Insurance (prudential standard) determination No. 1 of 2009 - Variation of Prudential Standard GPS 114 - Capital Adequacy - Investment Risk Capital Charge

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Legislation au F2009L01817 Not in force Legislative Instrument

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Insurance (prudential standard) determination No. 1 of 2009

EXPLANATORY STATEMENT

Prepared by the Australian Prudential Regulation Authority (APRA)

 

Insurance Act 1973, paragraphs 32(1)(a) and (b) and subsection 32(4)

 

 

Paragraphs 32(1)(a) and (b) of the Insurance Act 1973 (“the Insurance Act”) provides that APRA may determine, in writing, standards relating to prudential matters that must be complied with by general insurers and authorised NOHCs.  Pursuant to subsection 32(5A) of the Insurance Act and paragraph 6(d) of the Legislative Instruments Act 2003, such Prudential Standards are legislative instruments for the purposes of the Legislative Instruments Act 2003 (“the Legislative Instruments Act”).  Subsection 32(4) of the Insurance Act gives APRA power to vary Prudential Standards so determined.

 

 

  1.         Background

 

This Explanatory Statement explains the reasons for variations to Prudential Standard GPS 114 Capital Adequacy: Investment Risk Capital Charge, originally determined on 23 June 2008.

 

The variations are a clarification of the intent GPS 114 with regard to the investment risk charge applicable to reinsurance recoverables.  These variations are minor in nature, as the substantive intent of the prior standard remains unchanged.

 

The intent of GPS 114 was that a higher capital charge would apply to certain reinsurance recoverables from non-APRA-authorised reinsurers. After a grace period that expires on the second annual balance date following an event that gives rise to reinsurance recoverables, a higher capital factor will apply to all unsecured reinsurance recoverables. The factors will range from 20 per cent to 100 per cent depending on the counterparty rating of the non-APRA-authorised reinsurer. This treatment will only apply to recoverables arising under reinsurance contracts that incept on or after 31 December 2008. Insurers will be required to make this assessment at each quarterly reporting date.

 

The wording of paragraph 5 of Attachment A of the pre-variation GPS 114 could be interpreted as the grace period ending on the third annual balance date after the event giving rise to the recoverables. The relevant passage in the prior standard was:

 

For reinsurance recoverables due from non-APRA-authorised reinsurers, the Investment Capital Factors specified in Table 2 apply (in replacement of those specified in Table 1) to the reinsurance recoverables on and from the second balance date after the end of the financial year in which the event giving rise to each recoverable occurred.

 

This has been altered to read:

 

For reinsurance recoverables from non-APRA-authorised reinsurers, the Investment Capital Factors specified in Table 2 apply (in replacement of those specified in Table 1) to each reinsurance recoverable on and from the second annual balance date after the event giving rise to the reinsurance recoverable.

 

This variation ensures that the original intent is conveyed. 

 

The word ‘due’ was intended to convey the idea that the reinsurance recoverables be payable at some time (which might be a future date). However, concern was raised that the word would be interpreted as conveying the collateral does not need to be in place until the recoverables are actually ‘due and payable’ for paragraph 5 to apply. The amendments clarify that this meaning was not intended. The full definition of ‘reinsurance recoverable’ can be found in GPS 001 Definitions if clarification is required.

 

Generally in the prudential standards, the word ‘due’ is not meant to mean ’due and payable’.  It is merely intended to denote that there is an obligation to pay money which could be a future obligation. 

 

Additionally, paragraph 5 of Attachment A of the pre-variation GPS 114 commented that the reinsurance recoverables were to be identified in the Insurance Liability Valuation Report (ILVR) according to Prudential Standard GPS 310 Audit and Actuarial Reporting and Valuation. This was causing confusion within the industry. In order to overcome this, the requirement in GPS 114 to identify the reinsurance recoverables in the ILVR has been removed.  However, the requirement under GPS 310 regarding the Appointed Actuary assessing the reinsurance recoverables from non-APRA-authorised reinsurers remains unchanged.

 

2.            Purpose of the Instrument

 

The purpose of the determination is to vary the old GPS 114 and make a new Prudential Standard GPS 114 Capital Adequacy: Investment Risk Capital Charge.

 

3.            Operation of the Instrument

 

The operation of the instrument is as described in the background.

