On August 9, 2016, the Office of the Superintendent of Financial Institutions (OSFI) posted revised transaction instructions on its website for reinsurance on an assumption basis (Assumption Reinsurance). OSFI stated that the information requirements and administrative guidance contained in the revised transaction instructions have been updated in line with OSFI’s current expectations and views regarding Assumption Reinsurance.
Notably, in the administrative guidance, OSFI has now formalized its view that Assumption Reinsurance is appropriate only in the context of exiting the purview of the Insurance Companies Act (ICA), or exiting a line of business. OSFI has historically held and applied this view with respect to the limited purposes of Assumption Reinsurance, despite the fact that this is not set out in the ICA.
The revised transaction instructions serve as a good refresher of what Assumption Reinsurance is, and what it is not. Assumption Reinsurance is not a legal transfer of policy liabilities, although it is a means for a federally regulated insurance company to exit a line of business or exit the business of insurance altogether (that is, to stop insuring risks in Canada). In this context, OSFI has provided in the administrative guidance that it views a “line of business” as a specific product, a particular market in which a product is offered or a clearly defined segment of customers for a product.
The revised transaction instructions (which have gone from three pages to 15) now helpfully describe and distinguish Assumption Reinsurance, indemnity reinsurance and legal transfers of policies.
Under Assumption Reinsurance, the reinsurer agrees to assume the obligations that the ceding insurer owes under the assumed policies, including the discharge of the financial obligations and the policy administration functions. The reinsurer becomes directly liable to the holders of the assumed policies as an additional obligor. Policyholders are notified of the assumption and are requested to pay their premiums directly to the reinsurer, and to look to the reinsurer for the ongoing servicing of policies and the payment of claims made under them.
However, the ceding insurer retains liability regarding each policy that has been reinsured, until that liability ceases in accordance with the policy terms or otherwise by operation of statute or law (currently there is no statute or common law precedent in Canada for a complete discharge other than a legal transfer, described below).
Under indemnity reinsurance, the reinsurer agrees to indemnify the ceding insurer in respect of the payment of claims made under the reinsured policies, but the ceding company remains obligated to discharge all financial obligations and carry out policy administration. Policyholders continue to deal with, and pay premiums to, the ceding insurer and are typically unaware of the indemnity reinsurance arrangement.
Legal Transfer of Policies
After a legal transfer of policies from one insurer to another, the transferor is fully discharged from all of the obligations under the policies in accordance with the terms and conditions of the transfer instrument. Unlike in some countries where there is a method of transferring legal liability with court and/or regulatory approval, in Canada, a legal transfer is possible only with the consent of the policyholder — of each individual policyholder.
It is not always well understood that Assumption Reinsurance does not amount to a legal transfer of policies. As stated in the revised transaction instructions, Assumption Reinsurance is used where it is not commercially reasonable to effect legal transfer of policies (that is, where there are too many policies to obtain individual consents). It is a regulatory process specific to Canada, therefore foreign entities in particular may not be familiar with the process or the effect.
Despite the lack of legal discharge, the benefit of Assumption Reinsurance is that it amounts to a transfer of policy risks for accounting and actuarial purposes, which relieves the ceding insurer of the capital and regulatory burden associated with the risks. Assumption Reinsurance is often the only practical means by which a Canadian insurer can apply to dissolve or continue under a corporate statute, or by which a foreign insurer with a Canadian branch can close its branch and apply for a release of its Canadian assets. OSFI has always acknowledged the accounting and actuarial effect of Assumption Reinsurance in practice, and this is now set out in the administrative guidance.
The revised transaction instructions now include as administrative guidance that:
- OSFI expects ceding insurers to perform due diligence to assess the reinsurer’s suitability as an Assumption Reinsurance counterparty and to consider OSFI’s expectations set out in Guideline B-3 Sound Reinsurance Practices and Procedures
- If a policy contains a non-assignment clause and the ceding insurer cannot obtain the policyholder’s consent to amend or waive the clause, OSFI expects the ceding insurer to disclose, in both the notice of intention and in policyholder communications, the insurer’s intention to assumption reinsure the policy despite the non-assignment clause
- OSFI expects the assumption reinsurance agreement to not contain a typical “no third party beneficiaries” clause, on the basis that such a clause may prejudice the policyholders’ coverage from the reinsurer
- While Assumption Reinsurance between related parties does not require separate approval as a related party transaction, such a transaction is still subject to the self-dealing provisions of the ICA and must be conducted on market terms and conditions
Overall, although the revised transaction instructions are significantly more detailed than the previous version, they have not substantially changed the Assumption Reinsurance process. The revisions have formalized several aspects of the process that previously (but consistently) surfaced only in response to OSFI information requests or comments on the application materials and they have clarified the purpose and effect of Assumption Reinsurance.