue against that, and why?

Mr. Smith: I think the insurance companies individually will argue against it, and I think you might get some argument from members of the Office of the Superintendent of Financial Institutions.

I think the argument that was made by the prior superintendent, Mr. Mackenzie, who has never been recognized as a dear friend of mine, was that he wanted to be able to sit at the boardroom table of the insurance company, and therefore he had to do some quid pro quos in receiving confidential data to analyse this company in a more expedient manner. Therefore, he felt he had this duty to hold confidential any of the data that might be theoretically perceived as being of a competitive nature.

Frankly, I thought the whole thing was poppycock. There's really nothing in the filing that is of a competitive nature. The only exception you may identify in a life company would be the strategy of investment, but I think on balance it is so important to the policyholder that it's critical to declare.

Property/casualty companies don't have this problem. The average property/casualty company in Canada invests about 72% of its investment in government or commercial paper bonds that are rated; they have no more than 8% of their investments in real estate. Historically, on the equity side, they would only invest.... The old style was legal for life. You had to declare dividends for seven years before they could be approved. Now, of course, it's prudent person investment strategy and it must file a strategy of investment with the ministry or with OSFI and have it approved by their board of directors to proceed.

The life industry has been given far more latitude in investment strategies and they've made some terrible mistakes. Confederation Life, for example, at one point had in excess of 65% of its total investments in real estate and mortgage-related risks, and some of the other companies that still exist are bordering on that now.

The Chair: Should we be changing the investment powers this time around in order to prevent that type of thing?

Mr. Smith: The superintendent has tightened that, not in this legislation but in prior regulations over the past few years, on a prudent person investment strategy. Even the life companies and the banks and everybody else must file a prudent person strategy, approved by the board of directors. It's one of the major reasons why OSFI is zeroing in on who are affiliated and non-affiliated directors and so on, so they know there is a group of unaffiliated directors they can talk to who understand, who are not part of the action.

The soft area is the mutual companies. Don't misunderstand me; probably some of the very strongest life insurance companies in Canada, if not in the world, are Canadian mutual insurance companies, but some aren't, and they are difficult to regulate. They can move into subsidiary areas, and the filing requirements on those are very loose. I'm sure OSFI can go to ABC mutual life insurance company and ask it what this investment in a shoe business is and ask to see the balance sheet and what its involvement is, but this is not declared in public data, and we think the details of that should be declared.

The Chair: Thank you.

Mr. Fewchuk.

Mr. Fewchuk (Selkirk - Red River): As to data, you say that in the United States it's full disclosure?

Mr. Smith: Full disclosure.

Mr. Fewchuk: In how many countries around the world is there full disclosure?

Mr. Smith: Certainly, from my direct knowledge, the U.K., through the department of transport in the United States, has full disclosure. I have no personal knowledge of other countries.

The Chair: Are there any other questions?

Mr. Smith, this has been a very important intervention before us, and we will carry your thoughts through with the balance of our witnesses today and tomorrow, and we may have recourse to have you back. We hope you'll keep abreast of our hearings and feel free to contact us with further suggestions.

Mr. Smith: I'll be delighted to return if you should wish it, and I hope I made my one or two brief points as clear as possible.

The Chair: You made them very clear.

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Mr. Smith: Your brother and your cousin wish you the best.

The Chair: Which brother and which cousin?

Mr. Smith: Kathy and your brother. Call him on Sunday.

The Chair: Oh, wonderful.

Mr. Smith: Thank you very much.

The Chair: Our next witness is Victor Vipond. Welcome, Mr. Vipond.

Mr. Victor R. Vipond (Individual Presentation): I would like to begin by saying how pleased I am to be here this afternoon. I have actually been here all day listening to these hearings, and if there is one thing I have learned today that I did not know before, it is that parliamentary committees have tremendous levels of endurance. So I want to say that I think I'm doubly honoured to be able to address you.

