Difference between revisions of "OSFI.Reinsurance"

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Line 26: Line 26:
  
 
==Pop Quiz==
 
==Pop Quiz==
 +
 +
How is reinsurer non-performance risk handled in the calculation of the ARC/AIC?
  
 
==Study Tips==
 
==Study Tips==
  
−
This reading covers roughly 11 pages of material.
+
{| class='wikitable' style='background-color: navajowhite;'
 +
|-
 +
||  <span style="color: green;">'''Key Insight:'''</span>
 +
|}
 +
 
 +
* 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
 +
 
 +
{| class='wikitable'
 +
|-
 +
||  '''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'''
 +
 
 +
{| class='wikitable'
 +
|-
 +
||  '''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==
 +
 
 +
{| class='wikitable' style='background-color: lightcyan;'
 +
|-
 +
|| 🎪 '''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'''.
 +
 
 +
[https://battleactsmain.ca/FC.php?selectString=**&filter=both&sortOrder=natural&colorFlag=allFlag&colorStatus=allStatus&priority=importance-high&subsetFlag=miniQuiz&prefix=OSFI&suffix=Reinsurance&section=all&subSection=all&examRep=all&examYear=all&examTerm=all&quizNum=1<span style="font-size: 20px; background-color: aqua; border: solid; border-width: 1px; border-radius: 10px; padding: 2px 10px 2px 10px; margin: 10px;">'''mini BattleQuiz 1]'''</span> <span style="color: red;">'''You must be <u>logged in</u> or this will not work.''' </span>
 +
 
 +
==Section I: The 4 Key Principles==
 +
 
 +
===Principle 1: Sound Reinsurance Risk Management Policy (RRMP) ===
 +
 
 +
:{| class='wikitable' style='background-color: pink;'
 +
|-
 +
| 📝 '''CRITICAL''': What must the RRMP document? [Hint: <span style="color: red;">'''PCCC'''</span>]
 +
|}
 +
 
 +
:: <span style="color: red;">'''P'''</span>urpose and objectives for seeking reinsurance
 +
:: <span style="color: red;">'''C'''</span>eding limits 
 +
:: <span style="color: red;">'''C'''</span>ounterparty risk
 +
:: <span style="color: red;">'''C'''</span>oncentration limits
 +
 
 +
====Managing Risks THROUGH Reinsurance ====
 +
 
 +
:{| class='wikitable'
 +
|-
 +
| '''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
  
−
'''Estimated study time''': x mins, or y hrs, or n<sub>1</sub>-n<sub>2</sub> days, or 1 week,... ''(not including subsequent review time)''
+
⚠️ '''Important Exception''': OSFI will '''generally NOT''' recognize credit when:
  
−
==BattleTable==
+
* '''Foreign FRI''' cedes Canadian risks back to '''home office''' through '''affiliated reinsurers'''
  
−
No past exam questions are available for this reading.
+
====Managing Risks ARISING FROM Reinsurance ====
  
−
: {| class='wikitable' style='width: 1000px;'
+
:{| class='wikitable' style='background-color: yellow;'
 +
|-
 +
| '''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 ====
 +
 +
:{| class='wikitable'
 
|-
 
|-
−
! style='width: 175px;' | reference !! style='width: 175px;' | part (a) !! style='width: 175px;' | part (b) !! style='width: 175px;' | part (c) !! part (d)
+
| '''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 ===
  
 +
:{| class='wikitable' style='background-color: lightgreen;'
 
|-
 
|-
−
||  
+
| 📋 '''The 6 Due Diligence Factors''' [Hint: <span style="color: red;">'''CBFMER'''</span>]
−
||
+
|}
−
||
+
 
−
||
+
:: 💰 <span style="color: red;">'''C'''</span>laims payment record
−
||
+
:: 📊 <span style="color: red;">'''B'''</span>alance sheet strength 
 +
:: 💸 <span style="color: red;">'''F'''</span>unding sources (capital access, liquidity)
 +
:: 👥 <span style="color: red;">'''M'''</span>anagement quality & governance
 +
:: 🎯 <span style="color: red;">'''E'''</span>xpected future claims obligations
 +
:: 🔄 <span style="color: red;">'''R'''</span>etrocession 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''' :
 +
 +
:{| class='wikitable'
 +
|-
 +
|  '''Question''': What if comprehensive contract isn't signed by effective date?
 
|}
 
|}
  
−
==In Plain English!==
+
OSFI expects (for interim period):
−
E(r)-1/2 Aσ^2
+
* '''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'''!
 +
 
 +
:{| class='wikitable' style='background-color: lightcoral;'
 +
|-
 +
|  '''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
 +
 
 +
[https://battleactsmain.ca/FC.php?selectString=**&filter=both&sortOrder=natural&colorFlag=allFlag&colorStatus=allStatus&priority=importance-high&subsetFlag=miniQuiz&prefix=OSFI&suffix=Reinsurance&section=all&subSection=all&examRep=all&examYear=all&examTerm=all&quizNum=2<span style="font-size: 20px; background-color: aqua; border: solid; border-width: 1px; border-radius: 10px; padding: 2px 10px 2px 10px; margin: 10px;">'''mini BattleQuiz 2]'''</span> <span style="color: red;">'''You must be <u>logged in</u> or this will not work.''' </span>
 +
 
