Bill C-37 Update: OSFI Defines ‘Insuring in Canada a risk’

The Office of the Superintendent of Financial Institutions (OSFI) in May 2007 announced that the coming into force of certain amendments to Part XIII of the Insurance Companies Act (ICA) would occur on Jan. 1, 2009. The amendments will affect all foreign insurers and reinsurers carrying on business in Canada as branches. They will also have a significant effect on whether new foreign insurance insurers and reinsurers will decide in the future to become licensed in Canada. The amendments will apply in the same manner to both foreign insurers and reinsurers.

The amendments were intended to harmonize the ICA with the Winding-Up and Restructuring Act. OSFI was concerned that in the event of the insolvency of a Canadian branch of a foreign insurer, foreign policyholders could potentially argue that they were eligible to be covered by the assets that were vested in trust in Canada. In such a situation, there might be an inadequate amount of assets in Canada for the Canadian policyholders that the assets were originally intended to cover. The changes to Part XIII are intended to eliminate this concern.

As a result of the amendments, there will be a change to the basic test of when a foreign insurer is required to report its Canadian business to OSFI and to maintain assets in a vested trust account in Canada to cover them.

S. 573 of the ICA provides that a foreign insurer shall not “insure in Canada a risk” unless it is authorized by an order of the superintendent. OSFI has issued an Advisory on the Insurance in Canada of Risks (Advisory) that will provide guidance on when a foreign insurer will now be considered to be insuring in Canada a risk.

Historically, the test for determining when business should be reported to OSFI was whether the risk was located in Canada. The provinces use this same test for the payment of premium tax. For example, if a real estate property is located in Ontario, it would be considered a Canadian risk and reported to OSFI regardless of where the underwriting of it occurred. Ontario premium tax would also be paid on the amount of the premium.

The basic change that has occurred is this: Where the risk is underwritten, rather than where it is located, will be the most important determining factor as to whether it should be reported to OSFI. Payment of premium tax will continue to be required based on the location of the risk.

The following is a summary of the new rules:

1. Risks located in Canada but insured outside Canada by foreign companies will no longer be subject to Part XIII requirements (including reporting investing requirements); and

2. Risks located outside Canada but insured in Canada will become subject to Part XIII requirements.

S. 2 of the Advisory outlines a number of criteria used to determine whether a foreign insurer is insuring a risk in Canada. It says:

(a)the location where interaction leading to the formation or renewal of a policy takes place having regard to:

(i)the location of the policyholder;

(ii)the location where the foreign insurer receives an application for a policy;

(iii)the location of the person who, on behalf of the foreign insurer, negotiates the terms and conditions of a policy;

(iv)the location of the person who, on behalf of the foreign insurer, communicates an offer or acceptance of an offer, to provide or renew coverage;

(v)the location where the acceptance of an offer to provide or renew coverage is received by the foreign insurer; and

(vi)the location where the policyholder receives the policy.

(b)representations made by the foreign insurer with respect to the location where it will interact with the policyholder in the performance of activities related to the policy (including providing information about the policy, receiving premium payments and settling claims) as well as whether it will decide all matters related to the policy from that location or act as a liaison between the policyholder and another office;

(c)the jurisdiction with which the policy is most closely connected, having regard to the applicable law;

(d) the location where the foreign insurer promotes its products.

The Advisory indicates the business model of each foreign insurer must be considered on an individual basis in order to determine if it is insuring in Canada risks. It also indicates that the criteria in section 2(a) above are the most important factors.

In addition, the Advisory includes four scenarios that provide examples of when a foreign insurer will be considered to be insuring in Canada a risk. It also includes two scenarios of when a foreign insurer will be considered to be insuring outside Canada a risk.

It is important to note that the Advisory also indicates the following: where a foreign insurer is not insuring in Canada a risk, the ICA does not restrict the foreign insurer from carrying on any activity or business in Canada. As a result, a foreign insurer could still be involved in underwriting, policy administration or product development services in Canada.

OSFI says various transitional rules will apply to the implementation of the amendments. For example, OSFI will presume that all risks reported on the books of a Canadian branch as of Jan. 1, 2009 will be insured in Canada and subject to the Part XIII requirements unless the foreign insurance company satisfies OSFI that the risks were insured outside of Canada.

IDENTIFYING RISKS

OSFI says it expects foreign insurers and reinsurers to use their best efforts to identify all the risks located outside of Canada — risks that were insured in Canada prior to Jan. 1, 2009 — and comply with the Part XIII requirements in respect of these risks. For example, a foreign reinsurer underwriting a book of Caribbean business from its Toronto office would now be required to establish reserves for this business, notwithstanding that the actual location of the risks was outside Canada.

OSFI has also indicated it would likely allow a foreign insurer that has vested assets in Canada with respect to policies that were not insured in Canada (where the underwriting had occurred originally outside of Canada), to have the vested assets released. It is likely there will be a significant onus placed on a foreign insurer to satisfy OSFI that the criteria for not being considered to be insuring the risk in Canada have been met before assets will be released. OSFI must be careful in agreeing to asset releases, since it might become subject to criticism that it is allowing security that insureds and cedants believed they had in Canada to be given up.