The first question, I guess, is why I am here. I guess I'd better explain that as succinctly as I can.

I immigrated to Canada in 1967. I am one of those people who chose to live in this country. I came from New Zealand. I went to the London School of Economics in 1969 and got a bachelor's degree and a master's degree in economics there. Because my interests were financial institutions, I went from there to the University of Chicago, where I studied what, unbeknownst to me, became a rather serious course in a theoretical model of regulation, a worldwide international theory of regulation.

I graduated in 1975 and went back to live in Edmonton. Apart from watching my friends and colleagues in the States implement their versions of it, I paid very little attention to it until October 1990, when I was presented with a white paper, which eventually became our new Bank Act, which I read.

Most regrettably, I think, I was obliged to decide that the entire proposed act had missed the point. I have spent most of the time period for four and three-quarter years since then addressing virtually anybody who will listen to me with respect to what I think is the point.

If this committee would be so kind, I'd like to spend about five or ten minutes now to develop the point, which I want to bring across. Then perhaps you would be kind enough to ask me some questions.

First of all, I think it is possible to look upon this point I am trying to make as a decision point. I think we are at a decision point with our system of regulation where we can take a high road or we can take a low road. I want to suggest to you that everything you've been told today tells you to take a high road, and I want to suggest that you don't, that you can take a low road, a completely different approach to the entire subject.

I know this is very presumptuous of me, but I'm here because I sincerely believe this committee is entitled to, and should, hear this point.

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The point is an international one. I was taught there was a global system of financial reform starting off in the United States in 1972 and extending globally. I was greatly cheered when several of my colleagues in the United States phoned me up and said the Brits had done it. In 1987 virtually the entire Chicago model was implemented in the United Kingdom in what they call a ``big bang''.

This is the first sort of international flavour I would like to bring to you, the U.K. system. What I would like to do now is spend just a couple of minutes discussing some major differences between our system and the U.K. system, and I want to put this in terms of results. The proof is in the pudding.

First of all, I want to look at speed. From everything you have heard today, you must surely have got the message that the speed of the regulator is a vital consideration.

I want to compare two situations. I may not be terribly totally comfortable, and I think the analysts will probably jump on me for making this comparison, but I will bring this back to it: speed.

It took OSFI seven years and a bit to stop the red ink and the drain as a result of Confederation Life. It's going to take another five or seven years to clean up the mess. For the purposes of just a crude comparison, let's say that's 15 years. At 50 weeks per year, give or take, that is, say, 750 weeks.

The Barings situation in Britain was resolved totally, from start to finish, in three weeks flat. Now, that makes the British system 250 times faster than ours. No, it doesn't, because I can't say that yet. All I can say is that comparing these two situations, there is a possibility that maybe the British system is 250 times faster than ours.

You might be interested to compare some numbers about staffing. OSFI employs about 420 people. The economy they regulate is about half the size of the U.K. economy, so just to be very crude once again, I will suggest to you that if the U.K. were being managed by OSFI they would need, give or take, maybe 900 people. The amount of staff needed to run the equivalent organization in the U.K. - and it is an equivalent organization; it does almost exactly the same thing, apparently - is 320. They need 30%, 35%, maybe 40% of our personnel to run the regulator.

Now let's compare CDIC. Once again, CDIC runs at half the size, so if we take the 97 people currently working for CDIC and double it, say 200 people, we can compare that with the number of people who work for the British depositor protection board, and that number is eight people. In that case, they are operating with one-twenty-fifth the number of people.

All of this is not terribly important because the real importance is dollars, and that's really why this committee is discussing this today, why the Senate discussed it all last year, and why everybody has been discussing it for a donkey's age. In the last eight years since the new British system was formed, the Canadian CDIC system has lost approximately $8 billion in very rough figures, give or take a little bit. That means, of course, that because the U.K. is twice as big, if they were equivalent to us they would have lost $16 billion.

