Office of the Superintendent of Financial Institutions
This chapter describes the treatment of reinsurance in the determination of the LICAT ratios, collateral requirements for unregistered reinsurance, and the conditions necessary in order for an insurer to take credit for reinsurance.
The term "registered reinsurance" as used in this guideline means reinsurance that is deemed to constitute registered reinsurance as a result of meeting the conditions either in section 10.1.1 or in section 10.1.2 below. The term "unregistered reinsurance" refers to all reinsurance that is not deemed to constitute registered reinsurance.
An arrangement is deemed to constitute registered reinsurance if it is conducted with a registered reinsurer. OSFI considers a reinsurer to be registered if it is:
and is authorized by order of the Superintendent to do so; or
Note that in respect of item (a)(ii) above, a ceding foreign insurer will be permitted to treat a reinsurance arrangement as registered reinsurance only where the arrangement provides that the reinsurer does not have any right of set-off against obligations of the ceding foreign insurer other than those obligations related to the insurance business in Canada of the ceding foreign insurer.
Subsection 578(5) of the
Insurance Companies Act requires a foreign insurer, in respect of risks it reinsures in Canada, to set out in all premium notices, applications for policies and policies (which may include cover notes offer letters or quotations) a statement that the document was issued or made in the course of its insurance business in Canada. In cases where the cover note, offer letter or quotation can be considered neither an application for a policy nor a policy, an insurer will be permitted to treat a reinsurance arrangement as registered reinsurance only if the foreign reinsurer includes, in the cover note, offer letter or quotation, a statement that the reinsurer intends to issue the reinsurance contract under negotiation in the course of its insurance business in Canada, and that it will take measures to ensure that the cedant's risks will be reinsured in Canada in accordance with OSFI's Advisory No. 2007-01-R1 entitled
Insurance in Canada of Risks.
OSFI considers an entity to be an unregistered reinsurer if it is not a registered reinsurer as defined in section 10.1.1 above. Special purpose vehicles formed for the purpose of securitizing insurance risks are considered to be unregistered reinsurers.
All reinsurance arrangements under which an insurer or one of its subsidiaries cedes or retrocedes business to an unregistered reinsurer are treated as unregistered reinsurance for the purpose of this guideline, unless:
the ceding insurer is a Canadian insurer or a subsidiary of a Canadian company; and
all of the underlying policies ceded under the arrangement were directly written outside of Canada, and the ceding insurer has not assumed in Canada the risksFootnote 1 of these policies; and
the branch or subsidiary of the Canadian insurer issuing (reinsuring) the policies is subject to local solvency supervision by an OECD country in respect of the risks being ceded, and the reinsurance (retrocession) arrangement is recognizedFootnote 2 by that country's solvency regulator, or
the risks being ceded relate to policies that have been issued (reinsured) by a subsidiary of the Canadian insurer that is incorporated in a non-OECD country, and the reinsurance (retrocession) arrangement is recognizedFootnote 2 by that country's solvency regulator,
the reinsurer is regulated and subject to meaningful risk-based solvency supervision (including appropriate capital requirements) for insurance risks, or
the foreign solvency regulator has recognized the reinsurance arrangement on the basis that it has been fully collateralized by the reinsurer.
Reinsurance meeting all of conditions (a) through (d) above is deemed to constitute registered reinsurance.
In the remainder of this chapter, references to liabilities that have been "ceded" denote actuarially valued obligations due from a reinsurer under a reinsurance arrangement, before any reduction to account for the credit quality of the reinsurer. For the purpose of this chapter, all reinsured business should be valued based on the ceded policy liability and not the reinsurance asset appearing on the balance sheet.
Policy liabilities that are ceded by an insurer under unregistered reinsurance as defined in section 10.1 must be valued, in accordance with CALM, using assumptions about the assets supporting the liabilities that are consistent with the assets used to collateralize the reinsurer's obligation. In this chapter, for the purpose of valuing aggregate and policy-by-policy liabilities ceded to an unregistered reinsurer, the assets backing the ceded liability should be assumed to consist of all or a portion of:
If all of the above assets are not sufficient to back the ceded liability, the remaining assets backing the ceded liability should be assumed to be assets held by the ceding insurer or vested in trust that back the ceding insurer's unallocated Available Capital or Available Margin.
Insurers are required to deduct from Available Capital the ceded policy liabilities corresponding to reinsurance assets arising from unregistered reinsurance
For every unregistered reinsurer, the total value of the policy liabilities ceded to the reinsurer, if positive, must be included within an insurer's Deductions/Adjustments (qq.v. sections 2.1.2 and 12.2.4).
