Insurance (prudential standard) determinations Nos. 14, 15, 16 and 17 of 2008

EXPLANATORY STATEMENT

Prepared by the Australian Prudential Regulation Authority (APRA)

Insurance Act 1973, paragraph 32(1)(a) and 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.  Subsection 32(4) of the Insurance Act gives APRA power to revoke Prudential Standards so determined.

1. Background

This Explanatory Statement explains the implementation of the prudential supervision of general insurance groups by APRA.  General insurers that operate as part of a corporate group generally have various inter-relationships with other members (regulated and unregulated) in the group.  These range from simply having an ownership linkage to other group entities to complex intra-group arrangements for financial support, including funding and reinsurance, as well as common governance and risk management systems and controls. 

A Level 2 insurance group must be headed by either a Level 1 insurer (an operating holding company) or an APRA-authorised NOHC and contain all general insurance controlled entities (both domestic and international) and any other controlled entities integral to its general insurance business.  Consolidation of a Level 2 insurance group is in accordance with the requirements of Australian Accounting Standards.  APRA may determine that subsidiaries that are not APRA-authorised insurers are to be consolidated and that some subsidiaries are to be treated as non-consolidated subsidiaries.

The foundation of APRA’s approach to Level 2 supervision is that general insurance groups should meet essentially the same minimum capital requirements on a consolidated basis as apply to individual authorised general insurers.

Group supervision will be undertaken on a consolidated basis across a Level 2 general insurance group, which will include subsidiaries located outside Australia.  It is not APRA’s intention to require overseas subsidiaries of an Australian general insurance group to meet Australian prudential standards on a stand-alone basis.

2.     Purpose of the Instruments

The purpose of Determination No 14 is to revoke GPS 001 Definitions and replace it with a revised version.  The following determinations, 15 to 17, determines new prudential standards to implement the prudential supervision of general insurance groups.  The following list explains the purpose of each determination:

• Insurance (prudential standard) determination No 14 of 2008 revokes Prudential Standard GPS 001 Definitions (made on 23 June 2008 under paragraph 32(1) of the Insurance Act) (“the old GPS 001”) and determines a new Prudential Standard GPS 001 Definitions (“the new GPS 001”) which includes definitions relating to Level 2 insurance groups.

• Insurance (prudential standard) determination No 15 of 2008 determines a new Prudential Standard GPS 111 Capital Adequacy: Level 2 Insurance Groups (“GPS 111”).

• Insurance (prudential standard) determination No 16 of 2008 determines a new Prudential Standard GPS 221 Risk Management: Level 2 Insurance Groups (“GPS 221”).

• Insurance (prudential standard) determination No 17 of 2008 determines a new Prudential Standard GPS 311 Audit and Actuarial Reporting and Valuation: Level 2 Insurance Groups (“GPS 310”).

3.     Operation of the Instruments

The instruments introduce the following requirements:

The new GPS 001

• Inserted into the glossary of common terms to be used across all the general insurance prudential standards are terms used in the Level 2 Insurance Group standards, particularly the paragraphs defining a Level 2 Insurance Group.

The new GPS 111

• Introduces a capital adequacy requirement for general insurance groups consisting of a Minimum Capital Requirement and requirements for the capital base of a general insurance group.

The new GPS 221

• Introduces a risk management requirement for general insurance groups consisting of the requirement for a group-wide risk management framework including reinsurance management, policies relating to outsourcing arrangements and business continuity management.

The new GPS 311

• Introduces requirements for audit reporting and actuarial reporting and valuation for general insurance groups.  There are requirements for the appointment of a Group Auditor and Group Actuary along with requirements for audit reporting, requirements for valuation of insurance liabilities on a group basis and requirements for actuarial reporting on a group basis.

4.     Consultation

APRA’s consultation process began with a discussion paper, Prudential supervision of corporate groups involving authorised general insurers, released in May 2005.  APRA’s proposals were further refined in a response paper, Prudential supervision of general insurance groups, released in October 2006. The response paper contained responses to submissions received in relation to the 2005 paper.  The issue of a possible compliance burden from the need to report on a group basis was raised in submissions to both papers. 

APRA then set about developing the reporting framework so that the industry’s concerns about the reporting burden could be discussed.  In early 2007, APRA provided early drafts of the proposed reporting forms to the industry via the Insurance Council of Australia.  APRA conducted a public consultation process on reporting requirements for consolidated group supervision and released Consolidated group reporting for general insurers, in August 2007.

In April 2008, APRA released a response paper and draft prudential standards addressing submissions received in relation to the October 2006 and August 2007 papers.  Prior to this there were informal consultations with insurance groups

Further refinement of the proposals occurred through informal consultation with Insurance Groups on revised draft reporting forms and instructions in September and October 2008.

A more detailed explanation of APRA's consultation process is outlined in the attached RIS 

5.     Regulation Impact Statement

A Regulation Impact Statement is attached to this Explanatory Statement.

