OSFI probing as insurance companies push more risks offshore

Property and casualty insurance companies in Canada are pushing more of their risks to reinsurers that aren’t federally regulated and are often located offshore, and Canada’s most powerful financial services regulator has become concerned enough to conduct a probe of the scope of this business.

The Office of the Superintendent of Financial Institutions is assessing the growing practice among some firms of reinsuring commercial risks offshore, often through unregistered affiliates, with little capital retention in Canada.

“OSFI is currently assessing the effectiveness of these reinsurance practices,” the regulator said in an emailed statement, adding that the objective is “to ensure that Canadian policyholder protection remains in place.”

Offshore reinsurance has commonly been used to transfer large catastrophic risks when there is limited reinsurance capacity in Canada, but the regulator is now seeing what it believes is a different practice.

The new business model appears to allow insurers to increase policy limits and sizes without a change in their net risk retention.

OSFI has been able to determine that the transfer of risk exposure is quite large, and that exposures are going up without requiring the direct policy writer to increase the amount of capital held against that risk.

According to figures provided by OSFI to the Financial Post, there was an increase of approximately 30 per cent in the proportion of reinsurance ceded to unregistered reinsurers between 2011 and 2014, relative to the total level of premiums written.

“While OSFI is still collecting and assessing data, it has been observed in the industry that many policy limits have also increased during this period with most of the corresponding additional exposure being reinsured offshore,” an OSFI spokesperson said.

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The regulator’s guidelines include an expectation that insurers will conduct ongoing due diligence on reinsurance counterparties, and “a higher level of due diligence” for unregistered reinsurers, including an assessment of the regulatory and legal regimes of the reinsurer’s home jurisdiction.

OSFI regulates 89 Canadian property and casualty insurers including large operators such as Aviva Insurance Co. of Canada and Intact Insurance Co., as well as automobile and home insurance units within some of the country’s biggest banks. Officials have begun to speak to industry players about the growing share of reinsurance held by those that don’t fall within the regulator’s jurisdiction.

Jeremy Rudin, OSFI’s Superintendent, told insurance professionals gathered last week at an industry forum in Cambridge, Ont., that this shifting business model, if taken to extremes, would raise “prudential concerns” to the system, “given the possibility of distress in the unregistered reinsurer.”

It also “introduces a very concentrated credit risk to policyholders,” he told them.

OSFI is currently assessing the effectiveness of these reinsurance practices
“History has shown that over-reliance on reinsurance can be dangerous if it is used as a means to ‘rent’ capital to support rapid growth in insurance premiums,” Rudin said in his remarks prepared for the industry forum.

“Reinsurance cover can evaporate when an insurer encounters stress, and this usually happens when the company needs the reinsurance the most.”

If fresh funding to cover the shortfall can’t be raised quickly, insurers could fail, he warned.

“We want to ensure that when the use of reinsurance serves as a substitute for capital, it is not used in a manner that leaves policyholders less protected,” Rudin told the insurance professionals.

Officials at the Insurance Bureau of Canada declined to comment on the points raised in Rudin’s speech when contacted by the Financial Post. A spokesperson at Intact Insurance Co. said executives were unavailable.

In addition to domestic insurers, OSFI monitors 78 foreign P&C insurance companies that operate in Canada, including Allstate Insurance Co., and State Farm.