- Type of Publication: Guideline
- Date: December 2010
- No: B-3
- Audiences: Life / P&C
Reinsurance is an important risk management tool available to
an insurer. It can be used to reduce insurance risks and the volatility
of financial results, stabilize solvency, make more efficient use
of capital, better withstand catastrophic events, increase underwriting
capacity, and to draw on reinsurers’ expertise. However, reinsurance
exposes an insurer to other risks, including operational, legal,
counterparty, and liquidity risks. The combination of these risks
can make reinsurance complex and challenging to implement effectively.
Inadequate reinsurance risk management practices and procedures
can materially affect an insurer’s financial soundness and reputation,
and can ultimately contribute to its failure.
This Guideline sets out OSFI’s expectations for effective reinsurance
practices and procedures. These practices and procedures should
form an important part of an insurer’s overall reinsurance risk
management policy. It applies to all federally
regulated insurers, including life insurers and property and casualty
insurers, domestic insurance companies and foreign insurance companies
in respect of their insurance business in Canada, registered reinsurers
and fraternal benefit societies (collectively referred to as FRIs),
that are party to reinsurance cessions, retrocessions, and, where
applicable, to assumption reinsurance transactions.
FRIs are reminded that OSFI’s Guideline on Corporate Governance
extends to the business of reinsurance with respect to ensuring
effective oversight and risk management policies and procedures.
The following reinsurance principles are intended to assist FRIs
in developing prudent approaches to managing their reinsurance risks.
OSFI will assess a FRI’s reinsurance risk management policy against
these principles and, where considered necessary, will require remedial
action consistent with its early intervention mandate.
1. A FRI should have a sound and comprehensive reinsurance
risk management policy, subject to the oversight of the FRI’s
Board of Directors and implementation by senior management.
Reinsurance Risk Management Policy (RRMP)
OSFI expects that a FRI’s RRMP will form an integral component
of its overall enterprise-wide risk management plan.
The RRMP should reflect the scale, nature and complexity of a
FRI’s business, and have regard for its risk appetite and risk tolerance.
OSFI expects the RRMP to document the significant elements of the
FRI’s approach to managing risks through reinsurance, including
the purpose and objectives for seeking reinsurance, risk diversification
objectives, risk concentration limits,
and the practices and procedures for managing and controlling its
The RRMP should detail:
- the roles and responsibilities for those positions charged with
implementing the RRMP;
- the process for ensuring that the RRMP is updated to reflect
changing market conditions;and,
- the FRI’s policy on the use of registered and unregistered reinsurance.
Additionally, a FRI must assess the adequacy and effectiveness
of the reinsurance arrangements to ensure that exposures to large
and catastrophic losses are adequately addressed. This may require
stress testing of exceptional but plausible scenarios to determine
if the reinsurance arrangements entered into are adequate at mitigating
losses to acceptable levels in accordance with the FRI’s risk appetite
and risk tolerance.
Board of Directors (Board) and Senior Management Oversight
The RRMP should be overseen by the Board
and implemented by senior management. At a minimum, a FRI’s Board
should review and approve the FRI’s RRMP as part of its annual review
of the enterprise-wide risk management plan. Senior management has
the responsibility of ensuring that the RRMP is operationalized
through the dedication of adequate resources and is implemented
by the risk management and business line officers and managers charged
with the day-to-day responsibility for the RRMP.
It is the responsibility of the Board and senior management to
ensure that appropriate policies, procedures, and internal controls
exist to monitor the effectiveness of, and operational compliance
with, the RRMP on an on-going basis.
2. A FRI should perform a sufficient level of due diligence
on its reinsurance counterparties on an on-going basis to ensure
that the FRI is aware of its counterparty risk and is able to
assess and manage such risk.
A FRI should evaluate the ability of all current and prospective
reinsurance counterparties to meet their liabilities under exceptional
but plausible adverse events on an on-going basis. The level of
a FRI’s due diligence on any reinsurance counterparty should be
commensurate with its level of exposure to that counterparty.
In the evaluation of its current and prospective reinsurance counterparties,
however, a FRI should generally not rely solely on third parties,
including rating agency assessments
or broker analysis and recommendations.
Prudent practice dictates that the FRI should, to an extent proportional
to the importance of such counterparty, conduct its own due diligence
on the financial strength and capabilities of all reinsurance counterparties.
