Australian Prudential Regulation Authority instrument fixing charges No. 1 of 2009

Australian Prudential Regulation Authority instrument fixing charges No. 1 of 2009

For applications by general insurers to use the Internal Model-based Method for determining the Minimum Capital Requirement

EXPLANATORY STATEMENT

Issued by the authority of the Australian Prudential Regulation Authority (APRA)

Australian Prudential Regulation Authority Act 1998, paragraphs 51(1)(a) and (b)

This explanatory statement relates to the instrument fixing charges which is made under paragraphs 51(1)(a) and (b) of the Australian Prudential Regulation Act 1998 (the APRA Act) and which is dated 18 June 2009 (the instrument).  The instrument, made by a delegate of APRA, imposes a charge for certain services provided by APRA relating to the modification of the prudential framework for implementing the Internal Models-based Method (IMB Method) for determining the Minimum Capital Requirement (MCR) of general insurers (including Level 2 insurance groups) and assessment of applications from certain insurers that have sought to use that approach for assessing their minimum capital requirements.

Background

Legislative framework

The APRA Act is administered by APRA.  APRA has statutory responsibility for the prudential supervision of the superannuation industry, the life insurance and general insurance industries, and authorized deposit-taking institutions (ADIs).

Subsection 51(1) of the APRA Act provides that APRA may, by legislative instrument, fix charges to be paid to it by persons in respect of:

(a)   services and facilities that APRA provides to such persons; and

(b)  applications or requests made to APRA under any law of the Commonwealth.

(These paragraphs reflect the contents of paragraphs 51(1) (a) and (b).)

Subsection 51(2) of the APRA Act provides that a charge fixed under subsection 51(1) must be reasonably related to the costs and expenses incurred or to be incurred by APRA in relation to the matters to which the charge relates and must not be such as to amount to taxation.

General Insurance Internal Models-based Method

Under Prudential Standard GPS 110 Capital Adequacy (GPS 110)[1] and Prudential Standard GPS 111 Capital Adequacy: Level 2 Insurance Groups (GPS 111)[2], general insurers may choose one of two methods for determining the Minimum Capital Requirement (MCR).  These are the:

• Internal Model-based (IMB) Method; or
• Prescribed Method.

The Prescribed Method is the ‘default’ method and is currently being used by all authorised general insurers.   

During 2007, some insurers commenced discussions with APRA with a view to obtaining approval to use the IMB Method to determine their MCR.  General insurers seeking to use the IMB Method must have APRA’s approval to do so.

The IMB Method is expected to benefit those general insurers that seek to adopt it because it will align their regulatory capital requirements more closely with their individual risk profiles and their internal risk and capital management processes.  This approach should also result in more efficient use of capital in the industry. 

However, at least in the short term, only a small number of general insurers are expected to apply for approval to use the IMB Method because it requires the general insurer to have and maintain an advanced and stable approach to risk management together with a prudent approach to capital management.

APRA met in November 2007 with those insurers with a likely interest to discuss the procedure for internal model applications. To date, APRA has received two draft applications for approval to use the IMB Method. It is expected that APRA will receive three or four final applications for approval to use the IMB method over the period 2008-2011.

Adoption of the IMB Method by a wider range of general insurers remains a far more uncertain proposition at this stage. 

APRA’s work relating to implementation of the IMB method

APRA’s work relating to the implementation of the IMB Method has three phases, as follows:

Phase I commenced in 2007-08 and was completed in 2008-09.  It involved the development of the policy and technical framework for providing approvals to use the IMB Method and processes for assessment of applications.  Phase II commenced in February 2008 and will continue through to 2010-11 (or completion of the expected applications). It involves the in-depth review of the application material submitted by the individual general insurers, including necessary on-site reviews, and the provision of feedback to the insurers.  Finally, Phase III will involve the on-going monitoring of the capital adequacy positions of the general insurers that are approved to use the IMB method; this will be more intensive than for general insurers using the Prescribed Method due to the complexity and ongoing review of the internal models used.

Operation of Australian Prudential Regulation Authority instrument fixing charges No. 1 of 2009

The charge imposed by the current instrument is based on a two-tiered structure:

 (a) $275,000 plus GST (which totals $302,500) imposed on each of general insurers for the first application seeking approval to use the IMB Method made by the group;

 (b) $55,000 plus GST (which totals $60,500) imposed for each second and onward application for approval from a general insurance group.

These amounts have been set as a contribution to APRA’s:

• Phase I work, being the development of an appropriate policy framework and the establishment of the supervisory infrastructure and technical capacity required for the introduction of the IMB Method; and 
• Phase II work, being assessment of applications made by the general insurers.

Phase III work, being ongoing monitoring of the capital adequacy position of general insurers using the IMB method, will not commence until such time as general insurer(s) have been granted approval to use the IMB Method. The fees for this phase will be determined at a later date, in conjunction with the determination of the ongoing additional supervision fees that will be applied for ADIs that are approved to use the advanced approaches available under the Basel II capital standards for ADIs.

How the charge has been calculated

The charge is based on the need to recover APRA’s costs for carrying out the policy and technical development work, and the assessment of the expected applications for approval to use the IMB method.  Those costs are based on the estimated APRA staff time involved and any external costs that may be incurred that are directly attributable to the project.  In addition, an allowance for direct overhead costs has been added to the salary costs.  On this basis, APRA’s total estimated costs in respect of the implementation of the IMB Method for the period from 2007-08 to 2010-11 have been estimated at $1.1 million. (As noted above, this does not include the estimated additional costs for the ongoing monitoring of the capital adequacy position of general insurers using the IMB method.)

The charges are reasonably related to the costs and expenses incurred

As indicated above, the charges set by the instrument are fixed on a cost recovery basis for the work to which they apply.  They are based on estimated effort involved in the discharge of APRA’s responsibilities and incorporate all the direct costs and appropriate overheads.

The charges do not amount to taxation

As the charges are reasonably related to the costs incurred by APRA in providing the services concerned, the charges do not constitute a tax.

The charges are not retrospective

The charges are imposed prospectively.  They are payable 14 days after receipt of APRA’s invoice.

Cost Recovery Impact Statement

A Cost Recovery Impact Statement (CRIS) has been prepared for this instrument.

Consultation

As part of annual consultation, each industry sector is made aware of APRA’s cost recovery process including the reduction of levies through direct user charging.

Before making the instrument, APRA informed the general insurance sector of the proposed charges.  The general insurers that are expected to apply for IMB Method approval have raised no objection to the charges.

[1] Made by Insurance (prudential standard) determination No. 2 of 2008 - Prudential Standard GPS 110 - Capital Adequacy on 23 June 2008. FRLI reference F2008L02254.

[2] Made by Insurance (prudential standard) determination No. 15 of 2008 - Prudential Standard GPS 111 - Capital Adequacy: Level 2 Insurance Groups on 17 December 2008. FRLI reference F2009L00010.