When a federally regulated insurer ("FRI") wishes to enter into a reinsurance arrangement with a related party reinsurer that is not also a FRI (such related party being a "Related Reinsurer"), the Insurance Companies Act ("ICA") provides that the prior approval of the Superintendent of Financial Institutions (the "Superintendent") is required. Currently, such approvals are granted on an individual basis with respect to each reinsurance arrangement, and the information requirements for an approval are set out in OSFI's Transaction Instructions DA No. 21 Reinsurance with Related Unregistered Reinsurer (the "Transaction Instructions"). However, on November 8, 2013, the Office of the Superintendent of Financial Institutions Canada ("OSFI") issued a Memorandum advising that it is revising its approach for approval of reinsurance with a related party.

THE REVISED APPROACH

After January 1, 2014, approvals will generally be granted in respect of each Related Reinsurer as opposed to each individual reinsurance arrangement with a Related Reinsurer. As a result, the approval of the Superintendent will relate to an applicant's intention to cause itself to be reinsured, through one or more reinsurance arrangements on an ongoing basis, by a specific Related Reinsurer rather than in respect of each particular reinsurance arrangement. OSFI expects to publish revised Transaction Instructions prior to December 31, 2013 setting out the general information requirements in support of a FRI's application for approval in respect of the FRI's intention to cause itself to be reinsured with a Related Reinsurer. Under the revised approach, approvals will typically be granted for an indefinite term; however, approvals will be conditional on the FRI providing certain information to OSFI on an annual basis. The revised Transaction Instructions will describe such required information. Furthermore, the specific information that a FRI will be required to provide annually will be set out in the Notice of Approval letter that will be sent to the FRI by OSFI.

TRANSITIONAL GUIDANCE

OSFI has provided direction on the following situations to guide the industry's transition to the new approach:

  • where a FRI has obtained approval of a reinsurance arrangement with a Related Reinsurer under the current process for a defined period, that approval will be extended until June 30, 2015 and the FRI is expected to apply for approval of its existing Related Reinsurer(s) under the revised process prior to January 1, 2015.
  • where a FRI has obtained approval of a reinsurance arrangement with a Related Reinsurer under the current process with no approval expiry date, the FRI is expected to apply for approval of its existing Related Reinsurer(s) under the revised process prior to January 1, 2015.
  • FRIs should continue to seek the approval of the Superintendent using the current process in accordance with the existing Transaction Instructions in relation to new reinsurance arrangements with Related Reinsurers (or material changes to existing approved arrangements) to be executed prior to January 1, 2014.
  • FRIs should seek the approval of the Superintendent using the revised process in accordance with the revised Transaction Instructions to be published in relation to new reinsurance arrangements with Related Reinsurers (or material changes to existing approved arrangements) to be executed after January 1, 2014.

COMMENTARY

OSFI's revised approach to regulating reinsurance with an unlicensed related party reinsurer is an important development. Since the repeal of the Reinsurance Regulations (which included a 25% limitation on the use of unlicensed reinsurance), many insurers have implemented large quota share reinsurance arrangements with related parties, often in jurisdictions such as Bermuda and Ireland. Under the current regime, it was necessary for a new OSFI approval to be obtained each time a material revision was made to the reinsurance agreement (for example, increasing a quota share from 50% to 75%). Under the new regime, a one-time approval of the Related Reinsurer will be sought by the FRI. Once this approval has been granted, the FRI will generally be free to enter into any type of reinsurance arrangements with the Related Reinsurer that it wants to (provided that they are on fair market terms and conditions) or to change them at any time.

It will be interesting to see what the criteria in the Transaction Instructions will be for the approval of a Related Reinsurer. It can be expected that under the new approval process OSFI will conduct a more in-depth and comprehensive diligence of Related Reinsurers than in the past prior to granting an approval. It is possible that OSFI may impose various standards including minimum share capital, operating history, profitability and ratings from Standard and Poor or A.M. Best. It is also likely that not all home jurisdictions of a Related Reinsurer will be acceptable. OSFI will likely want to be comfortable that the home jurisdiction is an "equivalent regulator" that follows similar regulatory standards to those that it uses.

Although the new regime will impose more work for FRIs during the transitional period (since it will be necessary for all existing arrangements to be converted to the new approval system), in the long term it should provide more flexibility and certainty to FRIs regarding their reinsurance arrangements with Related Reinsurers. Many FRIs settle their reinsurance arrangements with Related Reinsurers only a few months before their inception date. The new regime will help alleviate some of the current uncertainty as to whether OSFI will provide its approval of a reinsurance arrangement in time for its inception date.

OSFI expects that the revised approach will better align with reinsurance industry practices which see FRIs entering into multiple reinsurance arrangements with the same Related Reinsurer, often on very short notice. Moreover, OSFI believes that in addition to allowing FRIs more flexibility in managing their reinsurance programs, the revised approach will provide OSFI with additional insight into FRIs' risk exposure to Related Reinsurers.

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