In point of fact, I have a letter here that I very fortunately received just last week from the Bank of England - and believe me, it takes just as long to get information out of the Bank of England as it does out of OSFI and with just as much difficulty. The Bank of England tell me that compared to the $16 billion they would have lost had we been the same size, doing it with our system, they lost about $0.5 billion Canadian. Their losses are one-thirty-second of ours.

That is a very crude analysis. If we got into a sophisticated analysis, I think I could show you that the British loss is in fact more like one-fiftieth of ours over the last eight years.

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So we have one-fiftieth of the losses and either one-twenty-fifth or one-third of the staff, whichever way you want to look at it, but 250 times the speed.

Surely somebody in the Department of Finance, OSFI, or CDIC has seen fit to ask a rather obvious question: what are they doing right that we're not? I suggest to you that question is presumably worth asking.

The Chair: Do you want me to ask that question? I will ask that question.

Mr. Vipond: Thank you, Mr. Chairman.

This is very dangerous ground, because it is very easy to isolate something they are doing that is different from us and say, hey, this is a wonderful idea; this is it. But of course life is not that simple. In regulation, appearances and reality are always very different.

Let me start with some of the things that appear to me.

First, we've had a lot of testimony today about the closure rules of OSFI and the contradictions that are attendant upon them and the grey areas.

In the U.K. the regulator has no authority whatsoever to close any institution, nor has the Minister of Finance. It's not part of their regulatory system. Furthermore, the regulator is not permitted to ask the courts for a winding-up order. In fact, he has to ask the courts if he's permitted to attend a winding-up action that is brought by somebody else. The regulator is not permitted even to ask the courts to put an institution into administration.

So all we're doing here, all of that discussion we had this morning on closure, is something to which the British would not pay one minute's worth of attention.

To what do they pay attention? As nearly as I can figure - and I'm drawing here from the theory I was taught 20 years ago, which I know they implemented, and from what I see of what they give me, which is small enough - -the British do not concentrate on attacking institutions, nor do they attack job titles. They don't care whether a guy is an inside director, an outside director, an affiliated director, or an upside-down director. They don't care whether a director is also a chief executive officer or what he is, or whether he works for a parent or a subsidiary. There's none of that in any of their legislation or their regulations. So that, too, might be a complete and total waste of our time.

What they do, with vigour and enthusiasm, is concentrate on regulating people. So what they start with is what they call the four-eyes rule, which simply says that the regulator has to be advised of the names and résumés of the two individuals who are designated as the policy setters of the institution.

I've spent a lot of time looking at the four-eyes rule, and I can assure you that there are subtleties beyond amazement in it. It does a number of things for them.

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First, it means that whenever an institution is taken over or incorporated, or even just run on a day-to-day basis, the regulator has in his hands the life history of the two people who are designated as the policy setters.

They also have the right to refuse a bank the permission of designating any person as a policy setter. What that means in the U.K.... Sorry, it does not mean that in the U.K., because it never occurred to them that anyone would be stupid enough.

What that would mean if it were applied here in Canada is that, no, the regulator would never let a property developer be a policy setter for a bank, or a corporate lawyer, or a deputy minister. Not on your life. Sorry. It would never occur to them that anyone would be stupid enough to do that.

The Chair: I have the impression that if that were the rule here, then Victor Vipond would be the only policy setter in Canada.

Mr. Vipond: I can assure you that there is no chance that they would permit this person to, either.

They have established some policy rules for who is to be a bank policy director. The main one as far as I can tell - and I cannot tell a whole bunch - is that there is a requirement for a long-term, steadily progressing managerial authority structure in a bank.

The rationale for that is that banking is an ethical business. Above all else, it is an ethical business.

You might have noticed that in my brief to you I suggested that the British stress integrity. One of the ways they do that is by stressing that they are looking for people who have 10- or 15-year track records working for banks in senior management positions who have consistently shown that they are, under pressure, able to take decisions that reflect integrity, and it is there. From the material I have read, that seems to me to be their main requirement.