When performing its due diligence, a FRI should give consideration
to, among other things, the reinsurance counterparty’s:
- claims payment record;
- expected future claims obligations;
- balance sheet strength;funding sources, including its level
of and access to capital, and form, amount and sources of liquidity;
- management, including the quality of its governance practices
and procedures; and,
- retrocession arrangements and the direct or indirect impact
they may have on the FRI’s own arrangements with the reinsurer.
Similarly, a FRI that is a reinsurer should, commensurate with
its level of exposure to the cedant, conduct its own due diligence
on the risk management and risk assessment criteria of the cedant.
The evaluation of each of a FRI’s reinsurance counterparties should
be updated throughout the life of the reinsurance contract. In cases
where there may be material exposures to incurred but not reported
losses, management should ensure that the evaluation continues beyond
the expiration date of the contract to ensure that the FRI assesses
potential reinsurance recoverables from expected future claims.
OSFI expects a higher level of due diligence by a FRI in respect
of any current or prospective reinsurance arrangement with an unregistered
reinsurer or with a
cedant that is not regulated by OSFI. This assessment of counterparty
risk should consider the regulatory and supervisory regime, and
the legal and insolvency frameworks of the unregistered party’s
3. The terms and conditions of the reinsurance contract
should provide clarity and certainty on reinsurance coverage.
A FRI should have processes and procedures in place to ensure
that a comprehensive, written, and binding
reinsurance contract is executed prior to the effective date of
reinsurance coverage. To achieve clarity and certainty on reinsurance
coverage, a reinsurance contract should be unambiguous, and there
should be complete and final agreement of all material terms and
conditions of the contract, documented in writing, by all parties
prior to the contract’s effective date.
OSFI recognizes that there may be situations where a comprehensive
reinsurance contract is only duly executed by all parties after
the effective date. In such circumstances, historical practice has
been that the reinsurance coverage during this interim period is
usually set out in a less formal document (e.g., slip, cover note,
letter of proposal, binding letter of intent, hereinafter referred
to as the “summary document”). If an event were to occur within
this interim period, lack of certainty relating to the terms and
conditions of the reinsurance coverage in the summary document could
result in actual operational and reputational risks for both the
cedant and the reinsurer. In an effort to mitigate these risks,
OSFI expects FRIs to:
- obtain contractually binding summary documents prior to the
effective date of the reinsurance coverage, including, but not
limited to electronic copies, or original hard copies, of signed
documents that set out:
- the premium / consideration paid by the cedant;
- the percentage of risk assumed by each reinsurer;
- the risk(s) reinsured;
- the duration of the coverage;
- where applicable, any exclusions to terms of coverage; and,
- any standard clauses that are to be relied upon or incorporated
by reference into the reinsurance contract;
- address, within the summary document, any material issues most
likely to arise, including all variable or unique agreement terms;
- ensure that all final comprehensive reinsurance contracts, including
any amendments thereto, bear the duly authorized signature of
both the ceding company and the reinsurer(s)
within a relatively short timeframe having regard for the nature,
complexity and materiality of the agreement (e.g., within 120
days of execution).
Generally, a reinsurance contract should stand on its own, providing
the necessary clarity and legal certainty on reinsurance coverage.
OSFI acknowledges, however, that there may be situations where it
is necessary and appropriate for a FRI to enter into a supplemental
or subordinated reinsurance contract, a side letter, or other types
of arrangements that are ancillary to, and form part of, the main
reinsurance contract. In addition to ensuring that these arrangements
meet the requirements of this Guideline, the FRI should be transparent
with stakeholders about these arrangements, ensure that such amendments
are appropriately reflected in its financial statements, and ensure
that they do not adversely change the terms or conditions of the
original contract to the detriment of policyholders.
4. A ceding FRI should not be adversely affected by the
terms and conditions of a reinsurance contract.
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
or reinsurer’s insolvency. To this end, reinsurance contracts should
include an “insolvency clause”, and particular attention should
be paid to the appropriate use
of “off-set” or “cut-through” clauses, the structure of “funds withheld”
arrangements , and other
such types of terms or conditions that may frustrate the scheme
of priorities under the Winding-Up and Restructuring Act (WURA).
