When does an Insurer or Reinsurer Need to be Licensed in Canada?

Association of Insurance Compliance Professionals Doing Business Internationally 2013 Conference October 6-9, 2013 Robert McDowell When does an Insurer or Reinsurer Need to be Licensed in Canada? Foreign insurers are regulated in Canada both federally and provincially, federally for solvency purposes and provincially for distribution, market conduct and policies. A foreign insurer must be licensed federally in order to then become licenced in any province or provinces. 2

When does an Insurer or Reinsurer Need to be Licensed in Canada? cont d The essential difference between the existing regime and the new OSFI Advisory (which came into force on January 1, 2010) is that the existing was about insuring a risk in Canada, and the new is about insuring in Canada a risk. After careful consideration and consultation OSFI determined that the right approach should be to regulate insurers based on where they carry out their insurance activity, not where the risk is. The Advisory is largely based on the common law about carrying on business in Canada but very particularly designed for reinsurers to protect policyholders. 3 The OSFI Advisory Indicia and Other Guidance A. The Indicia Based upon the foregoing, in the Revised Advisory, OSFI has set key indicia to consider in determining whether a foreign insurer is insuring in Canada a risk. According to paragraph 2 in the Revised Advisory, to determine whether a foreign insurer is insuring in Canada a risk, consideration should be given to whether any person acting for, or on behalf of, the foreign insurer: promotes the foreign insurer or the foreign insurer s insurance products through a medium of communication in Canada; directly incites a person located in Canada to request insurance coverage and that person is provided with the opportunity and/or means with which to make a request for insurance coverage; 4

The OSFI Advisory Indicia and Other Guidance cont d receives in Canada a request for insurance coverage from a policyholder; negotiates from Canada the terms and conditions of insurance coverage; decides in Canada to bind the foreign insurer to insurance coverage; communicates from Canada an offer to provide insurance coverage, or the acceptance of a request for insurance coverage, to a policyholder; receives in Canada an acceptance of the foreign insurer s offer to provide insurance coverage from a policyholder; receives in Canada payment for insurance coverage from a policyholder; and interacts in Canada with the policyholder in the provision of services related to the insurance coverage. 5 The OSFI Advisory Indicia and Other Guidance cont d B. How OSFI Will Apply Those Indicia The indicia are not necessarily exhaustive; Where an activity is partly in Canada and partly outside Canada, the place where most of the material aspects of that activity occur should be regarded as the location where it occurs; 6

The OSFI Advisory Indicia and Other Guidance cont d OSFI considers that a foreign insurer is insuring in Canada a risk where its business model encompasses: two or more of the activities referred to in any of bullets 2-8 above; any one of the activities referred to in any of those bullets and both of the activities referred to in the first and last bullets; reaching an agreement, actual or in principle, on most or all of the material terms and conditions of the insurance coverage in the course of its negotiations in Canada; 7 The OSFI Advisory Indicia and Other Guidance cont d OSFI considers that a foreign insurer is not insuring in Canada a risk where its business model encompasses no more than one of the activities referred to in paragraph 2. This is very strict and should be otherwise determined by legal counsel in any number of cases. 8

The OSFI Advisory Indicia and Other Guidance cont d C. Other Guidance from OSFI: In the Advisory, OSFI has provided further assistance. A foreign insurer that is authorized under the Act to insure in Canada risks operates in Canada on a branch basis. Depending on its business model, that foreign insurer may insure in Canada a risk (through its Canadian branch) or it may not insure in Canada a risk through its head office irrespective of the location of that risk. 9 The OSFI Advisory Indicia and Other Guidance cont d The Act does not restrict that foreign insurer from carrying on any activity or business in Canada. It could carry on any insurance business in Canada that does not involve the insurance of a risk by it, such as provide underwriting, policy administration or product development services to other insurers. In Canada, the federal and provincial governments share jurisdiction over foreign insurers. While a foreign insurer may, for the purposes of the Act, be considered not to be insuring in Canada a risk, its activities may cause that foreign insurer to require a license under one or more of the insurance statutes of the provinces in Canada. 10

