Financial Sector (Collection of Data) Determination No. 105 of 2005 – Reporting Standard GRS 170.1 (2005) applying to general insurers that are lenders mortgage insurers
EXPLANATORY STATEMENT
Issued by the authority of the Australian Prudential Regulation Authority (‘APRA’)
Financial Sector (Collection of Data) Act 2001 (‘FSCOD Act’), s 13(1) (a) and s 15
Subsection 13(1) of the FSCOD Act provides that APRA may, by writing, determine reporting standards that are required to be complied with by financial sector entities. Section 15 of the FSCOD Act provides that APRA may make a formal declaration of the date when reporting standards begin to apply. (Although s 15(2) provides for such declarations to be published in the Gazette, s 56(1) of the Legislative Instruments Act 2003 provides that this requirement is fulfilled by registration on the Federal Register of Legislative Instruments.)
The Determination
Financial Sector (Collection of Data) Determination No 105 of 2005 determines a new reporting standard, GRS 170.1 (2005) – Maximum Event Retention and Risk Charge for Lenders Mortgage Insurers, which will apply to general insurers (within the meaning of the Insurance Act 1973) that are lenders mortgage insurers (LMIs).
‘Lenders Mortgage Insurer’ or ‘LMI’ is defined to mean a general insurer which is required to comply with Guidance Note GGN 110.6 Concentration Risk Capital Charge for Lenders Mortgage Insurers, made under section 32 of the Insurance Act 1973. That Guidance Note applies to a general insurer that has written or reinsured, or proposes to write or reinsure, policies of lenders mortgage insurance. The Guidance Note provides that ‘lenders mortgage insurance’ has its ordinary commercial meaning, and includes insurance under a policy which protects a lender from losses in the event of borrower default on a loan secured by mortgage over residential and/or other property.
New reporting standard GRS 170.1 (2005) will require quarterly and financial year reporting. The first reporting period will be for the March quarter 2006.
Under the new reporting standard, an LMI must report the concentration risk capital charge imposed upon it under Guidance Note GGN 110.6 (made under section 32 of the Insurance Act 1973). There is scope under that Guidance Note for APRA to grant transitional relief in respect of the capital charge. However, if such relief has been granted in relation to an LMI, it must be ignored for the purposes of the reporting requirements under new reporting standard GRS 170.1 (2005).
Consultation
APRA consulted extensively on the proposed changes. The consultation process is described in the Regulation Impact Statement.
Regulation Impact Statement
A Regulation Impact Statement is attached.
Regulation Impact Statement
This Regulation Impact Statement covers:
- GRS 170.0 – Maximum Event Retention and Risk Charge;
- proposed GRS 170.1 – Maximum Event Retention and Risk Charge for Lenders Mortgage Insurers; and
- proposed GRF 170.1 - new Reporting Forms for Maximum Event Retention and Risk Charge for Lenders Mortgage Insurers.
Background
Lenders Mortgage Insurers (LMIs) protect lenders from losses in the event of borrower default on loans secured by mortgages.[1] Currently, 13 LMIs are authorised under the Insurance Act 1973 subject to the condition that they only conduct mortgage insurance business. Of the 13 LMIs, six LMIs are captive insurers[2] of Authorised Deposit-taking Institutions (ADIs), while four LMIs are in run-off and are restricted from writing new or renewal mortgage insurance business. In addition, two captive LMIs are domiciled in Singapore and are regulated by the Monetary Authority of Singapore. As at December 2003, LMIs had $2.9 billion in total assets and more than $200 billion worth of loans insured, including loans made by ADIs and unregulated lenders and insurance contracts on securitised portfolios. The LMI industry is highly concentrated, with the market share of the two major LMIs being 70 per cent.
LMIs are regulated under the general insurance framework administered by the Australian Prudential Regulation Authority (APRA) and comprising the Insurance Act 1973 and the General Insurance Reform Act 2001, Prudential Standards and Guidance Notes. LMIs are also required to comply with Reporting Standards made under the Financial Sector (Collection of Data) Act 2001.
There are currently 254 ADIs authorised under the Banking Act 1959, holding approximately $504.2 billion in deposits. ADIs, in aggregate, insure around 20 per cent of their on-balance sheet residential mortgage loans with LMIs. There are three principal reasons for which ADIs obtain mortgage insurance. Primarily, it transfers credit risk from their loan books. Secondly, ADIs obtain a concessional risk weight of 50 per cent on high Loan-to-Valuation Ratio (LVR) loans (defined as loans with an LVR of greater than 80 per cent), provided that such loans are mortgage insured by an approved LMI. Without mortgage insurance, high LVR loans attract a 100 per cent risk weight. Finally, ADIs use mortgage insurance as a credit enhancement tool to gain access to wholesale funding through the mortgage-backed securitisation market. Hence, ADIs use LMIs for risk transfer and to efficiently manage capital.
