Crediting Unlicensed Reinsurance

Canada’s solvency regulator, the Office of the Superintendent of Financial Institutions (OSFI), released a Draft Guidance for Reinsurance Security Agreements in August 2010. The document establishes the new regime for obtaining a capital/ asset credit in connection with unregistered reinsurance.

The current regime requires federally regulated insurers to enter into reinsurance trust agreements to be eligible for a capital/asset credit in respect of unregistered reinsurance.

OSFI’s new approach will require cedants to enter into a reinsurance security agreement, ensure that a collateral agent in Canada is holding the collateral and ensure that the cedant has a valid first-ranking security interest in the collateral. Also, cedants will have to provide a legal opinion addressed to the cedant and OSFI regarding the security interest.

With respect to newly entered arrangements, OSFI expects insurance companies to follow the draft guidance beginning Jan. 1, 2011. OSFI expects existing arrangements to have been replaced by reinsurance security agreements by Jan. 1, 2012.

OSFI is accepting comments on the draft guidance until Oct. 1, 2010.

OSFI will permit a capital/asset credit for reinsurance security agreements in situations in which the following criteria are met:

• assets of an unregistered reinsurer are pledged to the cedant to secure the payment of the potential liabilities of the reinsurer under a reinsurance agreement pursuant to a reinsurance security agreement made under provincial law;

• pledged assets are held in Canada by a collateral agent (which must be a Canadian financial institution that is not affiliated with the unregistered reinsurer);

• all documents are binding on the parties and legally enforceable in all relevant jurisdictions;

• the necessary steps have been taken to create and maintain a valid first-ranking security interest in the collateral in the cedant’s favour by the unregistered reinsurer;

• the cedant has the right to liquidate or take possession of the collateral in a timely manner in the event of the default of the reinsurer;

• if the pledged assets are financial assets to which securities transfer legislation applies, the collateral agent obtains control of these assets on behalf of the cedant;

• the cedant provides OSFI with a legal opinion addressed to the cedant and OSFI;

• the credit quality of the reinsurer and the value of the collateral must not have a material positive correlation (e. g., securities issued by the reinsurer or a related entity are ineligible); and

• the cedant must have clear and robust procedures for the timely liquidation of collateral.

OSFI’S EXPECTATIONS

The draft guidance says cedant companies are expected to approve assets pledged or withdrawn. In addition, the guidance lists certain provisions that OSFI expects will be addressed in a reinsurance security agreement.

The draft guidance also sets out matters to be addressed in the legal opinion addressed to the cedant and OSFI. For example, the opinion is required to be provided by a lawyer with expertise in personal property security legislation in the province where the assets are held. If the chief agent is the cedant’s legal counsel, the cedant should seek a legal opinion from outside legal counsel. If a ceding company provides an opinion from in-house counsel, OSFI expects the opinion will state it is provided by counsel in his or her professional capacity as a lawyer and not in any other capacity.

OSFI will continue to require ceding companies to obtain approval of the removal of pledged assets to obtain an asset credit for assets that are not listed in Schedule A or for any transaction involving foreign currency assets. As is currently the case, reinsurers will be permitted to withdraw assets provided that, prior to or simultaneously with such withdrawal, the withdrawn asset is replaced with assets listed in Schedule A of at least equal market value.

The draft guidance also states OSFI will require monthly reporting regarding the market value of assets subject to each reinsurance security agreement.

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OSFI’s new approach will require cedants to enter into a reinsurance security agreement, ensure that a collateral agent in Canada is holding the collateral and ensure that the cedant has a valid first-ranking security interest in the collateral. Cedants will also have to provide a legal opinion addressed to the cedant and OSFI regarding the security interest.