Canada: OSFI Finalizes Earthquake Exposure Sound Practices

On February 28, 2013, the Office of the Superintendent of Financial Institutions ("OSFI") released the final version of its revised Guideline B-9 Earthquake Exposure Sound Practices (the "Guideline") which will impact property and casualty insurance companies in Canada.

Last week we issued an e-lert commenting on the key principles set out in the draft Guideline published in August 2012 (the "Draft Guideline"). However, in response to submissions received from industry associations and insurance companies during the consultation period, the Draft Guideline has been revised to address certain concerns highlighted by these stakeholders. The key differences between the Draft Guideline and the Guideline are discussed below.

The Guideline has been revised to (i) emphasize and strengthen the principles-based approach to managing earthquake exposure, (ii) remove references to outdated default loss estimates, (iii) update the description of best practices in earthquake exposure management, (iv) increase OSFI's flexibility in the collection of relevant data, and (v) remove the details of the capital formula.

COMPLIANCE AND IMPLEMENTATION

OSFI expects that all insurers will complete a self-assessment of compliance with the Guideline by September 30, 2013. Each insurer's board (or chief agent, as applicable) is asked to review the self-assessment, together with its earthquake exposure risk management policy ("EERMP"), prior to January 1, 2014. If a self-assessment identifies potential gaps, the insurer should develop a plan appropriate to respond to those gaps. OSFI asks that each insurer keep its designated OSFI Relationship Manager (the "Relationship Manager") updated on its progress, provide the self-assessment and implementation plan on request, and file an approved copy of its EERMP with its Relationship Manager prior to January 1, 2014.

OVERALL CHANGES FROM THE DRAFT GUIDELINE

  • In response to expressed concerns with respect to the undue burden placed on small insurers with limited financial resources dedicated to catastrophe risk management, OSFI has added language to recognize that individual insurers may have differing earthquake exposure risk management depending on, among other factors, their size, ownership structure, nature, scope and complexity of operations, corporate strategy and risk profile.
  • Responding to the point that earthquake exposure risk management is best accomplished through its incorporation with overall enterprise risk management rather than independently outside such framework , OSFI has clarified that a stand-alone EERMP is not required when other policies clearly provide adequate coverage of the risks.
  • Modified wording makes it clear that it is not OSFI's intention to mandate an actuarial review of earthquake models.
  • The Guideline has clarified that probable maximum loss ("PML") is return period loss when probabilistic models are used, in response to comments that the PML definition cited in the Guideline is inaccurate.

OSFI RESPONSES TO INDUSTRY COMMENTS

Where comments received during the consultation period did not result in any changes to the Draft Guideline, OSFI's responses to such comments are summarized below.

  • In response to requests for additional support from OSFI on model evaluation and the strengthening of vendor catastrophe model documentation, OSFI notes that it believes insurers are best placed to evaluate the strengths and weaknesses of vendor models for their unique circumstances.
  • Where insurers have commented that it is inappropriate to consider the performance of the vendor models compared to earthquakes in other parts of the world, OSFI notes that insurers should consider the lessons learned from earthquake events across the world when using models.
  • In response to the concern that many risks cannot, or are difficult to, be adequately considered within PML estimation, OSFI notes that although this requirement is challenging, it is each insurer's responsibility to understand its own risks, and advises that it will, as part of its ongoing supervisory work, monitor the development of industry best practices and look for appropriate forums to share these approaches.
  • Although some commentators have suggested that disclosure of earthquake filings is in the public  interest and would elevate the annual earthquake filing from a compliance exercise to a statement of insurer preparedness to their policyholders, OSFI will not release earthquake filings to the public this year but will continue to work with the industry to find an appropriate solution.
  • As a result of a number of comments received on the proposed formula to measure the financial resource requirements, OSFI has agreed to continue discussions with the industry to finalize the methodology to measure earthquake exposure, and incorporate the revised proposal regarding the financial resources requirements in the Minimum Capital Test (MCT) Guideline. In the meantime, insurers should continue to build their 1:500 PML reserves towards the 2022 target, as required under the current methodology.
  • The industry's overriding concerns included (i) the potential increase in costs of reinsurance and/or other financial resources, (ii) the uneven playing field that may result from the use of country-wide PML and (iii) the potential impact on consumers' willingness to buy coverage due to resulting primary policy price increases. In response, OSFI (i) reiterates that its mandate is to maintain the overall confidence of the public in the system, which means that insurers should be able to respond to a high public profile event such as a major earthquake with a high degree of certainty, (ii) notes that there is general support for prudent financial resource requirements for earthquake exposure, and (iii) confirms that it would continue to work with the industry to finalize discussions regarding financial resources as defined in the Guideline, which may result in a reassessment of the PML measurement methodology.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Authors
Nilanka Maldeniya
Richard Da Costa
Miho Felicio
Gordon Goodman
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