OSFI has softened its stance on two of the Canadian P&C industry’s key concerns in the solvency regulator’s final published guidelines on Sound Reinsurance Practices and Procedures (B-3) and Property and Casualty Large Insurance Exposures and Investment Concentration (B-2).
Revised guidelines take effect Jan. 1, 2025, giving the industry a three-year transition period to adjust business practices to the new set of expectations.
“This will allow companies to continue to focus on IFRS implementation throughout 2022 and 2023, including the implementation of the revised MCT Guideline in 2023,” commented Sarah Fong, assistant chief economist and head of industry data and policy development at Insurance Bureau of Canada.
Fong welcomed the lengthy transition timeline. “IBC’s member companies are currently reviewing the guidelines. IBC, together with a number of member companies, and other P&C industry participants, had frequent dialogue with OSFI on this topic, and we thank OSFI for their active communication,” she said.
The guidelines are varied and complex. In an online post, OSFI addressed some of the industry’s major concerns with initial draft proposals in advance of the published guidelines.
Of particular concern to the P&C industry was OSFI’s original capital test (now changed) to account for solvency concerns around large reinsured insurance exposures. In its 2018 discussion paper, OSFI wanted the industry to account for what might happen if its three largest exposure risks all happened at the same time, and the reinsuring counterparties on each of the three exposed policies also simultaneously failed.
Industry actuaries calculated the odds of that happening as between 1-in-1-billion and 1-in-5-trillion-year loss events.
At the time, IBC announced taking that kind of loss into account would mean the Canadian P&C industry would have to raise additional capital of between $21 billion and $30 billion. (At the time, the Canadian P&C industry had a total pot of $50 billion to pay for all of the home, auto and business claims in the country.)
OSFI has since softened its stance on the test. Guideline B-2 “now requires a P&C [federally regulated institution] to be able to cover the maximum loss related to a single insurance exposure (as opposed to three of its largest policy limit losses) on any policy it issues, assuming the default of its largest unregistered reinsurer on that exposure.” OSFI has called on the companies themselves to determine what its largest “single insurance exposure” would be.
OSFI also modified its approach after hearing the industry’s concerns around the global flow of reinsurance capital.
Its original proposal wanted reinsurers outside of Canada to park enough capital inside Canada to cover off claims losses sustained here. The industry argued this went against the global nature of reinsurance, which shifts capacity to the areas of the world that most need it. In other words, if there are no catastrophe events happening in Canada, global reinsurers will move that capital to pay for claims elsewhere around the globe – such as an earthquake in Japan.
OSFI said it recognizes the global nature of reinsurance, but insolvency regimes globally are different – and some may make it more difficult to collect claims funds owed to Canadian policyholders. The regulator is therefore looking for reassurance that the reinsurance money will be available to Canadian policyholders.
OSFI has shifted its position, however, on whether that money actually has to be parked in Canada.
“The requirement for reinsurance to be collectible in Canada is an alternative to additional capital or collateral being held in Canada,” the new published Guideline B-3 reads.
“The terms and conditions of a binding reinsurance agreement should provide that funds will be available to cover policyholder claims in the event of either the cedant’s [i.e. the primary insurer that is covered by the reinsurer] or reinsurer’s insolvency. To this end, reinsurance contracts should include an insolvency clause….
Ceding [federally-regulated institutions] should ensure that all reinsurance contracts contain an insolvency clause clarifying that the reinsurer must continue to make full payments to an insolvent cedant without any reduction resulting solely from the cedant’s insolvency.
“Such a clause provides greater certainty that reinsurance receivables remain within the overall general estate of the insolvent ceding company, or as part of the assets in Canada of a foreign insurance company…rather than being allocated toward the payment of specific claims of creditors or policyholders.”
Feature image courtesy of iStock.com/and2DesignInc