Regulatory notice on using natural catastrophe bonds in the Minimum Capital Test guideline

Overview

This regulatory notice applies to all federally regulated property and casualty insurers excluding mortgages insurers. The notice communicates the addition of natural catastrophe bonds as a form of reinsurance to reduce capital requirements for insurance risk, subject to approval.

Background

Section 4.3 of the Minimum Capital Test Guideline (Risk Mitigation and Risk Transfer – Reinsurance) defines the terms registered and unregistered reinsurance and the conditions for determining whether insurers can take a capital credit for reinsurance.

Changes to this section are necessary to include the use of natural catastrophe bonds as a form of reinsurance for capital credit. The interim guidance provides timely and clear guidance to insurers who want to use natural catastrophe bonds as part of their reinsurance risk management.

Definition

Natural catastrophe bonds are insurance‑linked securities issued for the sole purpose of transferring natural‑hazard‑related risk from an insurer, reinsurer, or sponsor to capital markets for a predefined natural peril, such as:

• earthquakes
• hurricanes
• severe convective storms
• floods
• wildfires
• other naturally occurring environmental events

For the avoidance of doubt, natural catastrophe bonds exclude coverage for any man‑made or human‑initiated events, including but not limited to:

• terrorism
• war or political violence
• industrial or infrastructure accidents
• pollution incidents
• nuclear or radiological events arising from human actions
• cyberattacks
• any other non‑natural cause of loss

Revisions

Adding natural catastrophe bonds as unregistered reinsurance

Natural catastrophe bonds are considered unregistered reinsurance, with no margin requirement. We expect the natural catastrophe bond to have an indemnity trigger with the collateral invested in high-quality assets. The collateral is subject to the capital requirements for unregistered reinsurance. The collateral should be located in Canada and be fully paid in under a reinsurance security agreement. We will not recognize the natural catastrophe bond for capital purposes if these characteristics are not met.

Approval requirement

We expect insurers to obtain our approval prior to using natural catastrophe bonds to reduce capital required for insurance risk. The Appendix outlines the information to be submitted. Submit applications to your lead supervisor.

Conclusion

The adjustments outlined above take effect immediately. We expect to incorporate the adjustments in the next version of the Minimum Capital Test guideline, at which point we will rescind this regulatory notice.

Appendix – Information Requirements

Purpose

1. Copy of reinsurance program structure showing how the natural catastrophe bond fits into the applicant's reinsurance strategy including confirmation of compliance with applicant's reinsurance risk management policy and Guideline B-3 – Sound Reinsurance Practices and Procedures.

Reinsurance contract documentation and terms

2. Copy of the natural catastrophe bond reinsurance contract with description of the settlement of accounts if the bond is multi-peril, the governing law, the loss calculation, and payment.

Transaction structure documentation

3. Copy of the offering documentation and information provided to natural catastrophe bond investors.
4. Copy of any related inter-company agreements, including but not limited to those between the insurer and the special purpose vehicle, reinsurance security agreement, and/or the issued natural catastrophe bond, if applicable. Include a transaction structure diagram.
5. Confirmation that an event of default under the arrangement will not lead to cross-defaults or credit events in any other debt or derivative agreements of the sponsoring insurer.
6. Copy of any related auditor, legal, or other opinions or attestations received with respect to any part of the transaction.

Collateral

7. Copy of the documentation on the special purpose vehicle and/or issuing trust (for example, declaration of trust).
8. Copy of investment management guideline and oversight.
9. Description of the type and quality of capital held in the reinsurance security agreement.

Modelling

8. Copy of any stress testing and modeling reports related to the arrangement.