Ceding FRIs 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 as defined
under the WURA and the Insurance Companies Act (ICA), rather
than being allocated toward the payment of specific claims of creditors
Reinsurance contracts should not contain other types of terms
or conditions that may limit a troubled or insolvent cedant’s
ability to enforce the contractual obligations of a reinsurer, or
that may adversely affect the treatment of any claims in respect
of the cedant’s policyholders. and cut-through clauses may allow
certain creditors or policyholders to have preferential Off-set
treatment over other claims, contrary to the scheme of distribution
in the WURA. In the case of off-set clauses, for example, where
the ceding company is a foreign insurance company authorized to
insure in Canada risks, the reinsurer should not have any right
of off-set against the obligations of the ceding company other than
those related to the ceding company’s insurance business in Canada.
If a reinsurance contract provides for a funds withheld arrangement,
the contract must clearly provide that, in the event of the cedant’s
or reinsuer’s insolvency, the funds withheld, less any surplus due
back to the reinsurer, must form part of the property of the cedant’s
general estate, or part of the assets in Canada of a foreign insurance
company as defined under the WURA and the ICA.
OSFI expects all contracts related to reinsurance coverage to
stipulate a choice of forum, a choice of law, and the appointment
of agents for service of legal processes that are necessary to ensure
the reinsurance contract and any disputes arising from such contract
are subject to the laws and courts of a Canadian province or another
legal jurisdiction of, in the reasonable opinion of the FRI, equivalent
or greater reliability and certainty which has a natural connection
to the transaction.
Enhanced transparency will allow OSFI to better understand the
economic impacts and risks associated with a FRI’s reinsurance arrangements.
A FRI is required to maintain and provide to OSFI, upon request,
its RRMP and a complete description of all its reinsurance arrangements,
including levels of reinsurance, the due diligence performed on
reinsurance counterparties, and the proportion of registered and
A FRI should promptly inform OSFI if it becomes aware of any reinsurance
issues that could materially impact its financial condition.
Capital / Asset Requirements
Reinsurance may be a major part of a FRI’s overall risk management
program. Non-adherence to the principles in this Guideline could
result in a reinsurance program or reinsurance contract that does
not provide the intended protection to the ceding company. It may
also compromise the availability of balances that may have been
otherwise recoverable. If a FRI fails to meet the principles set
out in this Guideline, on a case-by-case basis, OSFI may not grant
a capital / asset credit for the reinsurance arrangement, or may,
commensurate with risk, use its discretionary authority under the
ICA, to adjust the FRI’s capital / asset requirements or target
solvency ratios to compensate for reinsurance that is not, or may
not, be wholly effective or reliable.
Federally approved provincial / territorial reinsurers may lose
their status if they fail to meet the expectations set out in this
A senior officer of a FRI should make an annual reinsurance declaration
to the Board or Chief Agent, as appropriate, to confirm that the
FRI’s reinsurance risk management practices and procedures meet,
except as otherwise disclosed in such declaration, the standards
set in this Guideline. The declaration should include an attestation
that the FRI’s reinsurance arrangements effect a risk transfer and
that they are accounted for in the appropriate manner.
When a deviation from this Guideline has taken place over such
year, the nature and extent of the deviation, and the measures taken
or proposed to correct or otherwise mitigate the risk associated
with such deviation, should be documented and disclosed to the Board
and to OSFI in full.
Implementation / Transition
OSFI encourages each FRI to implement the principles and expectations
set out in this Guideline as soon as practically possible.
OSFI expects that each FRI will comply with Principle 1, including
securing Board approval of its RRMP, by July 1, 2011.Once
the RRMP has been approved, each FRI is expected to implement and
fully comply with the remaining principles and expectations of this
Guideline, including the filing of its first reinsurance declaration
to the Board, by July 1, 2012.
With respect to existing multi-year contracts that do not naturally
come up for renewal during the transition period, OSFI expects that
each FRI will take all commercially reasonable efforts during the
transition period to make these contracts B-3 compliant. The designated
OSFI Relationship Manager will follow each FRI’s efforts and progress.
Other OSFI Guidance
This Guideline is complementary to, and should be read in conjunction
with, other OSFI guidance that implicitly or explicitly addresses
various elements of reinsurance or governance, including:
A FRI should consider that, before reinsuring with an unregistered
related party, an approval may be required under subsection 523(2)
or 597(1) of the ICA. A ceding FRI must seek the requisite approval
under subsection 254(2), 254(2.01) or 587.1(2) of the ICA prior
to causing itself to be reinsured on an assumption basis.