OSFI has released updated Transaction Instructions with respect to its new regime for Superintendent approvals for reinsurance with a related party that is not a federally regulated insurer. Under the new regime, which is effective January 1, 2014, approvals will be granted for each reinsurer rather than each reinsurance transaction. The new regime is described in a November 8, 2013 Memorandum from OSFI (a summary of that Memorandum is available here.)
The information requirements are extensive and reflect two overriding concerns: (1) that the reinsurance arrangements meet the expectations set out in Guideline B-3: Sound Reinsurance Practices and Procedures, and (2) that the concerns associated with related party transactions are addressed.
Some of the key information requirements are described below.
- Confirmation that the applicant’s board of directors or Chief Agent, as applicable, has reviewed and approved the applicant’s Reinsurance Risk Management Policy (RRMP).
- Details regarding the due diligence carried out by the applicant in respect of the related party reinsurer.
- Information regarding the proposed reinsurer including financial and capital information, regulatory examination report and a description of any material direct insurance, reinsurance, retrocession or other business arrangements between the reinsurer and any entities that are affiliated with or are related parties of the reinsurer.
- Extensive information regarding the proposed reinsurance arrangement, including a description of the applicant’s objective in seeking to enter into the proposed reinsurance arrangement and details of the benefits to accrue to the applicant, a draft copy of each reinsurance contract that the applicant and reinsurer intend to enter into, the manner in which the parties intend to offset their accounts, and the measures to be taken in the event of an insolvency of either party.
- A description in table format of the applicant’s entire reinsurance program setting out specified information for each reinsurance contract.
- Confirmation as to whether the applicant intends to claim capital/asset credits for the reinsurance.
- Confirmations from a senior officer or the Chief Agent that all reinsurance contracts between the applicant and the reinsurer will: (1) conform with Guideline B-3 and the applicant’s RRMP; (2) be entered into, renewed, modified or, where applicable, commuted/terminated on terms and conditions at least as favourable to the applicant as market terms and conditions, including the basis on which this assessment is to be made; (3) effect a risk transfer and be accounted for in the appropriate manner; and (4) not result in the reinsurer insuring in Canada a risk. With respect to the market terms and conditions requirement, the Transaction Instructions state that if OSFI has reason to doubt the accuracy of the assessment of this requirement, OSFI may commission an independent evaluation at the applicant’s expense.
The Transaction Instructions state that the applicant must demonstrate that it has a real intention to cause itself to be reinsured by the reinsurer, as opposed to a mere possibility or vague intention of causing itself to be reinsured at some future point. As well, while approvals will typically be granted for an indefinite term, the approval will generally be revoked where the applicant has not been a party to a reinsurance contract with the reinsurer for more than one year.
The Transaction Instructions state that the reinsurance arrangement must not be carried out to provide financial support to the reinsurer or to “bail out” a reinsurer in financial difficulty. This mirrors requirements OSFI has imposed with respect to other related party transaction approvals in recent years. This is examined very carefully by OSFI.
OSFI will require the applicant to provide specified information about the reinsurance arrangement on an annual basis (essentially confirming certain information listed above).
Transitional matters relating to approvals given prior to December 31, 2013 are addressed in an Appendix to the November 8, 2013 Memorandum.
Guideline B-3: Sound Reinsurance Practices and Procedures
Given the importance of Guideline B-3 to related party reinsurance it is appropriate to note a few of its most important points. One can only think that OSFI would expect that this Guideline would be applied even more strenuously in the case of related party reinsurance. The Guideline states that (1) OSFI expects a higher level of due diligence by an insurer of an unregistered reinsurer or by a reinsurer of an unregistered retrocessionaire and (2) the level of due diligence should be commensurate with the level of exposure and not be any less thorough where the counterparty is a related party.
The insurer’s RRMP is an integral part of its overall enterprise-wide risk management plan. It should reflect the scale, nature and complexity of the insurer’s business with regard to its risk appetite framework. It should include the objectives of reinsurance, risk diversification, risk concentration limits and ceding limits.
The other key aspect of the Guideline and an insurer’s RRMP is the nature and extent of due diligence the ceding insurer should do on its reinsurance counterparties independently not just relying on third parties, rating agencies or broker analysis. It should consider balance sheet and capital strength, funding sources, liquidity and sources of it, management, retrocession arrangements, claims payment record and expected future claims obligations. Also, due diligence is to be ongoing throughout the life of the reinsurance contract.