How many of our bank failures would not have taken place if the banks involved had not been run by property developers? I would guesstimate that more than half of our collapses have happened because we let property developers run banks.

I am not talking about job titles here; nor do the Brits. They talk about who is doing the job.

There are two parts of common law or just general law that they have applied, which strike me as being very intriguing. I would like to raise them for the benefit of the committee.

I am saying to you that Bill C-100 completely misses the point. The point is that there is a way of running a regulatory system. It is proven; it works. What you have listened to today, all day, are theories about how a system might work.

I am not unfamiliar with these theories. They are mostly imported from the United States. They might work even better. It might be that if we were to follow the example set for us by the British, we would achieve a system that is only 20, or 15, times as good as our own.

If we adopt the theories that are being announced to us, we might be able to adopt a system that is 50 times better than ours.

Mr. Fewchuk: Did you bring a brief with you?

Mr. Vipond: I published a brief and I sent it to the clerk.

Mr. Fewchuk: When did you send it?

Mr. Vipond: Two weeks ago.

The Chair: It's in the mail.

Mr. Vipond: This is all news to you? Oh, I am sorry. Oh dear!

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Mrs. Stewart: Just tell me why Barings happened.

Mr. Vipond: I think it has been said many times that no system is perfect. I am lauding this system quite heavily, but I'm not suggesting to you that it's perfect.

The other thing you might be interested to learn about Barings is that it cost the public nothing, in the entire eight years.

Mrs. Stewart: Do you count depositors as the public?

Mr. Vipond: Yes. Nothing. It was caught before it went insolvent.

Mr. St. Denis: That was in the newspapers.

Mr. Vipond: Then that was in the newspapers.

The Chair: Do you want to make any final summary statements to us? I take it that you're saying that if we were to adopt the British model we would have to find just two good, honest persons for every financial institution. That would be our only obligation, and the whole system would run without bureaucracy and without difficulty. Of course you've excluded a great number of those people who could be deemed to qualify as honest people, and perhaps you're correct.

As one who has studied these issues, do you have any other suggestions for us on the future direction of our financial institutions?

Mr. Vipond: I think I could leave it at that. There is a proven system. I do not understand, and I have not understood for the last five years, why we are pursuing untried, untested theories. I've never understood that.

The Chair: Thank you very much, Mr. Vipond. Again, this is something to challenge our conventional approach to these not-so-conventional issues.

Our next witness is Mr. Gordon Dowsley, from New World Approaches.

Welcome, Mr. Dowsley. I understand that you have a brief presentation for us before we go to questions and answers.

Mr. Gordon Dowsley (Principal, New World Approaches): Yes. Thank you.

I would like to restrict my comments to the life insurance aspects of Bill C-100 and to three points therein.

First, life insurance companies should not fail. A life insurance company's failure is a blot on our financial community.

It should be noted that the Confederation Life failure could have been avoided by one technique of finance; namely, if the actuaries had used the amortization period of mortgages in their cashflow projections rather than the renewal period. I will explain that briefly.

In testing the adequacy of reserves, actuaries will project into the future the cashflows that are coming in and the cashflows going out, and if there is a shortfall in any one year, say the 11th year or the 23rd year or whatever, then reserves would have to be increased in order to have enough cash available in that particular year.

What happened with Confederation Life, of course, is what most actuaries in most companies did. They assumed that the mortgages would come due at the end of, say, 5 years instead of 20 years, and at the end of 5 years they would suddenly have, say, $20 million being paid off by the person who borrowed the money. Of course, this didn't happen. It was always thought that if the guy didn't want to pay off the loan at the end of five years then he could go and borrow it from the bank and the company would be getting that money anyway. That was a faulty assumption. If it had been recognized early, then they would have been out of that business very quickly and would have recognized the inadequacy of their reserves.

