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Governance of Reinsurance -Canadian Initiatives

Editorial

Governance of Reinsurance–Canadian Initiatives

Steven W. Easson

Canada has been proactive in establishing governance frameworks for reinsurance transactions. Initiatives from individuals, the Office of the Superintendent of Financial Institutions (OSFI) and the Canadian Institute of Actuaries (CIA) have addressed concerns about and scrutiny of reinsurance transactions from worldwide securities and insurance regulators, rating agencies and the media. It is important to note that actuaries have played a vital role in identifying and developing these initiatives and will continue to have a major influence in further development of governance standards and in providing education.

The main source of concern and scrutiny about reinsurance transactions stems from the potential for a transaction between a ceding company and an assuming company that is inappropriately accounted for as "reinsurance" to significantly distort financial statements. One cluster of these potential transactions was U.S. "surplus relief" transactions before the regulatory tightening initiated by California in the early 1990s and the subsequent initiatives to address the potential abuses. It seems to me that a subsequent cluster of transactions that I will categorize as "pre–Spitzer" (early 2000s) has had more of an international awareness, at least partially due to Mr. Eliot Spitzer's efforts, which has led to a significant international movement toward establishing standards and guidance on the issue of governance of reinsurance transactions, especially those pertaining to reinsurance transactions that are purported to be "finite/financial."

Examples of initiatives from OSFI, Canada's main regulator, include:"

  • In 2005, OSFI recommended that all federally regulated insurers engaged in ceding or assuming reinsurance have well–developed policies and risk management practices regarding the use of reinsurance and that management present such policies in a report to its Board of Governors. The report was to include, among other elements, how management addresses concerns about the intent of the reinsurance agreement, the presence of risk transfer, the existence of side letters, the existence of other reinsurance agreements that offset the effect of the first reinsurance agreement and the impact on financial statement presentation.
  • Effective in 2005, OSFI added to its required reinsurance disclosures in Appointed Actuary Reports the existence of any finite reinsurance agreements and disclosure of their detailed terms.
  • More recently OSFI released a draft Guideline that addresses the timely execution of reinsurance treaties and issues that can be related to ambiguous wording.
  • OSFI asked the CIA to review the adequacy of its Standards of Practice (SOP) pertaining to reinsurance and to provide guidance on various reinsurance issues such as finite reinsurance and risk transfer.

The CIA's Practice Council and the Life and P&C Financial Reporting Committees concluded that under our principles–based regime of reserving under Canadian GAAP/Statutory, our SOPs are adequate with respect to the treatment of reinsurance and that no immediate changes were necessary. However, they also concluded that more clarity and direction would be appropriate with respect to the definition of reinsurance and its eventual financial and capital treatment and to that end it set up the Task Force On Appropriate Treatment Of Reinsurance in the summer of 2005.

Under the strong leadership of chairperson Doug Tozer, the Task Force reviewed numerous documents from the AAA (e.g., Risk Transfer Practice Notes), IAA, IAIS, RAA, ACLI and worldwide accounting and regulatory standards and guidelines. I served as a member of this Task Force. We had enjoyable and stimulating discussions, debates and deliberations for months on end. Very recently the Task Force submitted a 27–page draft Educational Note to the CIA Practice Council. The Note addresses:

  • Definitions
  • Finite/financial reinsurance
  • Current reinsurance accounting practices in Canada, the United States and internationally
  • Principles of risk transfer, assessing and documenting the existence and extent of risk transfer and the impact of risk limiting features such as loss limitsM
  • Other issues such as side agreements, mirroring, communication, bifurcation and reinsurance counterparty risk

The Task Force also submitted recommendations and opinions on reinsurance issues relating to the SOPs, principles versus rules, regulatory capital formulae, mirroring and bifurcation.

I encourage you to read our Note once it is released, but in the meantime I would like to whet your appetite by sharing my favorite three observations from a global perspective. Firstly, it seems that there are no universally accepted standards or robust bright line tests for quantifying risk transfer–in particular there is no universal agreement of what level of risk transfer would amount to a transfer of "significant insurance risk" (for example, to meet the paragraph 9(a) definition in SFAS113). Secondly, it is interesting to note the varying philosophies among the various bodies on how plausible an adverse event needs to be to conclude that there is adequate risk transfer and whether timing and/or underwriting risks need to be transferred to permit reinsurance accounting. Thirdly, not surprising to me, is the position from the IAIS that there is no universal definition of "finite reinsurance."

As I believe the most salient point in the governance of reinsurance transactions is the use of expert professional judgment, it is obvious that actuaries will continue to have vital roles in the further development of the governance framework for reinsurance, especially, but certainly not limited to, the area of assessing adequate risk transfer. We have stepped up to the plate. Let's stay there!