Unprecedented Depravity in a Life Insurance Company

A Disgrace to the Canadian Actuarial Profession

“How Camest Thou in this Pickle, Trinculo?”


Sharpening the Cutlasses for CLICO Canadian CEO Gene Dziadyk


A Complicit Regulatory Environment Bitten in the Ass

My history at CLICO began as the Buck consultant valuation actuary for the year 2000, which led to my appointment as CEO in 2002.

Ewart Williams remarked in Feb 2009, “Lack of robust capital requirements contributed greatly to CLICO’s problems,” but notwithstanding CBTT’s Big Steal, problems also arose from CBTTs abrogation of its responsibility to enforce the regulation through the Insurance Act (IA) to introduce and to administer appropriate “contingency reserves” and “Minimum Basis,” imposing capital requirements as I had urged the Supervisor of Insurance, Erica Joseph to act by my letter of Jan 8, 2002. I was ignored.

As CEO, I tried to bring change to CLICO, if it wasn’t already too late. The alarm bells were ringing, but nobody cared. I was set up. The CBTT regulator was complicit. Nobody wanted to change anything. 

A former CLICO executive observed, “Banks were lending huge amounts to CLF companies based on dated and consolidated balance sheets (i.e. Lascelles, HCL). Why? Because they knew regulators, mainly due to Monteil and his web of relationships, stood behind the Group, which made them view the Group as untouchable.  In effect, a complicit regulatory environment got CLF those loans.”

That seems right for that level of borrowing, certainly couldn’t be based on performance or capital resources.  It screamed out weird. Regulators were complicit, or at best turned a blind eye to brazen violations of IA prohibitions. CLICO must operate at arms-length from its directors.

There was a presumption that CLF was a safe environment for state-owned enterprises to invest vast sums of taxpayer money in the subsidiary CIB when Monteil was Chairman of CIB.

I had variously reported as CEO that a company cannot directly or indirectly deal in its own shares or lend or make advances on the security of its own shares [IA sec 48 (a)]. These rules are intended to prevent self-dealing. Loans to CLF would be backed by CLICO shares, “lending on shares” and hence would be against intent if not prohibitions of this provision. Yet, CLICO loaned vast amounts to CLF, brazenly and in plain sight to the regulator, the “current account,” on uncontrolled terms, with a CLF IOU obligation to CLICO backed by CLICO’s own shares, creating phony capital in CLICO.

CBTT allowed Monteil to pull Government bonds from CLICO statutory fund in 2006 without actuarial certification, in breach of the IA, as collateral for an acquisition. In fact, CBTT Sept 6, 2006 letter asks CLICO to put back $483 million in government bonds that it recklessly and unlawfully released 4 months earlier.

Express of Nov 28, 2010 reports, “Attorney Bindra Dolsingh says he has proof that CLF group was allowed access to CLICO’s Statutory Funds… and implicated Central Bank officials who allowed [it]”.

Today, GORTT and CBTT are being disingenuous claiming CLICO and CLF were Ponzi schemes, along with CIB, because they were what CBTT allowed them to become. I warned of violations of the IA in 2002, and those went back to 1995. GORTT rang the bell because it got caught with the Sept 2008 worldwide financial crisis, hoisted with its own petard, playing along in that game with massive taxpayer capital invested by wayward state-owned enterprises. CLICO could not carry on as it did, all those years, had CBTT done its job and, in effect, CBTT buried CLF and CIB time bombs in CLICO’s balance sheet. 

Gene, the CEO Machine

CLICO was distinguished by a portfolio of trophy assets: methanol plants, commercial real estate, and the likes. No, CLICO was not a conglomerate. Chairman Lawrence Duprey, the man with the golden touch, operated his “capital appreciation” business model acquiring assets all over the planet with policy premium from a delirious public by selling like hotcakes EFPA policies paying high rates of interest. 

The closest I ever got to methanol was watching my uncle back on the farm in Saskatchewan making whisky with wood alcohol, and I wasn’t an architect, these were tall buildings and I’m afraid of heights. So thank goodness for the agreement that I would “move CLICO to a completely different platform,” but alas, it was not specified what that platform would be, or more importantly, what it needed to be.