You might wonder why that happens. It is because the matching of assets and liabilities is still a relatively new concept in the insurance industry or in the financial community in North America. The first papers were written by Irwin Vanderhoof, a New York actuary, in the 1970s.

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The Canadian companies were among the first to recognize the absolute necessity of being able to match cashflows, but because the system was new, various errors were made.

One of the first was the failure to recognize that a bond does not always reach maturity, that the company may call it five years sooner on a particular issue; but that error was not enough to cause a problem.

The error on the mortgages was a fundamental error. This of course cannot be corrected by law, I do not think, but it is something that OSFI should remember and take into account when it is judging the adequacy of life insurance reserves.

The second point I would like to make is that the prohibition about the signing actuary not being the CFO is a strange one. There are just as good arguments that the CFO must be the signing actuary. Whether you wish to rule on one side or the other, that is the kind of thing that should be left to management, not put in legislation.

Let us recognize what that prohibition really is. All that does is reflect the change in the power base in the financial services community in the life insurance business that is going on between actuaries and accountants. Most life insurance companies in Canada did not have a chartered accountant on their staff before 1970. The accountants have added a great deal to the industry. They are much more powerful, and they now control OSFI. That is what this whole thing is about. It is simply the shift in power between the accountants and the actuaries in this industry, and it is something that should not be in the law.

Concerning the CFO and the signing actuary, Don Smith mentioned earlier the problems with the release of information. He is correct. The industry used to be one of the closest-to-perfect competitions ever.

The companies within the industry exchanged rate books. They exchanged the financial statements they filed with OSFI, and so on. The government itself published summaries of these. Then of course they stopped doing this and the information became very confidential.

The former chairman of OSFI was very adamant about how he interpreted that law, and the lack of information exacerbated the situation at Confederation Life.

The third point I would like to talk about is rehabilitation.

The white paper said that the American experience indicated that there should not be a rehabilitation process in Canada. That is simply wrong.

In the United States we have state regulation because of the McCarran-Ferguson Act of 1941, by which the feds passed regulation of the insurance companies over to the states. This was done because the large insurance companies lobbied quite strenuously, because they knew that they could kick around the state legislators a lot more easily than they could kick around the feds.

Many of them are now regretting this, and there is a big debate in the United States as to whether they should repeal the McCarran-Ferguson Act. The problem, of course, is that you have 50 different regulators and 50 different sets of rules, although they do not vary that much.

I can understand why people would come to the conclusion that rehabilitation has not worked in the United States. It depends on which state you choose. In the United States there is a tremendous difference in the attitudes towards financial institutions between the states northeast and the former frontier, the western states, the southwestern states.

If you are interested in how that has developed the U.S. economy, John Kenneth Galbraith's book Money goes through that to some extent.

If you choose states such as Texas, rehabilitation does work.

If you would like some examples, Bankers' Protective Life Insurance Company came through rehabilitation and had total assets of only $200,000. It now has capital and surplus of something like $4 million.

Atlantic & Pacific Life in Georgia was sold out of rehabilitation, as was State Mutual in Georgia. The big example in the United States was Executive Life, a huge corporation that has now come through rehabilitation and continued.

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But let's not restrict our views to the United States. If you want an example of why there should be rehabilitation, look to Japan, look beyond North America. Fifty years ago the war ended in Japan, and you can imagine what those life insurance companies looked like. The assets in the former colonies of Korea and Taiwan had all been seized. The bonds they had bought in the industries around Tokyo Bay were of questionable value. The claims were considerably higher. Those companies were all insolvent. They went through a rehabilitation process, and those companies today are by far the largest insurance companies in the world.

Let me just mention that four of them have offices in Toronto for investing assets in Canada. The two largest, Nippon Life and Dai-Ichi, invest in the neighbourhood of $5 billion each in the Canadian economy. They're not doing business here; they are simply investing in the Canadian economy. These are companies that under the OSFI situation would have been wiped out in 1945 and wouldn't even exist today.