OSFI has done a significant amount of consultation with the insurance industry over the past year. It has released a number of different versions of the Advisory for comments. One of the most common criticisms of OSFI’s approach is the lack of any “grandfathering” with respect to current business that was underwritten in Canada that relates to risks located in other jurisdictions. Effective Jan. 1, 2009, it will be necessary for foreign insurers and reinsurers to evaluate their books of business to decide what should be reported and what should no longer be reported. In some cases, it may be necessary for foreign insurers and reinsurers to vest substantial additional assets in trust on that date to cover risks outside of Canada that were underwritten by their Canadian branches.

Many foreign insurers will likely incur a significant amount of additional expenses in order to comply with the changes. In particular, many foreign insurers will spend large amounts of money making I.T. systems changes. It will be necessary to develop new I.T. systems to allow an ongoing tracking of the location of risks for the purposes of determining premium tax payable while at the same time complying with new rules that are based on where the underwriting activity is occurring.

HOUSEKEEPING APPLAUDED

Clearly, positive benefits will result from the amendments. There is general agreement, for exa mple, that it is desirable to have consistency between the ICA and the Winding-Up and Restructuring Act, in order to avoid problems in the event of the liquidation of a foreign insurer. The changes will also make it easier for foreign insurers to insure Canadian risks on an unlicensed basis. Moreover, the amendments will make it easier for foreign insurers licensed in Canada to write books of Canadian business at their head office that will not be subject to the normal OSFI reporting and asset vesting requirements.

The changes also eliminate an issue related to the requirement that foreign insurers must report small amounts of Canadian business that form part of global coverages being provided. For example, a global property policy underwritten at the head office of a foreign reinsurer for a large multinational corporation might include only a small amount of the premiums that could be allocated to Canada. Under the new rules, this business would not have to be reported to OSFI since the underwriting of it would occur outside of Canada. Previously, it would have been necessary to identify, allocate and report to OSFI the premiums for the small amount of incidental Canadian business.

OSFI has indicated during various industry consultation sessions that the amendments are not intended to stop new insurers from becoming licensed in Canada, nor are they intended to require existing ones to leave if they do not wish to. However, one practical effect of the changes is that some foreign insurers may now question whether there is any reason to become or remain licensed in Canada. Some foreign insurers may now decide to withdraw their assets and do all future underwriting from their home jurisdiction. It may also be possible for foreign insurers that are in run-off in Canada to now get a release of their vested assets and to withdraw from Canada. Many foreign insurers and reinsurers will want to continue to be licensed in Canada regardless of changes in the rules due to the consequences of doing business on an unlicensed basis. Unlicensed insurers have a competitive disadvantage as a result of the requirement for their clients to pay the federal 10% excise tax on premiums. Unlicensed reinsurers are at a competitive disadvantage due to the requirement to provide security in Canada in order for Canadian cedants to be able to take credit for the reinsurance. The reinsurance regulations under the ICA also limit the amount of unlicensed reinsurance that can be used by a cedant to 25% of gross premiums written (up to 75% of gross premiums written can be ceded to licensed reinsurers).

In the short term, there will likely be some degree of uncertainty as foreign insurers attempt to comply with the new rules. It is also likely OSFI will receive a number of requests for rulings or interpretations with respect to particular fact situations. Since no two foreign insurers operate in Canada in exactly the same manner, it will be necessary for each company to make a detailed review of its own particular situation in order to determine how best to be able to comply with the changes to Part XIII.

In some cases, insurers and reinsurers will have to change their procedures for doing business in Canada in order to be able to comply with the requirement to show that insuring in Canada of risks is occurring. In addition to having at least some underwriting or promotion activities occurring in Canada, it will also be important for insurers and reinsurers to provide evidence that the jurisdiction of the policies is under Canadian law and demonstrate the expectation of insureds that licensed policies are being obtained.

It is also likely that OSFI will impose much of the responsibility for ensuring compliance with the changes to Part XIII on the auditors, appointed actuaries and chief agents of foreign insurers and reinsurers. It will not likely be practical for OSFI during the course of its normal process to conduct an examination of a Canadian branch and review every individual risk to determine if it is properly being reported.

The changes to Part XIII represent a major policy initiative of OSFI and reflect an important shift in how foreign insurers and reinsurers will be regulated (or not regulated) in Canada in the future. Notwithstanding the problems and expenses that will be incurred during the transition period, it is likely a more clear and comprehensive set of rules will be established that will assist foreign insurers and reinsurers in determining when they are required to report business to OSFI and maintain assets in Canada. It is also likely the advisory that has been issued will be revised and evolve over time to reflect the practical issues that are encountered by foreign insurers and reinsurers in dealing with the important changes that OSFI will be implementing.