Where an insurer cedes positive policy-by-policy liabilities and negative policy-by-policy liabilities to the same unregistered reinsurer, the amount of offsetting policy-by-policy liabilities ceded to the reinsurer is defined to be the lower of the total:
This offsetting amount, net of any adjustments made to negative reserves under section 220.127.116.11Footnote 3, must be deducted from Tier 1 as a negative reserve and included in Tier 2 for Canadian insurers, or included in the negative reserve component of Assets Required for foreign insurers operating in Canada on a branch basis. This requirement is equivalent to the requirements that would apply under sections 2.1.2 and 2. 2.1, or sections 12.2.4 and 12.2.1, had an insurer retained equal amounts of positive and negative policy-by-policy liabilities.
Where the total value of the policy liabilities that a Canadian insurer has ceded to a particular unregistered reinsurer is negative, the insurer should deduct from Tier 1 and include in Tier 2 the reported amount of any assets appearing in the Life annual return arising from transactions with the reinsurerFootnote 4 unless the assets:
The deduction from Tier 1 and inclusion in Tier 2 required on account of any unregistered reinsurer is limited to the value of the aggregate negative policy liability ceded to the reinsurer, net of any adjustment to the negative reserve amount made under section 18.104.22.168Footnote 3.
Where the total value of the policy liabilities that a foreign insurer has ceded to a particular unregistered reinsurer is negative, the insurer should include in Assets Required the amount of any assets reported as vested in trust in the Life annual return arising from transactions with the reinsurerFootnote 4 unless the assets:
The amount required to be added to Assets Required on account of any unregistered reinsurer is limited to the value of the aggregate negative policy liability ceded to the reinsurer, net of any adjustment to the negative reserve amount made under section 22.214.171.124Footnote 3.
Examples: Requirements for Liabilities Ceded
This section describes the conditions under which the deductions from Available Capital that are required under section 10.3 may be reduced, and replaces the rules that would otherwise apply under sections 3.2 and 3.3.
An insurer is given credit, for each unregistered reinsurer, equal to the sum of:
1) the funds held by the ceding insurer for its exclusive benefit (e.g. funds withheld coinsurance) to secure the payment to the ceding insurer by the reinsurer of the reinsurer's share of any loss or liability for which the reinsurer is liable under the reinsurance agreement.
2) the value of assets pledged by the unregistered reinsurer that are located in Canada and subject to the ceding insurer's claim under a valid and perfected first priority security interest under applicable law in accordance with OSFI's guidance for reinsurance security agreements. All pledged assets must:
3) the amount of acceptable letters of creditFootnote 7 held to secure the payment to the ceding insurer by the reinsurer of the reinsurer's share of any loss or liability for which the reinsurer is liable under the reinsurance agreement.
In order for a ceding insurer to obtain credit for funds held under a funds withheld reinsurance arrangement, the arrangement must not contain any contractual provision that would require payment of funds withheld to the reinsurer before the end of the reinsurance term (e.g. an acceleration clause). Furthermore, the ceding insurer may not provide non-contractual or implicit support, or otherwise create or sustain an expectation that any funds withheld could be paid to the reinsurer before the end of the reinsurance term.
All collateral must be available for as long as the assuming insurer will have financial obligations under the reinsurance agreements for which the ceding insurer is taking credit. Where contract stipulations regarding the collateral may vary during the period, credit may only be taken if the ceding insurer maintains the exclusive option to retain the collateral and the additional cost of that option, if any, is fully recognized and explicitly accounted for at inception of the agreement.
Examples: Collateral for Unregistered Reinsurance
All letters of credit used to obtain credit in respect of an unregistered reinsurer must be issued by or have a separate confirming letter from a Canadian bank that is listed on Schedule I or Schedule II of the
Bank Act. In aggregate, the amount of credit taken for letters of credit is limited to 30% of the total positive policy-by-policy liabilities ceded to unregistered reinsurers.
The assets used to obtain credit for a specific unregistered reinsurer may not be obligations of the unregistered reinsurer itself or any of its affiliates. With respect to the above three sources available to obtain credit, this implies that:
Large Exposure Limits applies to assets used to obtain credit in respect of unregistered reinsurance. As a consequence, an insurer may not take credit for assets in which it has perfected a security interest or letters of credit, held under an unregistered reinsurance transaction or a series of such transactions (not necessarily all with the same reinsurer), if consolidating these assetsFootnote 8 on the insurer's balance sheet, along with the ceded liabilities they support, would cause a large exposure limit to be breachedFootnote 9. An insurer should comply with all other OSFI guidelines and advisories concerning investments (e.g., Guideline B-1:
Prudent Person Approach, Guideline B-5:
Asset Securitization) in respect of the aggregate of the assets it has used to obtain credit for unregistered reinsurance with the assets it holds in its own portfolio.