I suggest that the way in which they treated the companies in Japan at the end of the war that allowed them to grow would have been far preferable to what's being done with Confederation Life, where millions and millions of dollars are being spent on rehabilitators, liquidators, lawyers, and so on. We're losing a couple of thousand jobs. We're losing a significant financial institution - all because we have no rehabilitation program.

So those are the three points I wish to raise.

The Chair: Thank you, Mr. Dowsley.

What type of different system would we have needed in Canada to have so-called rehabilitated Confederation Life rather than putting it under?

Mr. Dowsley: Let me just go over what happened in Japan. We were not able to do this under the law in Canada, and I don't believe we will be able to after Bill C-100.

Dai-Ichi was a mutual company. Nippon Life was a stock company. Those are the two biggest companies today. It's interesting that one was stock and one was mutual. What they did first was eliminate all shareholders' equity, which made sense because it was negative. They then looked at the assets and at the reserves that were required for the policyholders. There still were not enough assets. So they simply said that every policyholder now has the same policy except that it's reduced to 90% of what it was, or 78%, or whatever the number was for the particular company. The companies kept on operating, premiums were collected, claims were paid, and everything kept on going.

The Chair: By way of contrast, under the current system and as proposed under Bill C-100, we have an industry-based association that will pay off 100% to all policyholders, CompCorp.

Mr. Dowsley: With limits?

The Chair: Yes.

Mr. Dowsley: In the Japanese example, they said, okay, everybody has 90%. If CompCorp picked up the 10%, then that would be fine, and the company would continue.

There were about two dozen companies. It's interesting. You would think a company such as Sumitomo is part of the Sumitomo group, and it is, but it is a mutual company. That's why, even though the shareholders' equity was removed, old friendships still exist and continue. But those companies continued.

The Chair: You're saying that really the difference, then, is that the company was allowed to continue as opposed to being picked up by the liquidator or trustee in bankruptcy, or whatever you want to call it, trying to sell off what business they could and then the industry, through CompCorp, picking up the difference between the 78% that the assets would cover and the remaining 22% that CompCorp was obliged to put up.

Mr. Dowsley: Yes.

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The Chair: The main difference is that Confederation Life no longer exists with its employees, and its business has gone elsewhere, but its policies will be honoured.

Mr. Dowsley: Yes, and we have lost another financial institution.

The Chair: Yes.

Mr. Dowsley: The concept of an insolvent company is interesting. A lot depends on what accounting system you use. It could be argued that every life insurance company has been insolvent at least twice, once during the Great Depression and the other time during the extremely high interest rates in 1981, when the value of bonds and mortgages went down. Depending on which accounting system is used, that's probably quite true. So we have had a kind of industry-wide rehabilitation, because we have used rules that recognize that life insurance is a long-term process and there are going to be some ups and down along the way.

The Chair: On point two that you made, about the signing actuary, you're saying that in Bill C-100 we have prohibited the signing actuary from being the chief financial officer of an insurance company, presumably to avoid conflicts of interest. You're saying just the opposite: that they are part of key management and are very responsible for a large percentage of the profits, and they should be right up where we can see them and where they can be participating fully and taking responsibility for it.

Mr. Smith, who preceded you by two witnesses, said that it would be better if the signing actuary was an outside person, using the accountant's analogy - an independent professional who would live and die by his or her professional reputation.

Mr. Dowsley: I saw a part of it on television. I might be incorrect, but I think he was saying that accountants produce statements and they are looked over or audited by outside accountants who say, as independents, that they believe the numbers are correct, and that the same process should occur for actuaries, that the signing actuary would produce his statements and his numbers and an outside firm would look them over and say, ``We have, in effect, audited this and we believe that it's true''.

The main problem with this shifting of balance within the industry is that the signing actuary may no longer be as high up the ladder as he used to be. It was always that the signing actuary reported directly to the president. We are seeing in some places that he is now being removed by a level. Once you get down a little bit lower, you're no longer privy to all that's going on, and it's very difficult to set accurate reserves when you are not privy to long-range decisions that are being made and fundamental decisions that will alter the composition of the balance-sheet.

