What OSFI expects insurers to know about reinsurance

While the Office of the Superintendent of Financial Institutions (OSFI) expects federally regulated insurers (FRIs) to comply with its guideline on reinsurance, it realizes that “this guidance was not always well-understood by the industry and [has] identified opportunities to clarify our expectations.”

Reinsurance is a tool used extensively by FRIs to manage insurance risks and sometimes capital. However, the use of reinsurance exposes an FRI to other risks such as counterparty credit risks and legal risks.

OSFI told Canadian Underwriter that it expects FRIs to “understand and prudently manage” all risks associated with the use of reinsurance as set out in the Sound Reinsurance Practices and Procedures guideline. For example, the federal regulator expects an FRI to conduct an “appropriate level of due diligence on its reinsurance counterparty.” (The Society of Actuaries defines reinsurance counterparty risk as the risk that a reinsurer fails to honour claims obligations due to default or commutation of reinsurance receivables due to financial stress).

OSFI also expects an appropriate level of due diligence for any current or prospective reinsurance agreements, whether registered or not. Unregistered reinsurance refers to reinsurance with a reinsurer that is not regulated by OSFI; there can be business or tax reasons why insurers choose different types of reinsurance.

“This expected due diligence should include an assessment of counterparty risk and, for unregistered reinsurance, a consideration of the regulatory and supervisory regime, and the legal and insolvency frameworks of the unregistered reinsurer’s home jurisdiction,” OSFI said.

Despite the guidance, Neville Henderson, assistant superintendent of OSFI’s insurance supervision sector, said on Tuesday at KPMG’s Annual Insurance Conference that “we noticed that a lot of companies really don’t understand the reinsurance coverage very well.”

The federal regulator reviews its guidance on an ongoing basis to ensure it is aligned with industry practices and the evolving financial services environment. In that spirit, it intends to release a reinsurance discussion paper next spring. The paper will include findings and concerns regarding reinsurance practices, proposals for change where they have been identified and will seek industry feedback.

Henderson suggested on Tuesday that increases in natural catastrophes and the price of reinsurance could also drive up the price of insurance products in Canada. “Our concern is in the longer run, we’ll see increases in the price of reinsurance, which will increase the price of products in Canada,” he said at the conference. “As some of the risks rise, the reinsurers may decide to not cover it and the direct writers won’t be able to recover it, so we may see an increase in the expense [category].”