Law Times

Law Times • OcTOber 18, 2010 FOCUS Foreign insurers on uncertain path BY JUDY VAN RHIJN For Law Times S ix months after the intro- duction of a new regulatory regime for foreign insurers, legal advisers are still treading an uncertain path despite last- minute changes designed to avert confusion between federal and provincial rules. Changes to federal regulations took effect on Jan. 1. They require the insurer to be regulated where the important insurance activities are carried on, not where the risk is located. This has opened the door for insurers to do some of their activities overseas, the ben- efit being that they don't need to maintain assets in trust in Canada to back up the affected policies. The Office of the Superinten- dent of Financial Institutions gave some guidance in late 2008 and again in early December 2009 as to the threshold of activity re- quired to come under federal reg- ulation. Frank Palmay, chairman of the corporate and insurance group at Lang Michener LLP in Toronto, says the change isn't too troublesome for companies that wish to organize their affairs in Canada. "The threshold for prov- ing local activity is not very high. Any significant contact will do. Lloyds, for example, wanted in- Canada status, but most if not all of their functions are carried out in London. Having a Canadian administrative officer sign off on the policy is enough to bring it under the federal ambit." Things are much more dif- ficult to organize if an insurer wants to be completely outside of the Canadian regime due to pro- vincial regulations. "Provinces are much more grounded on where the risk is located," Palmay says. "That's where the dichotomy has occurred. Now that the federal authorities have taken the posi- tion that it's the activities that are important, they have got the provinces riled up." The extent to which the fed- eral and provincial regulators are prepared to harmonize their regimes has been a major issue all along. According to Stuart Carruthers, a partner with ex- pertise in insurance and reinsur- ance matters at Stikeman Elliott LLP in Toronto, the rubber hit the road in the last three weeks of 2009. "In early December 2009, a number of provincial regulators who come under the Canadian Council of Insur- ance Regulators sent requests to foreign insurance branches to give undertakings about how they will carry on business," he says. "The concern is that if for- eign insurers are not required to maintain assets in Canada, it will leave people unprotected in the provinces. The draft undertak- ing required them to state that if they were going to be caught un- der the provincial test, then they would carry on their business in a way that made it come under the federal test as well." Although the undertaking was pitched as voluntary, Carruthers says people understood that if they Untitled-4 1 www.lawtimesnews.com 10/8/10 1:38:47 PM didn't sign, the provinces would move to make it mandatory. Quebec and British Columbia dealt with the matter by passing legislation entrenching the im- portance of the location of the risk. "B.C. took the exact oppo- site stance from the federal test," says Carruthers. "If the risk is in B.C., the insurer must be licensed in B.C. and the policy treated as being done in Canada. So even though insurers have received some flexibility from the federal regulators, they're still facing challenges due to provincial involvement. They now have the ability to carry on some business overseas and can release some assets in Canada and thereby repatriate some of their capital. This saves them the expensive regulatory burdens of keeping a branch open, such as the need for actuarial reports, au- dited reports, annual statements, maintaining a chief agent, and keeping assets in trust. Foreign insurers have also been able to apply to leave in a dialogue with the prov- inces about how a firm can exit Canada, particularly if it signed the undertaking. Apart from the confusion, Carruthers says the system is bringing other benefits. "The new regime is better aligned with the Canadian tax system. There have historically been issues for foreign insurers, but these changes have made them go away." On the other hand, there have 'Now that the federal authorities have taken the position that it's the activities that are important, they have got the provinces riled up,' says Frank Palmay. Canada altogether since they filed their returns for Dec. 31, 2009, and a number have asked to do so. But before they can withdraw, federal au- thorities have to make sure the province doesn't object. Cur- rently, the OSFI is engaged been huge costs stemming from compliance activities. "Insurers have had to go back through their entire book and do a due diligence exercise to see what's inside Canada and what's out- side," says Carruthers. The main impact of the changes is on very large financial institutions. Carruthers identifies the areas most affected as those where there's such a high risk that there's no capacity to write it in Canada, such as for oil rigs, huge industrial sites, large commercial aviation operations, and other very sophisticated businesses. Palmay also notes its effect on re- insurance, which is often written in offshore centres like Barbados, Bermuda, and the Cayman Is- lands. "This represents a recogni- tion of what the marketplace is doing in sophisticated operations where Canadian insurers have re- fused the risk," says Palmay. "They go to the international market to get insurance. They understand that it's not Canadian regulated and they're satisfied with that." In Carruthers' view, the dust is starting to settle on the whole issue and the government's fo- cus is moving to reinsurance. In August, a significant new draft guideline introduced sound prac- tices and governance to the rein- surance regime. It proposes that every federally regulated deposit- taking institution be responsible for developing and implement- ing an internal capital adequacy assessment process that must cov- er consolidated operations from the top-level regulated entity in Canada and consider the risks of foreign operations as well. LT PAGE 13

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