New transaction instructions for approvals of reinsurance arrangements between federally regulated insurers (FRIs) and certain related parties are now in effect. The Office of the Superintendent of Financial Institutions (OSFI) states that the new instructions are in response to the calls for greater supervision of “captives” coming from regulators across North America. FRIs considering contracting for reinsurance with a related party that is not an FRI (a Related Reinsurer), as well as those that have already received an approval from OSFI, will be subject to the new procedures and the new annual filing requirement.

Pursuant to sections 523 and 597 of the Insurance Companies Act (ICA), an FRI is required to obtain the prior approval of the OSFI before “caus[ing] itself to be reinsured in respect of risks undertaken under its policies by a related party.” Previously, OSFI would consider the information provided by an FRI and approve or disapprove each proposed reinsurance arrangement individually. An FRI seeking approval for multiple reinsurance arrangements with the same Related Reinsurer required a separate approval from OSFI in respect of each reinsurance arrangement.

On November 8, 2013, OSFI published a letter (Letter) advising FRIs that revisions to Transaction Instruction DA No. 21 - Reinsurance with a Related Party (Transaction Instruction) were forthcoming in 2013. The revised Transaction Instruction (Revised Instruction) was published on New Year’s Eve and provided that, effective January 1, 2014, instead of approving reinsurance arrangements, OSFI will approve the Related Reinsurer by which the FRI proposes to cause itself to be reinsured. Transitional rules are set out in the Letter for the benefit of FRIs holding approval letters issued under the previous Transaction Instruction.

Under the Revised Instruction, once a Related Reinsurer is approved, the FRI can enter into multiple reinsurance arrangements with the same Related Reinsurer during the term specified in the approval letter. However, an FRI should not proactively seek approval for a Related Reinsurer if there is only a “mere possibility or vague intention” of entering into a reinsurance arrangement with the Related Reinsurer. When applying for approval, the FRI must demonstrate “a real intention” to cause itself to be reinsured by the Related Reinsurer. If the FRI has not been a party to a reinsurance contract with the Related Reinsurer for more than one year, OSFI states that the approval “will generally be revoked.”

The “approvals will typically be granted for an indefinite term” on the condition that the FRI files an annual information about the Related Reinsurer. The information required will be set out in the approval letter from OSFI and will typically include: an analysis that the Related Reinsurer continues to be a related party; an organization chart; confirmations from a senior officer (or chief agent if applicable) that the reinsurance contracts meet certain criteria; a copy of the annual reinsurance declaration; and details of certain changes to the affairs of the Related Reinsurer in the past year, among other things. By requiring regular information updates regarding the Related Reinsurer, OSFI appears to be taking the same position as regulators in the United States – specifically, captives have only been subject to minimal disclosure requirements in the past and more information about the entities that hold billions in potential obligations to policyholders is required.

OSFI also states in the Revised Instruction that FRIs cannot use reinsurance arrangements as a means of providing financial support to, or bailing out, a related party facing financial difficulty. This echoes the concern expressed by the New York Superintendent of Financial Services that insurance companies can mask their financial well-being by shifting business to related entities that are not subject to the same degree of regulatory oversight.

Whether OSFI’s new approach can strike an appropriate balance between protecting policyholders from the risks posed by insurers under financial stress and enabling FRIs to keep premiums at an affordable level remains to be seen. No doubt, the outcome will be of particular interest to regulators in the United States and may serve as a blueprint for their own efforts.