The credit available in respect of an unregistered reinsurer may be applied to the following requirements of section 10.3:
The total credit available that may be applied toward requirement 2) in respect of all reinsurers in aggregate is limited to the greater of zero or:
N – max (R –
If the maximum credit that may be applied toward requirement 2) is less than the total of the requirement, the difference must be deducted from Tier 1 and added to Tier 2 (for Canadian insurers) or added to Assets Required (for foreign insurers) and may not be covered by collateral or letters of credit. If this situation occurs, the ceding insurer may allocate the maximum total credit allowed to particular unregistered reinsurers in any manner it chooses.
Any credit available for a particular reinsurer that exceeds the sum of the maximums allowed under 1) and 2) above or that is otherwise not applied towards these requirements may be applied towards the capital requirements for business ceded to the reinsurer, subject to the conditions in section 10.5.
Consistent with the substitution capital treatment used for collateral and guarantees, insurers are required to include, in required capital or required margin, the capital requirements for credit risk (as determined under Chapter 3) and market risk (as determined under sections 5.2, 5.3, and 5.4) for all assets subject to the insurer's claim under a perfected security interest, and for all letters of credit, that are used to obtain credit for ceded liability capital requirements relating to unregistered reinsurance or that are included in Eligible Deposits. A separate calculation is also required for currency risk as described in section 5.6.8. Available assets and letters of credit that are not used to obtain credit for ceded liability requirements and are not included in Eligible Deposits are excluded from all capital requirement calculations. A ceding insurer may designate which assets and letters of credit (or portions thereof) among those available that it will apply towards ceded requirements or include in Eligible Deposits.
In order for a ceding insurer to obtain a reduction in its Base Solvency Buffer or Required Margin on account of a registered reinsurance arrangement, or to recognize an Eligible Deposit on account of an unregistered reinsurance arrangement, the arrangement must conform to all of the principles contained in Guideline B-3:
Sound Reinsurance Practices and Procedures.The arrangement must also meet all of the conditions necessary for effective risk transfer specified in this section. The ceding insurer should be able to demonstrate that the change in risk it is exposed to as a result of the arrangement is commensurate with the amount by which it reduces its Base Solvency Buffer or Required Margin, or with the amount of Eligible Deposits that it recognizesFootnote 10.
Risk transfer must be effective in all circumstances under which the ceding insurer relies on the transfer to cover the capital/margin requirement. In assessing an arrangement, the ceding insurer should take into account any contract terms whose fulfilment is outside the ceding insurer's direct control, and that would reduce the effectiveness of risk transfer. Such terms include, among others, those which:
The ceding insurer should also take into account circumstances under which the benefit of the risk transfer could be undermined. For example, this may occur if the ceding insurer provides support (including non-contractual support) to the arrangement with the intention of reducing potential or actual losses to the reinsurer.
In determining whether there is effective risk transfer, the reinsurance arrangement must be considered as a whole. Where the arrangement consists of several contracts, the entire set of contracts, including contracts between third parties, must be considered. The ceding insurer should also consider the entire legal relationship between itself and the reinsurer.
No reduction of the Base Solvency Buffer or Required Margin, or recognition of Eligible Deposits, is allowed for a reinsurance arrangement that has material basis risk with respect to the reinsured business (for example if payments under the arrangement are made according to an external indicator instead of actual losses). Reinsurance assets arising from arrangements that are subject to basis risk may be subject to capital charges for insurance risk in addition to the capital charge for credit risk.
In assessing the effectiveness of risk transfer, the economic substance of an arrangement must be considered over the legal form or its treatment for financial statement purposes.
If a coinsurance arrangement does not cover all losses up to the level of the ceded insurance contract liability plus the marginal insurance risk requirement for the ceded business net of PfADs (the Requisite Level), then it is necessary for the ceding insurer to increase its required capital or margin, or reduce the limit on Eligible Deposits recognized. In particular, any coinsurance arrangement containing a provision under which the reinsurer is required to cover losses only in excess of a certain amount will require an adjustment, regardless of the treatment for financial statement purposes. Such provisions include, but are not limited to:
If a registered coinsurance arrangement does not cover all losses up to the Requisite Level then the ceding insurer should add to its required capital or margin the total amount of losses at or below this level for which it remains at risk. If an unregistered coinsurance arrangement does not cover all losses up to the Requisite Level then the quantity
SB1 used in determining the limit on Eligible Deposits for the coinsurance arrangement (q.v. section 6.8.1) is reduced by the total amount of losses at or below the Requisite Level for which the ceding insurer remains at risk.
