OSFI Releases Final Updated Reinsurance Guidance To Take Effect in 2025

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On February 11, 2022, Canada’s federal prudential insurance regulator, the Office of the Superintendent of Financial Institutions (“OSFI”) released long-awaited final versions of its key reinsurance guidance, Guideline B-3: Sound Reinsurance Practices and Procedures (“B-3”), and, for property and casualty (“P&C”) insurers, Guideline B-2: Property and Casualty Large Insurance Exposures and Investment Concentration (“B-2”). This concluded Phase II of OSFI’s review of reinsurance practices, launched in 2018 through its Reinsurance Framework Discussion Paper, and which was followed by a lengthy and intensive consultation with the Canadian P&C insurance sector. Our commentary on the Reinsurance Framework Discussion Paper and our commentary on the draft updated B-3 released in 2019 provide useful background on the process.

Key Points

  • The updated Guidelines take effect January 1, 2025, which is responsive to industry requests for a lengthy phase-in period. Until then, carriers are to comply with the current Guidelines B-3 and B-2.
  • The final B-3 is relatively unchanged from the draft released in 2019.
  • The final B-2 has been meaningfully revised, in response to industry feedback, from a draft released in November 2020, which in turn had been significantly revised from a much more onerous proposal originally contained in the Reinsurance Framework Discussion Paper.
    • The final B-2 will require P&C insurers to
      • develop a comprehensive “Gross Underwriting Limit Policy” (“GUWP”) consistent with the carrier’s internal Risk Appetite Framework; and
      • hold sufficient capital/assets to cover the maximum loss on its largest Single Insurance Exposure (as to be defined in its GUWP), assuming the default of its largest unregistered reinsurer on that Single Insurance Exposure.
    • The original version’s large loss limits had been strongly opposed by the Canadian P&C industry, which actively lobbied against them, as they would have required a massive increase in capital for certain Canadian P&C carriers and were understood to be markedly out of step with international regulatory norms.
  • OSFI will be holding industry information sessions later this year to provide additional clarity on its expectations and supervisory approach to the updated Guidelines.

Updated Guideline B-3

As noted above, the final B-3 is relatively unchanged from the 2019 draft. Key aspects include the following:

  • One of OSFI’s principal new recommendations in the consultation process was that reinsurance receivables be paid directly to the cedant in Canada, or a person acting for, or on behalf of, the cedant in Canada. In the final B-3, OSFI has distinguished as follows between receivables from third-party reinsurers vs affiliated reinsurers:
    • OSFI expects reinsurance contracts with third-party reinsurers (i.e., entities that are not in the same corporate group as the cedant) to contain an insolvency clause stipulating that, in the event of the insolvency of the cedant, all reinsurance receivables are to be paid directly to a cedant in Canada, or to a person acting for, or on behalf of, the cedant in Canada.
    • OSFI expects reinsurance contracts with affiliated reinsurers (i.e., entities within the same corporate group as the cedant) to contain a clause stipulating that all reinsurance receivables are to be paid directly to a cedant in Canada, or to a person acting for, or on behalf of, the cedant in Canada.
  • OSFI reaffirmed its expectation (contained in the 2019 draft, and in the current Guideline, which dates from 2010) that a cedant should not cede all or substantially all its risks (with OSFI viewing 75% or greater as constituting substantially all).
  • In a Summary, released with the Guideline, of comments received on the 2019 draft, and OSFI’s responses, OSFI included what appears to be a new expectation that cedants actively monitor applicable retrocessionaires: “The cedant retains the liability in the event a reinsurer is unable to meets its obligations. In order to protect policyholders, therefore, OSFI expects the cedant to be responsible for, and to monitor, its ceded business. For example, if a cedant is ceding a significant portion of its business to a reinsurer who, in turn, retrocedes 100 percent of this business to a single entity, OSFI expects the Canadian cedant to actively monitor the solvency position of the retrocessionaire.

