Considering Capital Movement

In the February 2009 edition of Canadian Underwriter, we provided an overview of the Discussion Paper on OSFI’s Regulatory and Supervisory Approach to Reinsurance, released by the Office of the Superintendent of Financial Institutions (OSFI) in December 2008. This article provides an update on the status of OSFI’s review of its approach to reinsurance.

OVERVIEW OF THE DISCUSSION PAPER

OSFI’s discussion paper provides an overview of the Canadian regulatory and supervisory regime governing reinsurance, summarizes a number of current OSFI initiatives relating to reinsurance and requests input on the direction of reinsurance regulation and supervision. In particular, the discussion paper addresses the following topics:

Unregistered reinsurance

• Collateral requirements for unregistered reinsurance.

• 25% limit on risks ceded by property and casualty insurers to unregistered reinsurers.

• 15% limit on the use of letters of credit as acceptable collateral for an insurer to obtain credit where it has ceded risks to an unregistered reinsurer.

• Mutual recognition regime for reinsurance supervision and risk-based collateral requirements.

• Approvals for unregistered reinsurance with related parties.

Registered reinsurance

• Capital requirements.

• 75% fronting limit applicable to property and casualty insurers.

• Approvals for registered reinsurance transactions.

Governance

• Guideline on Corporate Governance.

• Update of Guideline on Sound Reinsurance Practices and Procedures (B-3) to address OSFI’s expectation that insurers establish and implement sound reinsurance cession practices and procedures.

• Guideline on Reinsurance Agreements (B-13) to set out prudential considerations relating to time lags in reinsurance arrangements and address wording used in reinsurance agreements.

• Insolvency and other clauses in reinsurance agreements.

RESPONSES TO THE DISCUSSION PAPER

We understand OSFI has received approximately 30 submissions in response to the discussion paper, reflecting the fact that the issues addressed in the discussion paper are of central importance to insurers and reinsurers.

In some cases, the submissions reflect the differing views and interests of stakeholders. The European Insurance Committee (CEA), which represents European insurers and reinsurers, and The General Insurance Association of Japan, which represents the non-life insurance industry in Japan, have expressed their opposition to any collateral requirements in connection with unregistered reinsurance. Other parties, such as the Canadian Life and Health Insurance Association and the Canadian Institute of Actuaries, have expressed the view that in the absence of an effective system of mutual recognition, some form of collateral requirements is unavoidable. As well, the CEA and The General Insurance Association of Japan support eliminating the 25% limit on unregistered reinsurance and the 75% fronting limit. In contrast, the submission from the Canadian Institute of Actuaries expresses the view that these limits serve important functions.

There is also debate among Canadian stakeholders. The Insurance Bureau of Canada’s submission recommends a risk-based approach to collateral requirements. The Canadian Life and Health Insurance Association’s submission recommends that OSFI be cautious in this area and take a wait-and-see approach.

In other cases, there is some consensus. For example, the submissions we have reviewed are generally supportive of eliminating or modifying the 15% limit on the use of letters of credit as acceptable collateral. There also seems to be general support for the idea of mutual recognition, although there are different views on what this should mean.

AMENDMENTS TO PART XIII OF THE INSURANCE COMPANIES ACT

In considering the issues addressed in the discussion paper, it is important to be aware of amendments to Part XIII of the Insurance Companies Act. Amendments changing the concept of “insuring a risk in Canada” to “insuring in Canada a risk” will be implemented on Jan. 1, 2010. This will shift the focus from the location of the risks to the location of the insurance activities in determining whether an insurance activity is occurring in Canada and is thus subject to Canadian supervision and regulation. OSFI’s interpretation of “insuring a risk in Canada” is set out in its revised Advisory Insurance in Canada of Risks released in May 2009. (See article on page 18.) One consequence of the amendments to Part XIII is that reinsurance that was previously registered may become unregistered (i. e., because the reinsurance is conducted outside of Canada, notwithstanding that the risk reinsured is within Canada). This raises the possibility of federally regulated insurers inadvertently becoming offside the 25% limit on unregistered reinsurance.

To address this problem, OSFI issued a release on June 19, 2009 providing that it will exercise its discretion in adminis-tering the 25% limit as follows:

• OSFI will consider all premiums paid or payable by the cedant to registered reinsurers prior to or on Dec. 31, 2009, to continue to be considered registered reinsurance for the sole purpose of calculating the 25% limit beyond that date.

• In addition, in their annual calculation of the percentage of unregistered reinsurance, as applicable after Dec. 31, 2009, cedants will be permitted to continue excluding the premiums paid or payable prior to or on Dec. 31, 2009 that were up to that date excluded from this calculation.

The June 19 release states that any cedant that benefits from these discretionary relief measures will thereafter be expected by OSFI to refrain from ceding additional risks on an unregistered basis until their ratio of unregistered reinsurance (calculated without taking this relief measure into consideration) falls below the 25% threshold.

This release also provides that OSFI will consider all reinsurance agreements between cedants and the Export Development Corporation entered into after the date of this letter to be registered for the sole purpose of calculating the 25% limit.

NEXT STEPS

OSFI is currently considering the submissions it has received and developing its position on the various issues addressed in the discussion paper. We anticipate OSFI will release new guidance on reinsurance in the next several months. While we expect OSFI will set out its position on many of the issues addressed in the discussion paper, some of the issues, such as mutual recognition, are clearly long-term projects. Many of the issues addressed in the discussion paper are interrelated and, accordingly, OSFI will likely address these issues at the same time. However, certain relatively discreet issues (e. g., the 15% limit on the use of letters of credit as collateral) may be addressed on a stand-alone basis.

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While we expect OSFI will set out its position on many of the issues addressed in the discussion paper, some of the issues, such as mutual recognition, are clearly long-term projects.