 

4.   Consultation

 

The Section 17 of the Legislative Instrument Act requires consultation when a rule-maker makes a legislative instrument. However, Section 18 provides that consultation is not necessary when such consultation may be unnecessary or inappropriate. As this change is a minor change with a machinery nature, it is exempt from the requirement of consultation.

 

Further, APRA undertook extensive consultation prior to the determination of old GPS 114.  This is described in detail in the explanatory statement for Insurance (prudential standard) determinations No. 1 to 13 of 2008.

Overview

The Insurance (prudential standard) determination No. 1 of 2009 was enacted to address ambiguities in the existing Prudential Standard GPS 114 Capital Adequacy: Investment Risk Capital Charge. This determination was issued under the authority of the Insurance Act 1973, specifically sections 32(1)(a), 32(1)(b), and 32(4), and operates as a legislative instrument as per the Legislative Instruments Act 2003. The Australian Prudential Regulation Authority (APRA), as the rule-maker, was tasked with clarifying the intent behind the capital charge applicable to reinsurance recoverables, ensuring that the original policy objective of imposing a higher capital charge on certain reinsurance recoverables from non-APRA-authorised reinsurers remains intact. This minor variation aimed to correct misinterpretations of the grace period and the requirement for identifying reinsurance recoverables in the Insurance Liability Valuation Report, while maintaining the core intent of the original standard.

Scope and Application

The Insurance (prudential standard) determination No. 1 of 2009 applies to general insurers and authorised non-operating holding companies (NOHC) as defined under the Insurance Act 1973. These entities are required to comply with the prudential standards set forth by the Australian Prudential Regulation Authority (APRA). The Act operates within the Commonwealth jurisdiction, meaning it has a national reach across Australia. The variations made to Prudential Standard GPS 114 aim to clarify the intent of the original standard regarding the investment risk charge applicable to reinsurance recoverables. The changes do not alter the substantive intent of the prior standard but address ambiguities in the wording to ensure that the intended capital charge for reinsurance recoverables from non-APRA-authorised reinsurers is properly applied. The amendments specify that a higher capital factor will apply to all unsecured reinsurance recoverables after a grace period of the second annual balance date following the event that gives rise to the recoverables. This applies only to recoverables arising under reinsurance contracts that commence on or after 31 December 2008, and insurers must make this assessment at each quarterly reporting date. The Act does not specify any exclusions or thresholds, and while it extends the application through subordinate instruments, it does not restrict application in any manner.

Key Provisions

The Insurance (prudential standard) determination No. 1 of 2009 primarily modifies the Prudential Standard GPS 114 Capital Adequacy: Investment Risk Capital Charge, as per paragraphs 32(1)(a) and (b) of the Insurance Act 1973 (sections 32(1)(a) and (b)). This determination is aimed at clarifying the application of investment risk charges to reinsurance recoverables from non-APRA-authorised reinsurers. The new standard stipulates that a higher capital charge will apply to all unsecured reinsurance recoverables after a grace period that ends on the second annual balance date following the event that gives rise to the recoverables. This higher capital charge ranges from 20 per cent to 100 per cent, based on the counterparty rating of the non-APRA-authorised reinsurer. Such treatment applies to recoverables arising from reinsurance contracts that commence on or after 31 December 2008, and insurers must assess this at each quarterly reporting date. In line with the legislative requirements, this determination imposes specific obligations on general insurers and authorised NOHCs to comply with the prudential standards set forth by APRA. The changes clarify that the term 'due' in the context of reinsurance recoverables refers to an obligation to pay money, which might be a future obligation, rather than waiting until the recoverables are 'due and payable'. Additionally, the requirement to identify the reinsurance recoverables in the Insurance Liability Valuation Report (ILVR) has been removed to alleviate industry confusion. However, the obligation under GPS 310 for the Appointed Actuary to assess the reinsurance recoverables from non-APRA-authorised reinsurers remains unchanged. The legislation does not explicitly outline specific offences, penalties, or consequences for non-compliance with the Prudential Standard GPS 114. However, under the Insurance Act 1973, any failure to comply with the prudential standards can lead to regulatory actions by APRA. These actions may include enforcement measures, financial penalties, or other regulatory sanctions as deemed appropriate by APRA. The exact penalties would depend on the nature and severity of the non-compliance, and they are subject to the broader regulatory framework governing insurance practices in Australia.

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