On December 12, 2008, the Office of the Superintendent of Financial Institutions ("OSFI"), Canada's federal insurance regulator, released a consultation paper relating to its "Regulatory and Supervisory Approach to Reinsurance". The paper describes OSFI's overall philosophy with respect to reinsurance and outlines certain initiatives that are currently being considered.

OSFI has requested feedback from the industry and other stakeholders by March 6, 2009. The Insurance Bureau of Canada has announced that it is preparing a submission which it will in turn coordinate with the Reinsurance Research Council and the Property and Casualty Insurance Compensation Corporation.

To put the discussion paper in context, a number of regulatory initiatives relative to reinsurance have recently concluded or are underway in other jurisdictions. In 2007, the International Association of Insurance Supervisors published a discussion paper on mutual recognition arrangements for the supervision of reinsurance. The National Association of Insurance Commissioners in the United States is in the process of reviewing proposals for changes to its supervision of reinsurance. There have also been similar developments on insurance/reinsurance regulation and supervision in Australia and the European Union. These developments have prompted the discussion paper. OSFI is seeking consultation with respect to the topics set out below.

Unregistered Reinsurance

25% Rule For Unregistered Reinsurance

A current feature of OSFI's regulation of reinsurance is a 25% limitation on reinsurance that can be ceded by Canadian-licensed property and casualty insurers to reinsurers that are not licensed in Canada either as a subsidiary or a branch ("unregistered reinsurance"). This rule is to limit insurers' exposure to foreign reinsurers not regulated in Canada. OSFI is questioning the relevance and appropriateness of this rule in the current environment, noting that its application constrains diversification of risk by ceding companies.

OSFI is considering moving to a more principle-based approach and may consider replacing the 25% limit on unregistered reinsurance with an overall requirement for insurers to adopt sound reinsurance practices and procedures.

Limit on Letters of Credit as Collateral

Collateral is required to be vested in trust in Canada for unregistered reinsurance in order for ceding companies to receive credit for the reinsurance. There are rules regarding the types of assets that are acceptable for this purpose, one of which is to restrict the use of letters of credit to 15% of the risks ceded to the unregistered reinsurer. OSFI is considering changing the 15% limitation on letters of credit.

Mutual Recognition of Extra-Jurisdictional Reinsurance Regulation

Commentators have suggested that mutual recognition of reinsurance regulation could facilitate the cost effectiveness and availability of reinsurance. Basically, the concept of mutual recognition involves two or more reinsurance regulators that, by agreement, recognize the other jurisdictions' regulation of reinsurance as acceptable, such that collateralization and other restrictions relating to unregistered reinsurance could be reduced or eliminated.

OSFI recognizes that a number of steps would need to be taken before it could enter into mutual recognition agreements, including an analysis of the supervisory, legal and tax framework in the proposed jurisdictions to be recognized, development of risk-based capital requirements for Canadian companies ceding to unregistered reinsurers and coordination with the insurance regulators of the Canadian provinces.

OSFI may consider approaches similar to the current proposals in the United States and Australia, whereby collateralization requirements may be reduced or eliminated for certain reinsurers, for example, based on the reinsurer's risk ratings. OSFI notes that care would have to be taken to "avoid creating a competitive advantage for unregistered reinsurers".

Unregistered Reinsurance with Related Parties

Under the "self-dealing" provisions of the Insurance Companies Act, Canadian ceding companies must obtain OSFI's approvalbefore they can cede risks to affiliates that are not licensed inCanada. Administering this approval process may be usingup a disproportionate amount of OSFI's resources and OSFIis considering streamlining these approval requirements,for example, by the development of materiality criteria as athreshold.

Registered Reinsurance

Capital Requirements

Because the life and property and casualty sectors undertake different kinds of risks, OSFI has historically differentiated between the life and non-life sectors in the imposition of capital/asset charges for insurers ceding risks to Canadian-licensed reinsurers ("registered reinsurance"). Currently, OSFI imposes a "counterparty credit risk" capital charge on property and casualty insurers in respect of registered reinsurance that does not apply to life insurers. OSFI proposes to implement a capital charge on the life sector in the next round of changes to the credit risk component of the Minimum Continuing Capital and Surplus Ratio (MCCSR) test.

OSFI also proposes to implement a minimum capital charge of 25% of MCCSR gross capital requirements for life insurers to account for "operational risk" associated with registered reinsurance. Currently, life insurers have a 20% flat capital charge on business embedded in their MCCSR for this risk.

Limit on Risks Ceded

The regulations under the Insurance Companies Act impose a maximum limit on reinsurance by property and casualty insurers of 75% of gross written premiums. OSFI is questioning the effectiveness of this overall "fronting" limit and, because of existing regulatory risk controls, such as prudential requirements, actuarial reviews and required stress-testing of capital adequacy, will consider replacing the 75% limit with an operational risk capital charge similar to the proposal for the life sector. OSFI is also considering the formulation of new guidance for both life and property and casualty insurers which would require adequate due diligence with respect to reinsurance practices.

Approvals for Registered Reinsurance Transactions

In 2007, the Insurance Companies Act was amended to change the approval requirements for certain reinsurance transactions. These approvals relate to assumption reinsurance transactions where blocks of Canadian business are transferred from one licensed insurer to another. The amendments relating to Canadian insurers came into force in 2007 and the amendments relating to foreign companies licensed in Canada are scheduled to come into force on January 1, 2010.

The former approval requirements for assuming (purchasing) insurance policies from another licensed insurer were removed in the case of both domestic insurers and foreign Canadian-licensed insurers. For domestic insurers, the Minister of Finance's approval is only required for ceding, on an assumption basis, "all or substantially all" of the insurer's risks. For domestic insurers that cede, on an assumption basis, less than substantially all of the insurer's risks, only the Superintendent's approval is required. When the amendments respecting foreign companies come into force, only the Superintendent's approval will be required in connection with foreign companies that cede, on an assumption basis, all or any portion of its risks. So, OSFI will no longer regulate the assumption side of the transaction; only the cession.

Although the reinsurance approval regime is a key element of OSFI's regulation, OSFI is open to suggestions for improvement, particularly in light of the other proposed changes contained in the consultation paper.

Revised Guidance

OSFI is working on updating Guideline B-3 (currently entitled Unregistered Reinsurance). The update will apply to both registered and unregistered reinsurance and will require insurers to establish and implement sound reinsurance cession practices and procedures (including, for example, a reinsurance management strategy, criteria for reinsurer suitability, risk concentration limits, limits on authority to execute reinsurance agreements, internal systems for monitoring, and risk management and compliance mechanisms) as part of overall enterprise risk management. OSFI is considering whether this approach will pave the way to removing the 25% limit on cessions to unregistered reinsurers and the 75% aggregate limit on cessions of gross written premiums, both discussed above.

OSFI also plans to revise Draft Guideline B-13 (currently entitled Reinsurance Agreements) to address the issue of time lags between the date on which the reinsurance is agreed to in principle and the date on which final documentation evidencing the arrangement is actually executed by the parties. The revisions will also address specific clauses in reinsurance contracts, such as the need for an insolvency clause requiring the reinsurer to continue to provide reinsurance without diminution notwithstanding insolvency of the ceding company. OSFI points out that some jurisdictions in the United States require reinsurance agreements to have an insolvency clause in order for the insurer to receive credit for the reinsurance. The guidance will also address the use of types of clauses to be avoided; for example, those which could operate to allow the reinsurer to receive preferential treatment over creditors/claimants of the insolvent insurer.