Tabling Regulation Impact Statement

Prudential Supervision of General Insurance Groups

(OBPR Ref: 9923)

1              Background

The HIH Royal Commission Recommendations (38 and 39) outlined the need to develop a framework for the effective supervision of corporate groups that include general insurers and to do so without unduly restricting the commercial aspirations of the group.

General insurers that operate as part of a corporate group generally have various inter-relationships with other members (regulated and unregulated) in the group.  These range from simply having an ownership linkage to other group entities to complex intra-group arrangements for financial support, including funding and reinsurance, as well as common governance and risk management systems and controls.

There are 129 authorised general insurers in Australia and more than 50 are within corporate groups domiciled in Australia. Collectively, these insurers dominate the Australian general insurance market in terms of premiums written. 

2              Problem

Being part of a wider insurance group can alter the risk profile of a Level 1 general insurer. Financial inter-relationships may expose the general insurer to contagion risk from the financial weakness of another entity within the group and mask the true capital position of a general insurer within the group. Management and policy decisions at the group level may influence the type and level of risks assumed at the entity level. Subsidiaries may end up bearing risks beyond those that they would normally assume if they were operating as independent entities.

The failure of HIH was in part due to losses within parts of the HIH group that APRA did not supervise.  This demonstrates that financial weakness in one part of a group can have adverse consequences for the whole group.  However, it must be acknowledged that the APRA supervised entities were also under stress and these losses just made a bad situation worse.  However, a much more recent example has been provided by the largest insurance group in the world, AIG.  AIG required government support after one of its non-prudentially supervised subsidiaries sustained significant losses on a portfolio of credit default swaps.  The insurance companies within the AIG group were all financially sound but, without government support, the whole group is likely to have failed resulting in winding-up or run-off of the insurance companies due to loss of reputation, if nothing else.

There are also potential benefits from group membership, such as access to a greater pool of resources, both financial and technical, as well as risk diversification.

The market penetration of the identified groups is substantial.  The largest five groups control a market share of more than 90% of personal business (houseowners/householders and domestic motor vehicle classes of business).[1]  Therefore, general insurers operating within group structures provide coverage to most Australians.

It is APRA’s and the government’s intention to observe the core principles of the International Association of Insurance Supervisors (IAIS).  In order to observe Insurance Core Principle 17 (ICP 17), insurance supervisors need to demonstrate that they supervise general insurers on both a group basis and a solo basis.  At the moment APRA does not have a framework for supervising general insurers on a group basis.

APRA has been developing a tiered approach to the supervision of insurance groups and, in particular, to the assessment of capital adequacy.  The levels at which supervision would apply are:

• Level 1 - APRA’s existing framework, in which supervision is applied to the individual APRA-authorised general insurers (Level 1 insurers) on a stand-alone basis;
• Level 2 – consolidated general insurance groups (Level 2 insurance groups) that incorporate all general insurers, both domestic and international, within the group. The group may be headed by an APRA-authorised insurer (Level 1 insurer) or an APRA-authorised NOHC.  Level 2 supervision is the subject of this proposal; and
• Level 3 - conglomerate groups involving Australian insurers. This level would encompass the entire conglomerate group headed by an APRA-regulated entity and containing APRA-authorised institutions operating in more than one regulated industry.

These three levels of supervision are consistent with the levels of supervision of authorised deposit-taking institutions (ADIs) and their groups.  Currently there is an inconsistency in APRA’s supervision of insurance groups compared to banking groups.

3              Objectives of APRA’s initiative

The objective of Level 2 general insurance group supervision is to ensure that groups which contain authorised general insurers are financially sound and that group activities and inter-relationships do not adversely affect the financial soundness of those authorised general insurers within the group. This should reduce the risk of financial contagion across members of the group and enhance the protection of Australian policyholders as a result.

Secondary objectives include:

• Implementation of recommendations 38 and 39 of the HIH Royal Commission; and
• An ability to demonstrate that Australia observes IAIS’s ICP 17.

4              Options

4.1.     Option 1 - To introduce a prudential framework for the supervision of general insurance groups.

The foundation of APRA’s approach to Level 2 supervision is that general insurance groups should meet essentially the same minimum capital requirements on a consolidated basis as apply to individual authorised general insurers.

Group supervision would be undertaken on a consolidated basis across a Level 2 general insurance group, which would include subsidiaries located outside Australia.  It is not APRA’s intention to require overseas subsidiaries of an Australian general insurance group to meet Australian prudential standards on a stand-alone basis.

In assessing the capital adequacy of the group: 

• the MCR of the Level 2 group would be determined using the prescribed approach or via an internal model.  Responsibility for capital management would rest with the Board of Directors of the parent entity; 
• the capital base would be assessed on a group basis. The effect of intra-group transactions would be assessed at the group level. This may result in capital instruments within entities of the general insurance group which are eligible as capital on a Level 1 assessment being excluded from the capital base of the group as a whole on a Level 2 assessment;
• material subsidiaries operating in other industries, unrelated to the general insurance business, would need to be deconsolidated from the Level 2 general insurance group and their value would be deducted from the Level 2 group’s capital base; and
• APRA would not prescribe where the surplus capital of the group can be held.  However, Level 1 general insurers within the group would continue to be required to meet the MCR on an individual basis.