The prudential framework for ADIs comprises the Banking Act 1959 and Prudential Standards made under that Act. APRA also administers additional Guidance Notes.
Problem Identification
During 2003, APRA conducted a stress test involving 120 ADIs in order to assess whether they could withstand a substantial correction in the housing market without materially impacting on prudential requirements. The results demonstrated that ADIs would remain solvent under the stress scenario, and that more than 90 per cent of ADIs would do so without falling below their regulatory minimum capital requirements. A significant proportion of ADI counterparty default risk for housing loans is transferred to LMIs. This raised the question of whether LMIs could survive a severe housing downturn, given the higher risk of their portfolios. Hence, in late 2003, APRA extended the stress test to LMIs and conducted a broader review of the LMI industry including reinsurance arrangements, parental support, reporting requirements and relationships with ADIs.
Reporting Requirements – Maximum Event Retention and Risk Charge for LMIs
In reporting to APRA on the concentration risk charge in GRS 170.0 – Maximum Event Retention and Risk Charge, LMIs are required to submit only the final MER number. This has resulted in a lack of quality and frequency in the reporting to APRA on the profile of LMIs’ loan books, including sum insured and the drivers of default such as age, LVR and product type, and the level of reinsurance cover that could be relied upon in a downturn. The current method of reporting to APRA has also led to inconsistencies in the calculation of the concentration risk charge.
Objectives
The objectives of the proposed amendments to the prudential framework for LMIs and ADIs are to:
- increase the protection provided to policyholders and other beneficiaries of mortgage insurance policies through the prudential supervision of LMIs;
- ensure that LMIs’ capital requirements are more risk sensitive, and that their ability to withstand a severe downturn is enhanced;
- adopt a consistent approach in the prudential supervision of both LMIs and ADIs;
- clarify existing prudential requirements and provide additional guidance for LMIs and ADIs; and
- increase the transparency of LMI prudential requirements to market participants.
Identification of options
Reporting Requirements – Maximum Event Retention and Risk Charge for LMIs
Option 1 – Determine a new Reporting Standard and amend existing Reporting Standard GRS 170.0
Under this option, a new Reporting Standard GRS 170.1 Maximum Event Retention and Risk Charge for Lenders Mortgage Insurers would be determined for the concentration risk charge for LMIs and GRS 170.0 – Maximum Event Retention and Risk Charge would be amended. The new reporting framework would clarify existing prudential requirements and provide additional guidance to LMIs on determining and reporting the concentration risk charge. The new reporting form would also require reporting to APRA by LMIs on their risk exposures by age, LVR and product type and level of reinsurance cover on a quarterly basis.
Option 2 – Retain Reporting Standard GRS 170.0 without amendment
This option would retain the existing reporting framework for LMIs without amendment.
Impact Analysis
Reporting Requirements – Maximum Event Retention and Risk Charge for LMIs
Impact group identification
It is likely that APRA and LMIs would be affected by the proposed amendments to the reporting framework for LMIs.
Assessment of costs and benefits
Option 1 – Determine a new Reporting Standard and amend existing Reporting Standard GRS 170.0
APRA
Benefits
The additional reporting requirements would allow APRA to gain a clearer and more complete understanding of the risk profiles and reinsurance arrangements of LMIs on an ongoing basis. It would also reduce the need to seek additional clarification from LMIs and make inefficient and ad-hoc data requests. In addition, collecting consistent and detailed information from LMIs would ensure more appropriate supervision. Hence, APRA would be better placed to protect policyholders.
The changes to the reporting framework would enable APRA to better control and standardise the approach to calculating the concentration risk charge, resulting in higher levels of LMI compliance with the prudential requirements.
Costs
APRA would incur costs from implementing the new reporting requirements. Costs would arise from changing systems to handle the collection of additional data and training APRA staff, estimated at 24 person days and 10 person days respectively, and additional resources may be required to supervise LMIs in the short term as the new requirements are phased in. APRA would also incur costs in monitoring compliance by LMIs with the additional requirements.
LMIs
Benefits
The amendments to the current framework would ensure that reporting on the concentration risk charge is standardised across the LMI industry.
The new requirements would also ensure that LMIs review their risk profiles and reinsurance arrangements on a more regular basis. This would increase their awareness and understanding of the risks associated with their business activities.