 +
==Section II: Guideline Administration==
 +
 
 +
:{| class='wikitable'
 +
|-
 +
| 📁 '''What must FRIs maintain & provide to OSFI?''' [Hint: <span style="color: red;">'''RRDS'''</span>]
 +
|}
 +
 
 +
:: 📋 <span style="color: red;">'''R'''</span>RMP (Reinsurance Risk Management Policy)
 +
:: 📝 Complete description of all <span style="color: red;">'''R'''</span>einsurance arrangements
 +
:: 🔍 <span style="color: red;">'''D'''</span>ue diligence performed on counterparties
 +
:: 📊 <span style="color: red;">'''S'''</span>tress 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
 +
 
 +
[https://battleactsmain.ca/FC.php?selectString=**&filter=both&sortOrder=natural&colorFlag=allFlag&colorStatus=allStatus&priority=importance-high&subsetFlag=miniQuiz&prefix=OSFI&suffix=Reinsurance&section=all&subSection=all&examRep=all&examYear=all&examTerm=all&quizNum=3<span style="font-size: 20px; background-color: aqua; border: solid; border-width: 1px; border-radius: 10px; padding: 2px 10px 2px 10px; margin: 10px;">'''mini BattleQuiz 3]'''</span> <span style="color: red;">'''You must be <u>logged in</u> or this will not work.''' </span>
 +
 
 +
[https://battleactsmain.ca/FC.php?selectString=**&filter=both&sortOrder=natural&colorFlag=allFlag&colorStatus=allStatus&priority=importance-high&subsetFlag=miniQuiz&prefix=OSFI&suffix=Reinsurance&section=all&subSection=all&examRep=all&examYear=all&examTerm=all&quizNum=all<span style="font-size: 20px; background-color: lightgreen; border: solid; border-width: 1px; border-radius: 10px; padding: 2px 10px 2px 10px; margin: 10px;">'''Full BattleQuiz]'''</span> <span style="color: red;">'''You must be <u>logged in</u> or this will not work.''' </span>
 +
 
 +
==Quick Reference Charts==
 +
 
 +
{| class='wikitable' style='background-color: lightcyan;'
 +
|-
 +
! 🎯 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
 +
|}
 +
 
 +
{| class='wikitable' style='background-color: lightyellow;'
 +
|-
 +
! 🎪 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?====
 +
 
 +
{| class='wikitable' style='background-color: lightgreen;'
 +
|-
 +
|| '''Answer: <span style="color: red;">PCCC</span>'''
 +
|}
 +
 
 +
:* <span style="color: red;">'''P'''</span>urpose and objectives for seeking reinsurance
 +
:* <span style="color: red;">'''C'''</span>eding limits 
 +
:* <span style="color: red;">'''C'''</span>ounterparty risk
 +
:* <span style="color: red;">'''C'''</span>oncentration limits
 +
 
 +
====Question 2: What 6 factors should be considered in due diligence?====
 +
 
 +
{| class='wikitable' style='background-color: lightgreen;'
 +
|-
 +
|| '''Answer: <span style="color: red;">CBFMER</span>'''
 +
|}
 +
 
 +
:* <span style="color: red;">'''C'''</span>laims payment record
 +
:* <span style="color: red;">'''B'''</span>alance sheet strength
 +
:* <span style="color: red;">'''F'''</span>unding sources ''(including level of and access to capital, and form, amount and sources of liquidity)''
 +
:* <span style="color: red;">'''M'''</span>anagement quality ''(including governance practices and procedures)''
 +
:* <span style="color: red;">'''E'''</span>xpected future claims obligations
 +
:* <span style="color: red;">'''R'''</span>etrocession arrangements and their direct or indirect impact
 +
 
 +
====Question 3: When will OSFI generally NOT recognize capital credit for reinsurance?====
 +
 
 +
{| class='wikitable' style='background-color: lightcoral;'
 +
|-
 +
|| '''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?====
 +
 
 +
{| class='wikitable' style='background-color: lightyellow;'
 +
|-
 +
|| '''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'''
 +
|}
 +
 
 +
{| class='wikitable' style='background-color: lightyellow;'
 +
|-
 +
|| '''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?====
 +
 
 +
{| class='wikitable' style='background-color: pink;'
 +
|-
 +
|| '''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?====
 +
 
 +
{| class='wikitable' style='background-color: lightblue;'
 +
|-
 +
|| '''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?====
 +
 
 +
{| class='wikitable' style='background-color: navajowhite;'
 +
|-
 +
|| '''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?====
 +
 
 +
{| class='wikitable' style='background-color: lightgreen;'
 +
|-
 +
|| '''Answer: <span style="color: red;">RRDS</span>'''
 +
|}
 +
 
 +
:* <span style="color: red;">'''R'''</span>RMP ''(Reinsurance Risk Management Policy)''
 +
:* Complete description of all <span style="color: red;">'''R'''</span>einsurance arrangements 
 +
:* <span style="color: red;">'''D'''</span>ue diligence performed on reinsurance counterparties
 +
:* <span style="color: red;">'''S'''</span>tress 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==
 
==POP QUIZ ANSWERS==
 +
 +
As a decrease in expected recovery cash flows from reinsurance held

Revision as of 13:59, 25 July 2025

NEW for 2025-Fall:
  • This is a new reading for 2025-Fall.
  • We are currently working on the content and it will be posted here when we're done!

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

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

[insert linkForum]

BA Quick-Summary: title

info

  • info
  • info

info

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.

mini BattleQuiz 1 You must be logged in or this will not work.

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

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