Reinsurance and Other Forms of Risk Transfer Risk Based Supervision of Reinsurers and Insurer’s Reinsurance Coverage - Case Study May 26-28, 2015 Connie Dewar, Managing Director Life Insurance Group Office of the Superintendent of Financial Institutions

Case Study ABC Insurance is a medium sized company that has successfully sold life insurance products for the past 50 years. It had a conservative risk management philosophy – to not take on risks they don’t understand and to limit volatility in their results. They have not used reinsurance much, mainly just for a few policies each year that were in excess of their retention. A reinsurance treaty was in place with a well-established local reinsurer (Local Re) which also provides underwriting support to ABC Insurance for these larger face amount policies. Two years ago, the Chief Executive Officer retired after 20 years and was replaced by a new CEO from outside the company. After a few months, the new CEO decided to restructure and replaced both the Appointed Actuary and Chief Risk Officer with new people recruited from outside ABC Insurance. After a review of the company’s business plan it was decided that the ABC Insurance should expand from its traditional insurance business, which had been experiencing slow growth. The new CEO made the decision to expand into the disability income market, which was a successful business for the CEO’s prior company. The CEO’s performance is tied to the success of this new line of business. Since this was new to ABC Insurance, the decision was made to significantly reinsure the business.

Case Study continued The reinsurance was structured to be on a quota share basis with ABC Insurance retaining 20% of the risk. They chose two reinsurers, each to receive 40% of the business. The first was Local Re and the other was an offshore reinsurer that was newly formed two years ago (New Re). The latter was recommended by the Chief Risk Officer, who had previously worked with the CEO of New Re and thought that it would be good to give his former colleague some business. The Board agreed with the CRO without receiving information about New Re. Local Re is market leader in reinsuring disability income insurance. At the most recent Board meeting, the Chief Risk Officer provided an attestation that the company was in compliance with its reinsurance risk management policy and the regulator’s requirements for reinsurance. Given this significant change in the use of reinsurance by ABC Insurance, the regulator made the decision to review the company’s reinsurance program, focusing specifically on the new reinsurance arrangement for disability income.

Case Study Based on the information provided, what should the regulator look at as part of its review of the reinsurance program?

Questions What are the key inherent risks in the underlying products? (focus on disability income) What assessment would you give (high/medium/low)? Which of these risks could be mitigated by reinsurance? What risks are created by the use of reinsurance? What assessment would you give (high/medium/low)? How would you assess the quality of risk management of the reinsurance program? What would you consider? What is the net risk of the reinsurance program? / How would you assess the effectiveness of the reinsurance? What recommendations, if any, would you give to the company?

Significant Activities Quality of Risk Management Consider OSFI’s supervisory framework Significant Activities Inherent Risks Quality of Risk Management Net Risk Direction of Risk Importance   Traditional Life Insurance Disability Income Reinsurance Activity … Overall Rating Credit Market Board Regulatory Compliance Insurance Strategic Operational Management Financial Actuarial Operational Compliance Internal Audit Risk Management Senior Management   Rating Direction Time Frame Earnings Capital Liquidity Composite Risk Intervention Rating