Costs
The changes to the reporting framework may lead to an increase in the costs of complying with the additional reporting requirements for LMIs, such as training staff and modifying systems, as well as ongoing compliance costs. It is not envisaged that these costs would be significant as the data that would have to be reported under this option is similar to the data that is used to calculate the MER under the current framework.
Option 2 – Retain Reporting Standard GRS 170.0 without amendment
APRA
Benefits
If the current reporting framework was retained without amendment, APRA would not incur costs associated with designing new reporting forms, changing systems, training staff or monitoring compliance with the new requirements.
Costs
APRA would incur indirect costs under this option as the current reporting framework would remain. APRA would continue to receive insufficient information to adequately understand the risks of LMIs, and hence to adequately supervise LMIs and protect policyholders’ interests. The current framework would also mean a continued lack of transparency in how the model parameters are applied to risk exposures and how available reinsurance cover is determined in order to calculate the final concentration risk charge.
LMIs
Benefits
The benefit of this option for LMIs is that they would avoid additional reporting requirements and costs that they would otherwise incur if the framework was amended. These would include the costs of complying with the new requirements, changing systems and training staff.
Costs
Under this option, inadequacies in reporting requirements by LMIs would continue although direct costs would remain the same. There would be inconsistencies across the LMI industry in terms of the quality and frequency of information reported, leading to potential inconsistencies in the way that LMIs are supervised by APRA.
Consultation
APRA has consulted extensively on proposed changes to reporting requirements for LMIs. The consultation process involved the release of a consultation paper in August 2004 that proposed a standard model for LMIs to calculate the concentration risk charge, additional reporting requirements for LMIs, and changes to the eligibility requirements for mortgage insured loans for capital concession purposes. These changes are designed to address inadequacies in the current prudential framework that were identified by the stress test of LMIs and a broader review of LMI risk issues. A second consultation paper along with a draft reporting standard and the proposed draft reporting standards was released in February 2005. There has also been extensive direct consultation with industry involving meetings and other forums for discussion on the proposed new requirements.
Thirteen LMIs who operate in the Australian market provided responses on the proposals. A further two submissions were received from other parties.
There were no concerns raised in submissions about the actual reporting requirements. The first round of consultation on this matter in August 2004 saw all respondents approve of APRA’s proposed reporting requirements for LMIs in relation to the MER. Respondents on this matter also proposed that APRA should publicly release statistics on the LMI industry with concern expressed in one submission in the second round of consultation about public disclosure of matters reported to APRA under the reporting framework. APRA does produce data in aggregate form that does not identify individual institutions. As stated previously APRA will not be publicly disclosing data about individual LMIs. Any changes to APRA’s public reporting of aggregate data would be subject to further consultation with industry prior to any change being made.
Conclusion and recommended option
Reporting Requirements – Maximum Event Retention and Risk Charge for LMIs
Option 1 is the preferred option
Option 1 will ensure that APRA is better placed to supervise LMIs and hence protect policyholders. This option would enable APRA to collect detailed information about the industry and thus gain a clearer and more complete understanding of the risks faced by LMIs. The changes will ensure that reporting is controlled and standardised across the industry, leading to a consistent approach in the supervision of LMIs. It will also reduce the possibility of inefficient and ad-hoc data requests relating to the calculation of the MER risk charge.
The amendments to the reporting framework will result in modest costs for APRA and LMIs. However, the cost to LMIs is not likely to warrant an increase in premiums. APRA expects that the benefits of enhanced supervision and increased protection to policyholders are likely to outweigh these costs.
Option 2 falls short of meeting the stated objectives as it does not improve the current reporting framework for LMIs. Under this option APRA would continue to lack the information necessary to better supervise LMIs and protect policyholders’ interests. Hence, APRA’s supervisory task would be more difficult. This option would also mean continued inconsistencies in reporting to APRA across the LMI industry.
Implementation and review
It is proposed that APRA amend GRS 170.0 – Maximum Event Retention and Risk Charge; and introduce:
- a new reporting standard GRS 170.1 Maximum Event Retention and Risk Charge for Lenders Mortgage Insurers; and
- new Reporting Forms for Maximum Event Retention and Risk Charge for Lenders Mortgage Insurers.
It is intended that these reporting requirements will take effect from 1 January 2006 for all LMIs and ADIs. A transition period of up to three years may be available to LMIs affected by the changes, provided certain conditions are met.
It is intended that the new and amended Reporting Standards for LMIs and ADIs, will be reviewed in two years to ensure that they remain appropriate for the industry and continue to meet APRA’s prudential supervision needs.
[1] Although mortgage insurance protects lenders, the cost is borne by the borrower.
[2] A captive insurer provides insurance to companies within the same corporate group and does not solicit business from third parties.