 Life insurance is a long-term business based on trust, borrowing money from the public with financial product, “debt security” policy contracts that are not securities for purposes of securities laws. As it is a privilege to take the public’s money without the stringent requirements of a prospectus, the nature of the insurance company is in the sincerity of promise; a legitimate insurer holds capital assets to secure the “policy liability” accounting provision with a high degree of confidence, or it’s a sham, “heads I win, tails you lose.” 

There was clearly excessive asset default, asset depreciation, and liquidity risk in that balance sheet, and a substantial leveraging of capital, insufficient to sustain adverse experience but also to grow and to meet goals.

I had intended a balance sheet restructure, moving to fixed-income securities (i.e. bonds, mortgages) and an agency regeneration to move off high-interest EFPA, developed a family of mutual funds (no guarantees) to build on CLICO expert asset manager franchise and to move risky assets off the balance sheet. 

Large holdings of illiquid private assets with highly speculative marked-to-model valuations produced problems for CLICO policyholders, to the extent the “authorities” would later sell them, and that I had tried to address as CEO; you don’t sell methanol plants overnight to pay claims and thus there becomes a reliance on new money that is uncontrolled, can spiral into disaster and policyholder moral hazard.

In fact, such excessive asset risk was the common factor of many financial institution insolvencies at the time (i.e. Confederation Life, Executive Life, Mutual Benefit, Standard Trust, Sovereign Life).

Yet, as an actuary and fledgling CEO, I had more basic questions than answers about what to do.

The cost of borrowing was exceedingly expensive. My first question was that as policyholders were getting a spread over the comparable treasury, then what return would subordinate corporate bondholders require? What should be the expected return on shareholder equity (ROE)?

As nobody knows if the price of an asset will rise or fall the very next day, capital is needed to protect policyholders, but there’s a limit on how much capital cost can be passed through to customers. How much asset risk is too much, or perhaps, as little as possible, leave asset bets to shareholders in their own accounts?

It bothered me that by acquiring risky assets, I would be investing in other businesses, betting those CEOs know how to run their business to make money so they will make me look like I know how to run my business, essentially exchanging CLICO’s credit rating for those of the securities it holds.

As I was sorting my way through the challenges of fitting risky assets into the nature of the life insurance company, I needed like a hole in the head the looming imposition of a cookie-cutter version of the Canadian regulatory model, the Minimum Continuing Capital and Surplus Requirement (MCCSR) as administered by the Office of the Superintendent of Financial Institutions (OSFI) incorporating the CIA’s “Canadian Asset and Liability Method” (CALM) Standard of Practice (SOP) for the determination of the policy liability.

A Canadian insurer wishing to invest in risky assets must put up the capital required by the MCCSR (i.e. public equity at 35% of market value, private equity at 40% of model value, 0% for treasury). Canadian insurers hold about 150% of such base requirements. Excessive asset risk indicates inherent instability, requires a very large capital base to bear the volatility; the large Canadian insurers invest so heavily in risky assets that over 50% of their total capital is held to protect policyholders from self-imposed asset risk.

There is capital at risk, so there must be capital costs, but what are the real capital costs in a zero-sum game, and who is paying them? Perhaps no one, at least for now?

Why is that? CALM and thus MCCSR actually encourage asset risk. Is this too good to be true? Is $1 of stock worth more than $1 of treasury bond? The rest of the world must wait for gains to be realized through the market mechanism. I refused to go down that road when I served as the CLICO valuation actuary.

Shareholders don’t need an insurance company to make money betting on risky assets, interest rates, or currency, and attempting to do so would logically deliver a relatively low ROE and surely appear abnormal. That is, excessive and volatile earnings that may arise from credit spreads and asset appreciation will not provide a sufficient margin to offset the effects of the increased capital requirement; the benefit of a higher return is logically more than offset by higher equity in ROE denominator.

Assets are marked-to-market (and model) but Canadian insurers are banging out ROEs of 10-15%, a sign there’s something fishy with the accounting. Canadian insurers, like CLICO, albeit in a small equity market, hold private energy assets, such as oil and gas properties and private equities. Oil and gas is a business, so I asked, “what the hell do oil and gas have to do with insurance?” What’s holding all this up?

I was fortunate to collaborate with compatriot, Michael Hawkins exploring these questions in formulating a strategic plan for CLICO, and Michael gives me too much credit for my contribution.