Mr. Fewchuk: What side do you take on the issue of full disclosure?

Mr. Dowsley: Oh, I'm very much in favour of full disclosure. Now they have a thing called minimum continuing capital and surplus requirements, or MCCSR. Companies don't tell what their numbers are. I don't understand why the strong companies don't come out and say that their company has a ratio of 180% and be proud of that.

Mr. Fewchuk: You referred to two accounting systems. With full disclosure, that would be another protection, where everybody could see. Would it not fall into line?

Mr. Dowsley: Absolutely, yes.

I would point out that one of the first companies to stop releasing its statements and information under the change in the law, whenever that was, was Confederation Life. Those statements suddenly were not available to anybody.

Mr. Fewchuk: That's very interesting.

Mr. Dowsley: You can understand why.

Mr. Fewchuk: Yes.

The Chair: You have incredible experience in the insurance industry itself, Mr. Dowsley, having spent over 20 years with Crown Life, which experienced real difficulties but which was ``rehabilitated'' and continues to exist and which, I understand, is now flourishing. Do you see this as an example of rehabilitation, along the lines you've suggested to us?

Mr. Dowsley: Yes.

Let me draw what I think was the big difference between Crown Life and Confederation Life. The stories were very similar. Both of them decided that they would enter the banking field - in fact, most life insurance companies did at that time - by taking in large five-year deposits, GICs, and investing in mortgages. Both Crown and Confederation ended up with 40% to 42% of their assets in mortgages, as compared to a North American average of 20% to 22%. They doubled it.

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At that time they did not have some of the financial tools that are available today through different techniques of securitization. However, in 1990 or thereabouts Crown Life recognized that it had a big problem and started setting up reserves and taking big hits every year. But Confederation Life did not do that. In fact, from when Confederation Life issued its last statements to when it was declared insolvent was a matter of.... The statements were as of December 31 and they were declared insolvent in August, so in an eight-month period their assets went down by $800 million.

I don't believe they lost $800 million in that period. I believe those assets had not been recognized fully soon enough and that their statements.... Well, you have a lot of different accounting rules and variations there. But how could they have lost $800 million in that time?

Another question - and I don't understand why it hasn't appeared - is how could they possibly have sold those securities in Europe if they had made full disclosure of that? Nobody seems to be inquiring into this.

The Chair: Mr. Dowsley, do you have any concluding words for us before we adjourn?

Mr. Dowsley: Perhaps one thing. The problems at Confederation Life were caused because they looked across the street and said the other guy's job is always easier. In the public we look and we say that the MP's job is pretty easy, that anybody can do it. The life insurance people looked at the bankers and said, ``We can do that too'', and they got into the GIC business and they destroyed the fundamental aspects of their balance-sheet. Instead of having a large number of unsophisticated, widely spread, small stakeholders, they ended up with a small number of big stakeholders who were professional, full-time investors for those pension funds.

Not in Bill C-100, but at some later point, you're going to be looking over the powers that should be going between insurance companies and banks and all that, and I hope you will keep in mind that each of them will view the other as having a job that's much easier than the ones they're doing and they could do it with their hands tied behind their backs.

The Chair: On that note, Mr. Dowsley, thank you for your wisdom and for the experience you've brought to our deliberations. I think there is merit in the three points you brought before us, and we will look to them further.

Colleagues, I neglected earlier to introduce Pierre Rodrigue, who will be serving us in the capacity as clerk, along with Martine Bresson, and will be playing an instrumental role in our travels on the pre-budget this fall.

Also, I understand that we have agreement to begin our pre-budget consultations the day after Parliament returns in September, which will make it Tuesday, September 19. We will be looking forward to submissions from those people in Canada who have words of advice on our future budget.

We stand adjourned until 9:30 tomorrow morning.