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Canadian insurers took advantage of new rules and issued $2.2 billion in limited recourse capital notes in the first quarter of this year, a report from DBRS Morningstar says, with more firms likely to follow.

In March, the Office of the Superintendent of Financial Institutions (OSFI) began allowing limited recourse capital notes (LRCNs) to qualify as Tier 1 capital other than common shares for life insurance companies. For mortgage and property and casualty insurers, LRCNs can qualify as Category B capital.

The rules are an expansion of changes OSFI introduced last summer when the regulator started allowing banks to recognize LRCNs as additional Tier 1 capital. Canadian banks responded by issuing $5.7 billion in LRCNs last year, DBRS said.

LRCNs have two components: the interest-bearing instrument with a 60-year term that’s issued directly to investors, and the perpetual, non-cumulative preferred shares issued to a special-purpose vehicle (SPV) to be held in trust for the benefit of the note holders.

“The preferred shares technically act as collateral for the LRCN investors,” DBRS said. “In the event of default, the only recourse investors have against the issuer will be the receipt of the preferred shares held in trust by the SPV.”

The notes can be issued only to institutional investors.

Empire Life Insurance Co. and Manulife Financial Corp. were the first insurers to issue LRCNs, combining for a total of $2.2 billion, DBRS said. Others are likely to follow given the notes’ advantages, the report said, including favourable regulatory capital treatment and tax deductibility.

The report said insurers could issue LRCNs to replace the amount of outstanding preferred shares, which would allow the companies to maintain or improve their Tier 1 capital requirements.

The notes also have the “incremental benefit” of enhancing net earnings, since the interest payments are tax deductible, the report said.

“At the same time, institutional investors will find these instruments attractive because of the prospect of earning a high yield from an instrument issued by a regulated financial institution,” DBRS said.