Possible Implications/Changes Arising from the Implementation of the New Part XIII A. Best of Both Worlds A foreign reinsurer or insurer may have the best of both worlds, namely, it can arrange its affairs so that, based upon its own choice, it can write business in Canada which it wishes to and maintain books and assets (representing reserves and surplus) in Canada; and it cannot write business in Canada whenever that makes sense, with the result that it is not regulated in Canada with respect to that business. It is unlikely that any of this will change the way business is conducted for personal lines and small and mid-sized commercial business. 11 Possible Implications/Changes Arising from the Implementation of the New Part XIII cont d B. Provincial Regulation The Canadian Council of Insurance Regulators (CCIR) has sent a Consent and Undertaking (the "Undertaking") to all foreign insurers licensed under the Insurance Companies Act (Canada) (the "ICA") The effect is that where a foreign insurer is engaging in insurance business in a province under provincial insurance legislation, that foreign insurer must also ensure that it is "insuring in Canada risks" under the Advisory so that assets are required to be vested in trust in Canada under the ICA. The conditions listed in the Undertaking have the effect of harmonizing the reporting basis for the provincial and the federal insurance regulators. 12

Possible Implications/Changes Arising from the Implementation of the New Part XIII cont d British Columbia In addition to the activities-based test that already existed under B.C. legislation to determine whether an insurer is engaging in insurance business in B.C., certain amendments to the B.C. insurance legislation came into force on January 1, 2010 to provide that if the risk or peril is in B.C. then it is deemed to be carrying on insurance business in B.C. Quebec The Quebec Insurance Act was amended to provide that Quebec may require vested assets in trust for insurers carrying business of insurance in Quebec. 13 Unlicensed Reinsurance As an unlicensed (Re)Insurer you will reinsure Insurers in Canada from outside Canada. What is involved? The new OSFI Reinsurance Guideline applies to reinsurance from within and from outside of Canada. For offshore reinsurers it involves a particular regime of a Reinsurance Security Agreement with collateral in Canada. 14

OSFI Reinsurance Guideline December 2010 1. A federally regulated insurer ( FRI ) should have a sound and comprehensive reinsurance risk management policy. 2. A FRI should perform a sufficient level of due diligence on its reinsurance counterparties on an on-going basis to ensure that the FRI is aware of its counterparty risk. 15 OSFI Reinsurance Guideline December 2010 cont d 3. The terms and conditions of the reinsurance contract should provide clarity and certainty on reinsurance coverage: obtain contractually binding summary documents prior to the effective date of the reinsurance coverage that set out: the premium; the percentage of risk assumed by each reinsurer; the risk(s) reinsured; the duration of the coverage; any exclusions; and, any standard clauses to be relied upon or incorporated by reference; 16

OSFI Reinsurance Guideline December 2010 cont d address, any material issues most likely to arise; and, ensure that all final comprehensive reinsurance contracts, are signed by both the ceding company and the reinsurer(s) within a short timeframe (120 days). The reinsurance agreement should provide that funds will be available to cover policyholder claims in the event of either the cedant s or reinsurer s insolvency. Reinsurance contracts should include an insolvency clause, pay cedant even if insolvent, and appropriate use of off-set or cut-through clauses and address the structure of funds withheld arrangements. 17 OSFI Reinsurance Guideline December 2010 cont d Off-set and cut-through clauses may allow certain creditors or policyholders to have preferential treatment over other claims, this is not acceptable. If a reinsurance contract provides for a funds withheld arrangement, the contract must provide that, if the cedant or reinsurer is insolvent, the funds withheld, less any surplus due back to the reinsurer, must form part of the property of the cedant s general estate. 18

