On November 26, 2020, the Office of the Superintendent of Financial Institutions ("OSFI") issued for public comment a draft revised Guideline B-2, Property and Casualty Large Insurance Exposures and Investment Concentration (the "Draft Guideline") which would replace the current Guideline B-2, Investment Concentration Limit for Property and Casualty Insurance Companies (the "Current Guideline").
The significant changes to the Draft Guideline address single large insurance exposures of federally regulated property and casualty insurers ("P&C Insurers"). The Draft Guideline departs from a proposal in 2018 (the "2018 Proposal") that, among other things, required that P&C Insurers be able to cover their three largest policy limit losses.
The Draft Guideline specifies investment concentration requirements, including the requirement to have an internal policy on investment concentration along with management information and control systems necessary to give effect to the insurer's policies.
OSFI has requested feedback on the Draft Guideline by March 18, 2021.
In response to concerns about a so-called "leveraged business model" whereby Canadian insurers write large policies in Canada and then cede a significant portion of these risks outside of Canada, with little capital or vested assets remaining in Canada to support the risks, in the Draft Guideline OSFI proposes a rule that would require that a P&C Insurer be able to cover the maximum loss related to a single insurance exposure on any policy it issues ("Single Insurance Exposure"). This requirement assumes the sudden failure of the largest unregistered reinsurer on that exposure and is calculated without regard to the probability of the loss event occurring.
The proposed wording in the Draft Guideline is a deviation from the 2018 Proposal in which the maximum policy limit that a P&C Insurer could issue would depend upon its level of capital and excess collateral, as well as the diversity of its reinsurance counterparties. The 2018 Proposal assessed the ability of a P&C Insurer to handle losses equivalent to its largest three policy limits, and assumed the default of its largest reinsurer on those policies. The Draft Guideline seeks to respond to concerns raised by P&C Insurers that this scenario underlying the 2018 Proposal is excessively severe and extremely improbable, with a significant impact on capital requirements for P&C insurance companies and on collateral requirements for Canadian branch operations of foreign P&C insurance companies. The Single Insurance Exposure proposed in the Draft Guideline requires a P&C Insurer to be able to cover the maximum loss related to a single insurance exposure, as opposed to three of its largest policy limit losses as required by the 2018 Proposal. The Quantitative Impact Study that OSFI conducted in 2019 following the input it received from the industry on its 2018 Proposal confirmed that certain P&C Insurers would be substantially impacted by the 2018 Proposal.
Gross Underwriting Limit Policy
The Draft Guideline also lists OSFI's expectation that P&C Insurers have a comprehensive Gross Underwriting Limit Policy ("GUWP") that is consistent with the P&C Insurer's Risk Appetite Framework. The GUWP, which is to be reviewed at least annually by senior management, should:
- define what constitutes a Single Insurance Exposure by class of insurance, as appropriate, including, where appropriate, aggregated exposures across multiple coverages and classes or insurance; and
- establish limits by class of insurance of the level of gross insurance risk that the P&C Insurer is willing to accept in respect of a maximum loss relating to a Single Insurance Exposure.
Property, credit, surety, and title insurance are identified in the Draft Guideline as classes of insurance having unique considerations in respect of determining a Single Insurance Exposure, notably concentration risk.
OSFI expects that P&C Insurers will develop and establish their own criteria and approach for determining and measuring the maximum loss on a Single Insurance Exposure. In addition, P&C Insurers should have systems and reporting procedures in place to identify and actively manage Single Insurance Exposures and ensure compliance with their GUWP. OSFI also expects that P&C Insurers will provide upon request all information with respect to such exposures.
Insurance Exposure Limit
The Draft Guideline expresses the insurance exposure limit as a percentage of total capital available (Canadian companies) or net assets available (branches in Canada of foreign companies). Under the Draft Guideline, a P&C Insurer's retained insurance exposure, plus the largest amount of its ceded unregistered reinsurance on an insurance exposure provided by an insurance group (including a reinsurance group) will not be permitted to exceed the following due to a loss on a single exposure:
- Insurance Companies: 25% of total capital available;
- Branches of Foreign Insurance Companies: 100% of net assets available, subject to satisfying certain criteria (25% otherwise); and
- P&C Federally Regulated Insurance Subsidiaries in Canada: 100% of total capital available of the subsidiary, subject to satisfying certain criteria (25% otherwise).
These revisions include material differences from the limits proposed in the 2018 Proposals. The changes were made in response to concerns raised by P&C Insurers about the improbability of the scenarios underlying the Proposals, and the policy's impact on the industry. OSFI has expressed the view that the Draft Guideline places a prudent and reasonable expectation on P&C Insurers to be in a position to cover losses with funds available in Canada or from diverse reinsurer panels.
The Draft Guideline reiterates OSFI's expectation that P&C Insurers maintain policies with respect to management of investment concentration, consistent with the P&C Insurer's Risk Appetite Framework, and including internal limits.
Investment concentration limits are established in the Insurance Companies Act (Canada) and the Investment Limits (Foreign Companies) Regulations and the Investment Limits (Insurance Companies) Regulations, subject to any further constraints in insurer policies.
The Draft Guideline includes a further guardrail that a P&C Insurer's aggregate market value of investments (excluding loans to, and loans guaranteed or securities issued or guaranteed by the Government of Canada, a Canadian province, or a member jurisdiction of the Organization for Economic Co-operation and Development) in any one entity or group of affiliated companies should not exceed:
Insurance Companies: 5% of the value of the company's assets reported on the balance sheet of the company's regulatory return filed with OSFI.
Branches of Foreign Insurance Companies: 5% of the value of assets vested in trust in Canada by the foreign company, as reported on the balance sheet of the foreign company's regulatory return filed with OSFI.
P&C Insurers should also consider other investments or commitments to an entity or group of affiliated companies, such as options, futures, forward contracts, and unfunded portions of committed loans.
Where there are investments in excess of the 5% limit above, OSFI will require that the P&C Insurer deduct those amounts from capital or assets available when calculating the company's Minimum Capital Test or the branch's Branch Adequacy of Assets Test.
Consultation Period and Feedback Sought by OSFI
As noted above, OSFI has started a public consultation period on the Draft Guideline ending March 18, 2021. OSFI has explained that it is running this extended consultation period of 16 weeks to provide time for thoughtful discussion and assessment of the issues at a time when P&C Insurers are managing operational constraints during the COVID-19 pandemic. In particular, OSFI has expressed interest in stakeholder views in respect of the following:
- How a P&C Insurer should determine and measure its maximum loss on a Single Insurance Exposure;
- Potential counterparty risk mitigation techniques that a P&C Insurer could use; and
- Suggestions contributing to an effective balance between protecting policyholders and allowing P&C Insurers to compete and take reasonable risks.
The Draft Guideline was designed to alleviate concerns raised by P&C Insurers relating to the onerous requirements of the 2018 Proposal. It is anticipated that the extended period of public consultation now underway will result in further revisions to Guideline B-2.
With strategic leveraging of deep industry expertise, we enable our clients to traverse Canada's complex, highly regulated insurance environment. Please contact Nancy J. Carroll or Hartley Lefton if you have any questions or for assistance, including for assistance preparing a submission to OSFI in respect of the Draft Guideline.
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