I struggled to re-price EFPA using the legendary actuarial “Embedded Value” (EV) methodology. Actuaries crunch EVs to price not only policies but entire insurance companies by projecting future profit, including the performance of the supporting risky assets and the release of the capital over time, and then discounting that series of cash flows back on some assumed ROE interest rate.

Now, EVs are so important that Canadian mutual insurers demutualizing in the late 1990s spent many millions of dollars on independent actuaries crunching EVs as input to the formula actuaries devised for the distribution of the demutualized stock company shares among participating policyholders, and also crunching equally famous “asset shares” going back 100 years to roll forward the net assets for various groupings of policies (i.e. historical premiums and investment income less the policy benefits and expenses).

I can’t make EVs work with EFPA. Scratch asset shares, I’m not going back 100 years, so what was I missing, what’s the secret to the EV?

The famous seminal Canadian actuarial paper, “Embedded Value Calculation for a Life Insurance Company” provided all the answers, “the provisions for adverse deviation [in the policy liability accounting estimate] are profits held back in the reserves.”

Well, “PADS are for Profit” will come as quite a surprise to shareholders grappling with IFRS:

  • Those provisions are not for profit, they’re held for uncertainty in the accounting estimate, so what the hell are you doing discounting them?
  • As for projections, they’re hunches, not the market’s implied forward rates.
  • There is a misguided preoccupation with an arbitrary ROE. In what other business do they impose ROE for expected overall aggregate compensation for risks taken; you impose risk premium, and for the insurance company the capital cost, for each specific risk taken and the ROE is the output result of the risks taken.
  • Insurance policy is a debt security, not unlike a corporate bond. Bonds don’t have EVs. EVs are garbage.

As for the demutualized stock company, no stone could be left unturned or cost spared in the pursuit of equitable distribution of shares. Alas, garbage EV input into an entirely arbitrary distribution formula helped to create the monstrosity of the participating account in today’s Canadian stock company.

There was an incident I was involved with at Manufacturers Life’s demutualization in 1999 that illustrates, in my view, the wrong-headedness of the share distribution imposed by the actuaries and their EVs and asset shares. Manufacturers Life, conforming to these actuarial theories, behaved disgracefully that, in comparison to its branch operations in the USA and Hong Kong, policyholders in its Barbados branch of 100 years received no shares in the demutualization, apparently because the branch had poor financial results. 

Well, whose fault was that? Were the operating expenses too high? Were the policies underpriced? Were the assets poorly selected, underperforming? Bajan policyholders were equal owners of the entire enterprise in terms of voting rights, the only thing that counted, among all the participating policyholders. Local policyholders do not have ownership rights in the local branch. These Bajans were a drop in the bucket and their proper allotment went to others who won the actuarial lottery in a zero-sum game.

Back from the past, I was still looking for answers and there’s a celebrity CEO of a very large Canadian insurer who was very comfortable in his own skin, and he has all the answers:

To meet our long-term obligations, we invest for the very long term…  much as a pension plan… capital is invested in debt and equity, public and private… despite the fact we benefit by this long-term view, investments are marked to market… volatility in the short term… we expect positive results from real estate, energy, oil and gas, timber and equities over the long term.”
And I’m thinking, Geez, this guy makes Duprey look like a boy scout.”
  • He even invests capital in risky assets, requiring even more capital and adding to the capital cost just to protect the capital. How does that make any sense to a shareholder? Where do you draw the line on that?
  • What’s he talking about “much as a pension plan?” They don’t hold capital or pay taxes.
  • Net Income volatility is a sign that something is very wrong, and on its face requires even more capital. In fact, it’s worse than that. You can thank IFRS to take the eye off the volatility ball. Net Income is a smoothed illusion, the closest thing to what’s roaring under the surface is Total Comprehensive Income.
  • He’s blaming investments marked to market, disrupting his cushy world when that’s the real world. The long run is a free lunch for these guys, as it’s rare that any company meets even the 3rd year of its projections. Ok, for a given $1 of policy premium, risky assets are expected to out-perform treasuries in the long run through the market mechanism, but that needs shareholder capital in the short run incurring capital costs to sustain volatility and adverse experience in the instance that they don’t.

Fast forward briefly from 2002 to 2007; CBTT got around to a new regulatory model, engaged Canadian consultants for a cookie-cutter version, proposing to abolish the statutory fund and regulate a local company’s foreign business, holding companies and groups, all of which I had argued was misguided but to little avail. I alone argued for the retention of the statutory fund, and miraculously it did survive.

