On November 26, 2020, the Office of the Superintendent of Financial Institutions (OSFI) released a draft revised Guideline B-2 (Property and Casualty Large Insurance Exposures and Investment Concentration) (the Draft Revised Guideline), for public comment.
The revisions made in the Draft Revised Guideline primarily address single large insurance exposures of P&C insurers, and was released following significant industry concerns regarding the proposed approach set forth in OSFI's 2019 Discussion paper on the reinsurance framework.
A revised draft of Guideline B-3 is also expected to be released soon, which will reflect additional items that were addressed in the Discussion paper.
The Discussion Paper highlighted several industry practices that were causing OSFI concern. Of particular concern was what OSFI referred to as the "leveraged business model," which involved a Canadian insurer issuing a high-limit policy in Canada and subsequently reinsuring a very significant portion of the risks, typically with an unregistered reinsurer.
To address this concern, the Discussion Paper proposed a rule on the issuance of high-limit policies, whereby the maximum policy limit that a P&C insurer could issue depended upon its level of capital and excess collateral, as well as the diversity of its reinsurance counterparties.
The industry expressed significant concerns with the policy limit rule, noting that it captured a scenario that is excessively severe and extremely improbable and that the impact to capital (or collateral) requirements would be significant. OSFI conducted a Quantitative Impact Study in early 2019, which confirmed that certain P&C insurers would be substantially impacted by the proposed policy limit rule.
In the Draft Revised Guideline, OSFI is proposing an amended rule that will require P&C insurers to be able to cover the maximum loss related to a single insurance exposure (as opposed to three of its largest policy limit losses as was proposed in the Discussion paper) on any policy it issues, assuming the default of its largest unregistered reinsurer on that exposure.
Under the Draft Revised Guideline, P&C insurers are to have a comprehensive Gross Underwriting Limit Policy (GUWP). The GUWP is to be consistent with the insurer's Risk Appetite Framework and:
- define what constitutes a "Single Insurance Exposure" by class of insurance;
- establish limits by class of insurance regarding the level of gross insurance risk that the insurer is willing to accept in respect of a maximum loss related to a Single Insurance Exposure; and
- be reviewed by senior management, at a minimum, annually.
The maximum loss on a Single Insurance Exposure is to be calculated without regard to the probability of the loss event occurring.
OSFI expects P&C insurers to develop and establish their own criteria and approach for determining and measuring the maximum loss on a Single Insurance Exposure.
The Draft Revised Guideline amends the policy limit rule to provide that at no time is a P&C insurer's Net Retention, plus its Largest Net Counterparty Unregistered Reinsurance Exposure, due to the occurrence of a maximum loss on a Single Insurance Exposure, to exceed the following limits:
- Insurance Companies: 25% of Total Capital Available
- Foreign Branches: 100% of Net Assets Available of the foreign branch provided that certain criteria are met (otherwise, the limit is 25% of net assets available)
- Subsidiaries in Canada: 100% of Total Capital Available of the subsidiary provided that certain criteria are met (otherwise, the limit is 25% of total capital available)
Largest Net Counterparty Unregistered Reinsurance Exposure is defined to means the largest amount of ceded unregistered reinsurance on an insurance exposure provided by a (re)insurance group on a net basis after recognition of any eligible Counterparty Risk Mitigation technique.
Part III of the Draft Revised Guideline addresses investment concentration. P&C insurers are to have policies with respect to the management of investment concentration, which include internal limits. In this regard, an insurer's aggregate market value of investments in any one entity or group of affiliated companies is not to exceed 5% of the company's assets (or, in the case of a branch of a foreign insurer, 5% of the company's assets in Canada.
The consultation period is open until March 18, 2021. OSFI is particularly interested in stakeholder views on the following:
- how a P&C insurer should determine and measure its maximum loss on a "Single Insurance Exposure";
- the potential counterparty risk mitigation techniques a P&C insurer could use; and
- any other suggestions that contribute to an effective balance between protecting policyholders and allowing P&C insurers to compete and take reasonable risks.