Updated Guideline B-2

As noted above, P&C insurers will be required to develop a comprehensive “Gross Underwriting Limit Policy” (“GUWP”) consistent with the carrier’s internal Risk Appetite Framework.

  • The GUWP should:
    • Define what constitutes a Single Insurance Exposure by class of insurance, as appropriate. A carrier could aggregate insurance exposures across multiple coverages and/or classes of insurance. (Many industry commenters on the draft Guideline had requested clarification on this definition, but OSFI chose to leave it to each carrier to determine for itself, while reserving the right to advise a carrier to use specific criteria or a specific approach for the determination.);
    • Establish limits by class of insurance regarding the level of gross insurance risk that the carrier is willing to accept in respect of a maximum loss related to a Single Insurance Exposure; and
    • Be reviewed by the carrier’s senior management at least annually.
  • Using relevant, reasonable and supportable information, carriers should measure and determine the maximum loss on a Single Insurance Exposure. They should make this determination without regard to the probability of the loss event occurring, while using approaches that are risked-based and forward-looking (i.e., not solely based on past losses).
  • Carriers should have adequate systems to identify and actively manage insurance exposures and effective monitoring and internal reporting procedures to ensure ongoing operational compliance with the GUWP.
  • Carriers are expected to provide, at OSFI’s request, all information with respect to their large Single Insurance Exposures. OSFI may, at its discretion, advise a carrier to use specific criteria or an approach to determine and measure its maximum loss on a Single Insurance Exposure.

As noted above, a carrier’s Net Retention (as defined in the Guideline), plus its Largest Net Counterparty Unregistered Reinsurance Exposure (also as defined in the Guideline), due to the occurrence of a maximum loss on a Single Insurance Exposure, should not exceed the following limits:

  • For insurance companies – 100% of Total Capital Available (as defined in OSFI’s Minimum Capital Test for P&C carriers (“MCT”)) where any entity in the carrier’s control chain is a widely held company, and/or a regulated financial institution; otherwise only 25% of Total Capital Available (and this was a change from the prior draft B-2, which, for Canadian P&C carrier subsidiaries, permitted a 100% limit only if certain criteria were met relating to the parent company’s home regulatory regime, and otherwise only 25%); and
  • For branches – 100% of Net Assets Available (as defined in OSFI’s Branch Adequacy of Assets Test for P&C branches (“BAAT”)) (which was also a change from the prior draft B-2, which permitted a 100% limit only if the criteria were met respecting the home office’s regulatory regime, and otherwise only 25%).
  • In summary, OSFI’s preference and position, as it noted in a Letter released with the Guidelines, is that “It is prudent and reasonable to expect a P&C [carrier] to be in a position to fully cover its losses with funds available in Canada or from a diversified panel of reinsurers [emphasis added].”

With respect to the Largest Net Counterparty Unregistered Reinsurance Exposure, carriers should measure their ceded unregistered reinsurance exposures to a given counterparty, or group of affiliated counterparties, on both a gross and a net basis. That is, it should be measured before and after the recognition of any eligible Counterparty Risk Mitigation (“CRM”) technique. Only the aggregate net counterparty exposures for unregistered reinsurance are subject to the 100%/25% limits noted above. Eligible CRM techniques may include excess collateral, letters of credit and other CRM techniques deemed acceptable by OSFI in the MCT/BAAT (being funds withheld; and assets deposited into a reinsurance security account in Canada at a Canadian financial institution custodian). It is to be noted that B-2 limits the use of letters of credit to 30% of the Largest Net Counterparty Unregistered Reinsurance Exposure. This appears to differ from the extent of permitted use of letters of credit as collateral under the MCT/BAAT more generally, which is 30% of the aggregate of all liabilities and unearned premium reinsured with unregistered reinsurers. Industry commenters had requested higher limits on the use of letters of credit, generally, but OSFI was not persuaded.

The investment concentration limits in B-2 are unchanged from the previous draft, and the current B-2.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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