Reinsurance arrangements, other than coinsurance, that provide tranched protection or under which the ceding insurer otherwise retains a loss position, are treated as stop loss reinsurance and are subject to the conditions in section 6.8.5.
The amount of the loss position that a ceding insurer retains under a reinsurance arrangement should be recalculated, according to the treaty, at each reporting date.
All capital requirements for which it is possible to obtain credit for reinsurance may be calculated net of registered reinsurance. For example, policy liabilities ceded under registered reinsurance arrangements are excluded from the policy liability cash flows used to calculate all LICAT insurance risk components.
The 2.5% credit risk requirement for registered reinsurance assets may be reduced in accordance with this section using the substitution approach described in section 10.4.3 if the asset is secured by collateral meeting the conditions in the introduction to section 3.2 and in section 3.2.2Footnote 11, or a guarantee (including a letter of credit) meeting the conditions in section 3.3.
If an insurer cedes business under a funds withheld coinsurance or modified coinsurance arrangement that constitutes registered reinsurance, it is possible that the asset risks covered in Chapter 3 and sections 5.2 to 5.4 are transferred to the reinsurer. Such a transfer may occur if, for example, the contractual rate of accrual of the funds withheld liability or modified coinsurance adjustment is not fixed, and instead depends on the returns of a pool of assets held by the ceding insurer. The capital treatment for asset risk transfers follows the treatment for collateral (section 10.4.3) or guarantees (section 3.3), as applicable, both of which are based on the substitution approach.
The credit risk requirement for reinsurance assets arising from registered reinsurance may be reduced on account of:
Such liabilities are treated as collateral for the reinsurance asset due from the reinsurer, and the capital treatment of the reinsurance asset follows the substitution approach described in section 10.4.3. If the liabilities due are not subject to fluctuations arising from changes in asset prices, then the credit risk factor associated with the liability under the substitution approach is 0%. However, if the value of the liability fluctuates directly with that of one or more on-balance sheet assets, then:
Examples: Credit and market risk requirements for business ceded under funds withheld
1) Under a funds withheld coinsurance treaty, an insurer has a reinsurance asset of $120 due from a registered reinsurer, and a funds withheld liability of $100 due to the reinsurer. The contractual interest rate used for the funds withheld balance is 2% per year, and therefore the reinsurance does not transfer any of the asset risks borne by the ceding insurer. Of the $120 reinsurance asset, $100 is treated as collateralized, and the remaining $20 is treated as uncollateralized. As a result, the credit risk requirement for the reinsurance asset is reduced from $3.00 to:
0% × $100 + 2.5% × $20 = $0.50
The asset risk requirements for the rest of the insurer's on-balance sheet assets remain unchanged.
2) Suppose instead that the amount that is contractually accrued on the funds withheld liability is equal to the return on the following portfolio of on-balance sheet assets, none of which are obligations of the reinsurer or its affiliates:
If the reinsurer is not an affiliate of the ceding insurer, a total of $10.56 of asset risk requirements for these assets is removed from the insurer's credit and market risk solvency buffers. Additionally, $50 of the portfolio has an asset factor lower than that of the reinsurance asset, which allows the ceding insurer to treat this portion of the reinsurance asset as collateralized; the remainder is treated as uncollateralized. The credit risk requirement for the reinsurance asset is therefore reduced from $3.00 to:
0.5% × $25 + 2% × $25 + 2.5% × $70 = $2.38
If a registered modified coinsurance arrangement transfers asset risks associated with on-balance sheet assets to the reinsurer, the arrangement must meet all of the requirements of section 3.3 in order for the ceding insurer to take credit (e.g., the reinsurance must provide protection at least as strong as a guarantee, and the reinsurer cannot be an affiliate of the ceding insurer). If an insurer is eligible to take credit for the transferred asset risks, the capital treatment follows the substitution approach. The credit risk factor substituted is the factor corresponding to the reinsurer's claims-paying ability rating and the maturity of the covered asset, rather than 2.5%. For assets covered under the risk transfer that are subject to market risk factors, the factor substituted should be the reinsurer's credit risk factor corresponding to a 10-year maturity. If the term of the modified coinsurance arrangement is shorter than the maturity of a covered fixed-income asset, then the maturity mismatch adjustment in section 3.3.7 should be applied.
