OSFI.Reinsurance

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Reading: “Sound Reinsurance Practices and Procedures,” January 2025. Official Link

Author: OSFI (Office of the Superintendent of Financial Institutions Canada)

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BA Quick-Summary: Reinsurance Practices This reading applies to all federally regulated insurers using reinsurance and includes these topics: Policy & Oversight: Requires a formal reinsurance risk policy with senior management oversight. Counterparty Risk: Ongoing due diligence is needed for all reinsurers, especially unregistered ones. Contract Terms: Contracts must be clear, binding, and include insolvency protection clauses.

Pop Quiz

How is reinsurer non-performance risk handled in the calculation of the ARC/AIC?

Study Tips

Key Insight:

• This paper is all about balancing the benefits and risks of reinsurance
• Reinsurance is a double-edged sword: it reduces insurance risk but creates counterparty, operational, and liquidity risks

Study Strategy Summary:

This is a principles-based guideline rather than rules-based with a focus on comprehensive risk management frameworks and ongoing processes.

Key things to focus on:

• 4 Key Principles: RRMP, Due Diligence, Contract Terms, Adverse Effects
• RRMP Components: Purpose, Limits, Counterparty Risk, Concentration
• Due Diligence Factors: 6 key areas to evaluate reinsurers
• Contract Requirements: Insolvency clauses, binding agreements, legal jurisdiction

Before You Start:

This guideline is comprehensive and detailed - it's not a quick read! The key to success is understanding that every requirement exists to manage a specific risk. Ask yourself: "*What risk is this addressing?*" as you study each section.

• Benefits vs. Risks: Understand the reinsurance trade-offs
• Process-oriented: Focus on ongoing procedures, not one-time requirements
• Perspective shifts: Sometimes you're the cedant, sometimes the reinsurer

Estimated study time: a few hours

Overview: The Reinsurance Paradox

🎪 The Reinsurance Balancing Act

Benefits of Reinsurance :

• Reduce insurance risks & volatility
• Stabilize solvency
• More efficient capital use
• Withstand catastrophic events
• Increase underwriting capacity
• Access reinsurers' expertise

Risks Created by Reinsurance :

• Operational risk
• Legal risk
• Counterparty risk ⭐ (most important)
• Liquidity risk

💡 Key Insight: The goal is to capture the benefits while comprehensively managing the new risks created.

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Section I: The 4 Key Principles

Principle 1: Sound Reinsurance Risk Management Policy (RRMP)

📝 CRITICAL: What must the RRMP document? [Hint: PCCC]

Purpose and objectives for seeking reinsurance

Ceding limits

Counterparty risk

Concentration limits

Managing Risks THROUGH Reinsurance

Question: When does OSFI recognize capital credit for reinsurance?

Under MCT (Minimum Capital Test), if certain conditions are met, the FRI may reduce required capital for insurance risk ceded

⚠️ Important Exception: OSFI will generally NOT recognize credit when:

• Foreign FRI cedes Canadian risks back to home office through affiliated reinsurers

Managing Risks ARISING FROM Reinsurance

Golden Rule: Should NOT cede 100% or substantially all risk in normal course of business

Counterparty Risk Management :

• Consider all elements of counterparty risk
• Include legal and insolvency framework of counterparty's home jurisdiction
• Assess at aggregate level (groups of affiliated counterparties)
• Evaluate going-concern AND gone-concern scenarios
• Consistent process across all counterparties (affiliates and non-affiliates)

Concentration Limits :

• Establish limits for individual counterparties
• Establish limits for groups of affiliated counterparties
• Reflect both counterparty risks AND risks to be ceded

Senior Management Oversight

Question: What are senior management's responsibilities for RRMP?

• Oversee development, implementation, and operationalization
• Ensure appropriate policies, procedures, and internal controls exist
• Review RRMP annually (minimum)
• Monitor effectiveness and compliance on ongoing basis

Principle 2: Ongoing Due Diligence on Counterparties

📋 The 6 Due Diligence Factors [Hint: CBFMER]

💰 Claims payment record

📊 Balance sheet strength

💸 Funding sources (capital access, liquidity)

👥 Management quality & governance

🎯 Expected future claims obligations

🔄 Retrocession arrangements

• Due diligence should be commensurate with exposure level
• NOT less thorough for affiliates
• Should NOT rely solely on third parties (rating agencies, brokers)
• Must be updated throughout contract life
• Higher level required for unregistered reinsurers

Retrocession Visibility :

• If counterparty relies significantly on retrocessions → seek greater visibility of retrocessionaires
• Know the identities and financial standing of retrocessionaires

Principle 3: Clear Contract Terms & Conditions

The Binding Agreement Challenge :

Question: What if comprehensive contract isn't signed by effective date?

OSFI expects (for interim period):

• Contractually binding summary documents prior to effective date
• Must include: premium, percentage of risk, risks reinsured, duration, exclusions, standard clauses
• Address material issues most likely to arise
• Final comprehensive contracts signed within reasonable timeframe (e.g., 120 days)

Generally NOT Acceptable: Agreement bearing only reinsurance intermediary signature (unless intermediary has proven authority)

Principle 4: Terms Should NOT Adversely Affect Ceding FRI

This principle is all about protecting policyholders!