So, I was at odds with the contemporary big picture, the “Insurance Core Principles” (ICPs) developed by the International Association of Insurance Supervisors and specifically at odds with the Canadian model administered by OSFI.

Isn’t it the public, and only the public that’s supposed to be the 3rd party beneficiary of ICPs? Well, if that’s so, ICPs miss the trees for the forest, overbearing and wholly inadequate where the rubber hits the road.

Insurance supervisors to their delight regulate holding companies, jumping on planes going hither and yon is crazy. Even crazier is inciting an insurance company into a conglomerate within a conglomerate holding insurance company subsidiaries so it can report consolidated regulatory capital that double counts the real capital locked up in foreign jurisdictions. These subsidiaries should be sisters in a real holding company.

I saw my primary mandate, as I expected CBTT and OSFI to see its: ensure that those who bought policies in Trinidad and Tobago, and in Canada, whether from a local or a foreign company, are the first and only priority and will receive the benefits that they are owed. 

Alas, with the inevitable “failure” of CLICO, and despite my recommendations, CBTT ran more in line with the ICPs, and the local policyholders, who should have been its first and only priority, suffered grievously.

I drew “the line of death… CLICO has very serious problems… and time is running out.”

 Well, that pretty much ran out my time as the CEO. Duprey’s heart wasn’t in it, and why should it be? That Canadian model would grease the skids, and who is Gene Dziadyk anyway? What Duprey’s heart was really into was me pumping up sales to move CLICO to the new platform of international drinks. I was sacked, Sharpening the Cutlasses,” within 4 months; I should have taken notes from the uncle with the homebrew.

Sharpening the Cutlasses for CEO Gene Dziadyk

The Guardian reported on Dec 5, 2002 that Peter Salvary was the go-to guy for business magnate Lawrence Duprey… when any part of his massive CL Financial empire is seriously threatened.”  

Salvary was pressed into action in the prior year to defend CLICO when Trevor Sudama “used an official document to draw attention to the insurance company’s technical insolvency.” 

And again it was Salvary to the rescue, the management sharpened the cutlasses for me: 

As he related to the backroom maneuverings, Salvary explained CLICO executives feared the CEO, Canadian actuary Gene Dziadyk, would go to the media with his complaints about the way CLICO was being run… We wanted to fire him but we wanted to manage the fallout… Management got really angry when Dziadyk began to criticize the compensation of CLICO agents, especially the 20% commission from the new high-interest, executive annuity products… key executives complained that Dziadyk was “very critical” of the company and suspected that he might attempt a “scorched earth” policy… We believe he might be able to hurt us.”

So they went to the media. Did they think I was going to set fire to the place?  The Guardian went on:

CLICO had consistently run afoul of the Supervisor of Insurance with regard to the deficits of the statutory fund. (Table listing year-by-year deficits going back to 1995) Carolyn John explained the statutory fund is consistently in deficit is because… Supervisor refused to value at market value. But according to the table John provided… In 2000 the deficit was $563.6 million,” or US $85 million.

“Scorched earth” is corporate parlance for “poison pill” and CLICO had gulped the “asset appreciation” business model poison pill years earlier, and all bulked up in borrowed trophy assets that had absolutely none of the attributes of its expensively acquired fixed-term liabilities, it was staggering around, ready to fall over.

I presented to the CLICO board on June 17, 2002, “Establishing the Current Position,” which outlined what needed to be done, drew the line of death, scared the hell out of them, and on June 20, 2002:

It would be a mistake to underestimate the severity of CLICO’s position, including a precarious balance sheet, a lack of profit and direction, and time is running out.  Liabilities outperform assets by a margin of nearly 10%.  How long can that go on? This is intuitively obvious and strikingly clear on proper accounting, but measurement on the arcane 1966 regulatory “funds accounting” abomination masks CLICO’s slide into oblivion… Funds accounting has spawned a line of thinking that is wrong and dangerous. 

The alarm bells were ringing, but nobody cared. I was set up. The CBTT regulator was complicit. Nobody wanted to change anything. 

Please leave a comment with impressions and suggestions. I can be reached at geneD@avenueDconsulting.ca

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