Example: Asset risk requirements for business ceded under modified coinsurance
If, in example 2) in the previous section, the reinsurance arrangement is modified coinsurance instead of funds withheld, the term of the reinsurance is 20 years, the reinsurer has an AA claims-paying ability rating, the return on the asset portfolio is included in the modified coinsurance adjustment, and the reinsurance meets all the requirements of section 3.3 (including that the reinsurer is an eligible guarantor per section 3.3.4), then the credit and market risk requirements for the asset portfolio go down from $10.56 to $1.31, based on the following substituted asset factors:
Collateral and letters of credit that are used to obtain credit for unregistered reinsurance or for insurance risk capital requirements give rise to additional capital requirements for credit and market risks (section 10.4.3).
If an unregistered reinsurance arrangement transfers on-balance sheet asset risks to the reinsurer, the ceding insurer does not receive any credit for these requirements, as the credit risk factor assigned to the unregistered reinsurer is effectively 100% and does not lead to a credit under the substitution approach.
An "excess deposit" is the difference, if positive, between the credit available for an unregistered reinsurer under section 10.4.1, and the credit that has been applied towards the requirements for liabilities ceded to the reinsurer under section 10.4.2. If an unregistered reinsurer has placed an excess deposit, all or a portion of the deposit may be included in Eligible Deposits in the calculation of the Core and Total Ratios. Refer to section 6.8.1, which specifies the limit on the amount of the excess deposits that may be recognized.
For the sole purpose of determining whether reinsurance is deemed to constitute registered or unregistered reinsurance under this section, all Canadian insurers (i.e., companies, societies, and foreign companies operating in Canada on a branch basis) should refer to the considerations set out in OSFI's Advisory No. 2007-01-R1 titled
Insurance in Canada of Risks to determine whether it, as the ceding insurer, has assumed in Canada the risks related to the underlying policies, or whether it assumed those risks from outside Canada.
Return to footnote 1
The term "recognized", as applied to a reinsurance arrangement by a foreign solvency regulator, means that the ceding company is able to report an improved capital adequacy position to the solvency regulator as a result of the reinsurance arrangement.
Return to footnote 2
No reduction of the adjusted amount is permitted for amounts recoverable on surrender.
Return to footnote 3
Assets appearing in the Life annual return that should be deducted exclude negative reinsurance assets and reinsurance liabilities due to the reinsurer. The value of other assets arising from transactions with the reinsurer may not be netted with negative reinsurance assets or reinsurance liabilities in calculating the amount deducted from Tier 1 or added to Assets Required.
Return to footnote 4
A foreign insurer ceding risks related to its Canadian business will be given credit for assets located in Canada only where the reinsurance arrangement provides that the reinsurer does not have any right of set-off against the obligations of the foreign insurer other than obligations related to the foreign insurer's insurance business in Canada. In particular, the reinsurer must not be able to set off amounts due to the foreign insurer against any liabilities of the home office or affiliates of the foreign insurer that are not liabilities arising out of the Canadian operations of the foreign insurer.
Return to footnote 5
Cash must be in a form in which it is possible to perfect a security interest under applicable law.
Return to footnote 6
Insurers should contact OSFI's Securities Administration and Approvals Reporting Unit (SAAR) to obtain OSFI's standards for letters of credit. SAAR's contact information is:
Via mail: 255 Albert Street, 15th Floor, Ottawa, ON K1A 0H2;
General guidance on requirements for approval of letters of credit can be found in the OSFI document General Guidelines for Use of Letters of Credit (LOC's).
Return to footnote 7
The expression "consolidating these assets" means, for letters of credit, recording the full amount of the letters of credit as obligations due from the issuing banks.
Return to footnote 8
This consolidation test must be performed in respect of unregistered reinsurance notwithstanding that Guideline B-2 does not establish quantitative limits for exposures to reinsurers. Assets and letters of credit having a residual maturity of less than one year may not be excluded from the definition of exposure. For the purpose of the consolidation test, the additional amount of total capital that a ceding insurer may assume would be available is limited to the amount of Eligible Deposits recognized in the LICAT total ratio.
Return to footnote 9
Without limiting the requirement that ceding insurers should abide by the risk transfer principle with respect to all reinsurance transactions, OSFI may, if it is unclear how much risk the ceding insurer bears post-reinsurance and OSFI determines it is desirable to provide greater certainty, issue further guidance (including quantitative requirements) to implement this principle with respect to any reinsurance arrangement. Insurers are encouraged to contact OSFI to discuss reinsurance arrangements for which the measure of risk transfer may be unclear when applying this principle or for which implementation guidance may be required.
Return to footnote 10
The conditions for eligible financial collateral from section 3.2.2 that should be used for registered reinsurance are those for capital markets transactions rather than secured lending. If collateral is denominated in a currency different from that of the reinsurance asset, its market value must be reduced by 30%.
Return to footnote 11