Guidance for Reinsurance Security Agreements the assets of an unregistered reinsurer are pledged to the ceding company to secure the payment of the potential liabilities of the reinsurer under one or more reinsurance agreements pursuant to a security agreement made under provincial law; the pledged assets are held in Canada by a Collateral Agent ; the Collateral Agent is a Canadian financial institution that is not affiliated with the unregistered reinsurer; all documentation is binding on all parties and legally enforceable in all relevant jurisdictions; 19 Guidance for Reinsurance Security Agreements cont d the ceding company takes all necessary steps to obtain and maintain a valid and enforceable security interest that has priority over any other security interest in the collateral; the ceding company has the right to liquidate or take legal possession of these assets, in a timely manner, in the event of default by the reinsurer; Collateral Agent obtains control of these assets on behalf of the ceding company; 20

Guidance for Reinsurance Security Agreements cont d the ceding company obtains a legal opinion by a lawyer with expertise that a valid and enforceable security interest, that has priority over any other security interest in the pledged assets, has been or will be created in its favour for the type of assets covered by the legal opinion; and the ceding company must have clear and robust procedures for the timely liquidation of collateral if there is reinsurer default. 21 Guidance for Reinsurance Security Agreements cont d OSFI expects that the RSA, at a minimum will: specify events of default, specify remedies and/or rights upon default; provide that the pledged assets may not be used as part of a securities lending program; 22

Guidance for Reinsurance Security Agreements cont d provide that the reinsurer agrees to deliver to, and maintain with, the Collateral Agent as collateral under the RSA assets having a market value at all times at least equal to a specific amount or a formula amount; provide that the Collateral Agent shall at all times permit the Superintendent, the reinsurer and the ceding company access, for purposes of examination, to all pledged assets under the RSA and the records. 23 Alternatives to RSAs Letters of Credit (LOCs) are acceptable collateral subject to specific limits and conditions. LOCs are held by the ceding company, not the Collateral Agent. Funds withheld arrangements are acceptable collateral if it creates a first ranking security interest and otherwise satisfies the requirements. If the ceding company or reinsurer become insolvent, the funds withheld less any surplus due back to the reinsurer, must form part of the property of the ceding company s general estate. OSFI has not prescribed a list of permitted assets. Ceding companies are expected to define in their policies prudentially acceptable pledged assets and limits. 24

Guide re Establishment of a Branch by a Foreign Insurer in Canada So following the requirements above re Insurance in Canada of Risks, or in any event, you decide to register in Canada. What is involved? First I will address this topic and then what is involved if you decide to set up a subsidiary in Canada, in each case very briefly 25 Guide re Establishment of a Branch by a Foreign Insurer in Canada cont d The applicant is to provide a reasonable amount of general information and regulatory information about it, significant financial information including the most recent three year regulatory filings, a very significant Business Plan, very significant risk management policies and other information and commitments. The Business Plan is to include the reasons why the applicant is seeking to establish the Branch; and analysis of target markets, opportunities and competitors; the reasons the applicant believes the Branch will be successful; three year pro forma financials and three year pro forma Capital Adequacy Calculations showing base case and scenario stress testing and contingency plans to address the worst case and other adverse scenarios 26

Guide re Establishment of a Branch by a Foreign Insurer in Canada cont d The Business Plan must also describe the projected reinsurance arrangements and material outsourcing arrangements. Risk management policies have to deal with market and credit, operational and regulatory compliance, reputational and strategical and product design, pricing and underwriting risks. A detailed description of internal controls, policies and procedures is also required. 27 Guide to Incorporating a Canadian FRI The requirements to incorporate a Canadian FRI are similar to a Branch but there are more because it will be a company. Comprehensive information is also required about the ownership and financial strength of the applicant. The Business Plan requirements are similar to those for a Branch. Detailed information is required for the proposed directors and management. The requirements for the risk management policies are similarly extensive as they are for a Branch 28