Insolvency Clause Requirements

For Third-Party Reinsurers:

• Reinsurer must continue full payments to insolvent cedant
• No reduction solely from cedant's insolvency
• Receivables paid directly to FRI-cedant in Canada

For Affiliated Reinsurers:

• Same requirement: receivables paid directly to FRI-cedant in Canada

Other Protective Requirements :

• Choice of forum: Canada or equivalent legal jurisdiction
• Choice of law: Canadian law or equivalent
• Agent appointment for service of legal processes
• Funds withheld: must form part of cedant's general estate in insolvency

Problematic Clauses: Off-set and cut-through clauses may give preferential treatment contrary to WURA distribution scheme

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Section II: Guideline Administration

📁 What must FRIs maintain & provide to OSFI? [Hint: RRDS]

📋 RRMP (Reinsurance Risk Management Policy)

📝 Complete description of all Reinsurance arrangements

🔍 Due diligence performed on counterparties

📊 Stress testing performed on reinsurance program

Ongoing Reporting :

• Regular reports to senior management
• Confirm practices meet guideline principles
• Assurances that arrangements effect risk transfer
• Appropriate accounting for arrangements

Material Issue Notification :

• Promptly inform OSFI of issues that could materially impact financial condition
• Document and disclose any deviations from principles
• Include nature, extent, and corrective measures

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Quick Reference Charts

🎯 Principle	📝 Key Requirements	🔍 Focus Areas
1️⃣ RRMP	Document PCCC, Annual Review	Purpose, Limits, Risk Management
2️⃣ Due Diligence	Ongoing evaluation, 6 factors	CBFMGR, Retrocession visibility
3️⃣ Contract Terms	Binding agreements, 120 days	Summary docs, Comprehensive contracts
4️⃣ No Adverse Effects	Insolvency clauses, Canadian law	Policyholder protection, Legal jurisdiction

🎪 Benefits	⚡ Risks Created	🛡️ Risk Management
Reduce insurance risk	Counterparty risk	Due diligence, concentration limits
Stabilize solvency	Operational risk	Comprehensive RRMP
Efficient capital use	Legal risk	Proper contract terms
Catastrophic protection	Liquidity risk	Ongoing monitoring

Practice Questions

Conceptual Questions:

What are the 4 key elements that must be documented in an RRMP?

What 6 factors should be considered in due diligence?

When will OSFI generally NOT recognize capital credit for reinsurance?

What's the difference in insolvency clause requirements for affiliated vs third-party reinsurers?

Application Questions:

A FRI wants to cede 95% of its catastrophe exposure. What principle does this violate?

What documents are needed if a comprehensive reinsurance contract isn't signed by the effective date?

Why might OSFI require higher due diligence for unregistered reinsurers?

What must FRIs maintain and provide to OSFI upon request?

Practice Questions Answer Key

Conceptual Questions

Question 1: What are the 4 key elements that must be documented in an RRMP?

Answer: PCCC

• Purpose and objectives for seeking reinsurance
• Ceding limits
• Counterparty risk
• Concentration limits

Question 2: What 6 factors should be considered in due diligence?

Answer: CBFMER

• Claims payment record
• Balance sheet strength
• Funding sources (including level of and access to capital, and form, amount and sources of liquidity)
• Management quality (including governance practices and procedures)
• Expected future claims obligations
• Retrocession arrangements and their direct or indirect impact

Question 3: When will OSFI generally NOT recognize capital credit for reinsurance?

Answer: When a foreign FRI cedes Canadian risks back to the foreign FRI's home office through affiliated reinsurers.

OSFI will generally not recognize or grant credit for such arrangements.

Question 4: What's the difference in insolvency clause requirements for affiliated vs third-party reinsurers?

Third-party reinsurers:

Must contain insolvency clause stipulating that reinsurer continues full payments to insolvent cedant without reduction solely from cedant's insolvency, AND all receivables paid directly to FRI-cedant in Canada

Affiliated reinsurers:

Must contain clause stipulating that all reinsurance receivables are paid directly to FRI-cedant in Canada (but doesn't specifically require the "no reduction" language for insolvency)

Application Questions

Question 5: A FRI wants to cede 95% of its catastrophe exposure. What principle does this violate?

Answer: This violates Principle 1 (Sound RRMP)

Explanation: The guideline states that "a FRI should not, in the normal course of its business, cede 100 per cent, or substantially all" of its risk. Ceding 95% would likely be considered "substantially all" and therefore inappropriate.

Question 6: What documents are needed if a comprehensive reinsurance contract isn't signed by the effective date?

Answer: Contractually binding summary documents that include:

• Premium/consideration paid by cedant
• Percentage of risk assumed by each reinsurer
• Risk(s) reinsured
• Duration of coverage
• Exclusions to terms of coverage (where applicable)
• Standard clauses to be relied upon or incorporated by reference
• Address material issues most likely to arise
• Final comprehensive contracts must be signed within reasonable timeframe (e.g., 120 days)

Question 7: Why might OSFI require higher due diligence for unregistered reinsurers?

Answer: Unregistered reinsurers present higher counterparty risk because they:

• Are not subject to Canadian regulatory oversight
• May operate under different legal/regulatory frameworks
• Present greater uncertainty regarding financial strength and claims-paying ability
• May have different insolvency protections
• Could create additional complexity in recovery processes

Question 8: What must FRIs maintain and provide to OSFI upon request?

Answer: RRDS

• RRMP (Reinsurance Risk Management Policy)
• Complete description of all Reinsurance arrangements
• Due diligence performed on reinsurance counterparties
• Stress testing performed on the reinsurance program

Final Exam Strategy

High-Probability Exam Topics:

• The 4 key principles
• RRMP components (PCCC)
• Due diligence factors (CBFMGR)
• Insolvency clause requirements
• What FRIs must maintain/report (RRDS)

• Perspective: Make sure you can think from both cedant and reinsurer perspectives - the guideline addresses both!

POP QUIZ ANSWERS

As a decrease in expected recovery cash flows from reinsurance held