Insurance (prudential standard) determination No. 1 of 2010
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 the power to vary Prudential Standards so determined.
- Background
General Insurance Prudential Standard GPS 116 Capital Adequacy: Concentration Risk Capital Charge (GPS 116) forms part of a comprehensive set of prudential standards that deal with the measurement of a general insurer’s capital adequacy. GPS 116 sets out the calculation of the Concentration Risk Capital Charge under the Prescribed Method of calculating the Minimum Capital Requirement (MCR) applicable to a general insurer. There are specific requirements for this calculation for lenders mortgage insurers (LMIs) detailed in Attachment A of GPS 116.
The Concentration Risk Capital Charge is the component of the MCR that takes into account the highest aggregation of risks of an insurer. It is calculated as the addition of the insurer’s Maximum Event Retention (MER) after taking into account acceptable reinsurance arrangements, plus the cost of one reinstatement of those reinsurance arrangements. GPS 116 sets out issues that affect an insurer’s MCR that must be taken into account in the calculation of the MER.
In September 2008, APRA released the discussion paper Maximum Event Retention for Lenders Mortgage Insurers. The discussion paper made six proposals in relation to the determination of the MER for LMIs. The discussion paper was accompanied by a draft GPS 116 Attachment A and a quantitative impact study (QIS).
The changes are intended to achieve two objectives:
- to clarify the intention of GPS 116 Attachment A; and
- to reduce prescription in the technical application of GPS 116 Attachment A.
Four of the original six proposals are implemented by this instrument. Two have been postponed.
2. Purpose of the Instrument
This instrument makes changes to GPS 116 Attachment A to implement the following proposals:
- Reinsurance principles
GPS 116 Attachment A has been amended to reduce the prescriptive instructions regarding the calculation of allowable reinsurance for the MER calculation. Instead, it now requires an LMI to apply a principles-based approach to this calculation. This approach enables an LMI to consider the impact of the prescribed stress scenario on its overall reinsurance arrangements and take account of the relevant financial impacts, such as reinstatement premium and reversal of experience bonuses. Changes have been made to GPS 116 Attachment A to reflect the principles-based approach and paragraphs 3, 13, 14, 30, 31, 32, 33, 34, 35, 36, 39 and 40 have been removed.
2. Capitalised premium
APRA requires capitalised premium to be included in the Loan-to-Valuation Ratio (LVR) calculation for PML purposes, irrespective of whether or not the premium is insured. This reflects that the probability of default on the loan by the borrower is dependent on the total quantum of the loan and not the amount of protection which the LMI has extended to the lender. The words ‘irrespective of whether the premium is insured’ have been inserted into GPS 116 Attachment A at paragraph 5 for the avoidance of doubt.
3. PML for pooled policies
GPS 116 Attachment A has been amended to clarify the calculation of probable maximum loss (PML). The following changes to GPS 116 Attachment A have been implemented:
- defining more clearly the product types and coverage types at paragraphs 13 and 14;
- clarifying the seasoning factor to be used when additional loans are extended to existing borrowers at paragraph 26;
- clarifying the PML calculation for non-proportional reinsurance at paragraph 25;
- requiring an LMI to consult with APRA where it is not clear how to calculate the PML for any of its business at paragraph 27; and
- advising that an LMI cannot use summarised information by applying a weighted average LVR to determine PML for pooled mortgage insurance at paragraph 26.
4. Reinsurance cover for new business
APRA requires an LMI to consider its new business volumes and the extent to which these volumes are protected by reinsurance. APRA is allowing LMIs to base the MER calculation on the current business in force. Changes have been made to GPS 116 Attachment A to require an LMI to describe in its Reinsurance Management Strategy (REMS) how it manages exposure to and the mitigants in place for the risk in relation to future reinsurance arrangements at paragraph 39.
3. Operation of the Instrument
This instrument is to take effect from 1 May 2010.
4. Consultation
Section 17 of the Legislative Instruments Act 2003 requires consultation when a rule-maker makes a legislative instrument. The changes to prudential standard General Insurance Prudential Standard GPS 116 Capital Adequacy: Concentration Risk Capital Charge (GPS 116) have been subject to an external consultation process since September 2008.