This approach to Level 2 supervision is consistent with that applied to authorised deposit-taking institutions (ADIs).

A group-wide risk management framework would be required which includes reinsurance management, business continuity management and policies relating to outsourcing arrangements. The requirements are based on the principles applying to Level 1 general insurers but are appropriately modified for application at the group level.

The Level 2 group would need to appoint a Group Auditor and Group Actuary.  The Group Auditor may be the Appointed Auditor of any Level 1 insurer within the group or a responsible auditor of the authorised NOHC.  The Group Actuary may be the Appointed Actuary of any Level 1 insurer within the group or, where the parent entity is a NOHC, an actuary who is responsible for providing actuarial services to the Board of the NOHC, including reporting to the Board of the NOHC on actuarial matters relating to the group.

Semi-annual reporting would be required based on existing group accounts prepared in accordance with Australian equivalents of International Financial Reporting Standards (AIFRS). One significant adjustment to AIFRS is that liability valuations would be established at a 75 per cent probability of sufficiency - AIFRS does not mandate a level of sufficiency.  Initially reports would need to be submitted to APRA within twelve weeks of each half–year end.  The Level 2 group annual accounts, as reported to APRA, would be subject to a limited assurance review by the Group Auditor.

The Insurance Liability Valuation Report (ILVR) prepared by the Group Actuary would need to be submitted within four months of the end of year balance date.

A summary of the proposed framework for the prudential supervision of general insurance groups is provided in Appendix 1.

4.2.     Option 2 - To maintain status quo.

The status quo is that APRA has no formal mechanism to supervise insurance groups.  APRA’s group supervision activities would then be limited to:

• authorisation of NOHCs with application of governance and fit and proper requirements to those entities;
• visits to overseas subsidiaries of Australian insurance groups to understand the risks of these ventures;
• close consideration of publicly reported consolidated financial statements; and
• assessment of group risk management frameworks (RMFs) particularly where Level 1 insurers rely on these group RMFs for compliance with their individual risk management requirements.

While this supervision goes some way towards addressing the risks to Level 1 general insurers from group membership, it does not provide for a comprehensive framework for supervision.  The most significant anomaly is that there is no mechanism for assessing capital adequacy at the group level.

5              Impact analysis – costs, benefits and risks

5.1.     Impact group identification

The parties affected by the identified options are expected to be APRA, policyholders and insurance groups.

The insurance groups affected by this proposal have diverse characteristics.  The groups range from multinational groups that compete in many international markets to simple groups with one holding company and one insurer that operate only in Australia.  In terms of ownership of the groups, they range from widely held public companies listed on the Australian Stock Exchange to Australian domiciled subsidiaries of foreign insurance groups.

5.2.     Assessment of costs and benefits

As with all discussion papers issued by APRA, the affected parties are asked to provide details of the impact on them and are invited to use the Business Cost Calculator.  This would be particularly useful in assessing compliance costs.  Over the course of various consultations, only one service provider submitted cost estimates for complying with APRA’s proposals.  This is detailed in section 5.3.3.

No insurance group, however, provided such data and APRA is unaware of the reasons.  However, it is likely that the cost of providing this data, which is linked to the difficulty in estimating the impact of the proposals, was a factor.  Moreover, submissions did not argue points based on estimates of costs compared to benefits.  The arguments were based on impediments to complying with certain requirements often along with alternative suggestions to achieve an outcome that was considered more practical.  Therefore submissions were not reliant in any sense on quantified costs.  Since APRA has been provided with only one cost estimate (without a cost base to compare to in order to identify the scale of these costs), it would be difficult to extrapolate this to an entire industry as a basis for estimating the costs of these proposals. As a result no attempt will be made in this RIS to quantify those costs.

In submissions during consultation (see Section 6), non-monetary information about costs and impediments to implementation have been provided by insurance groups.  It is impossible to take this information and accurately assess costs across a range of insurance groups.

5.3.     Option 1

5.3.1.                                 APRA

Benefits

The proposed consolidated approach to the supervision of corporate groups involving one or more locally incorporated general insurers would allow APRA to supervise general insurers on a group-wide basis, minimising any adverse impact from group activities on individual Australian insurers in the group.  Accordingly, this option could enhance APRA’s capacity to better meet its statutory mandate to protect policyholders where their insurers operate within a larger corporate group.

This option would also allow APRA to advance its approach to the supervision of Australian insurers that operate within a larger corporate group, in accordance with international standards and principles for the supervision of insurance groups or financial conglomerates.

Costs

Implementing a group-wide supervision framework for general insurers would incur additional supervisory and related costs for APRA.  APRA would need to train its supervisors to implement the new requirements and monitor compliance by general insurers on an on-going basis.  Also, more time would be involved in assessing group information in order to understand the risks involved in group activities, and their impact on the Australian insurer in the group, which could be costly where the group has a complex structure.

APRA is not able to quantify these additional costs since the complexity of supervision will differ between corporate groups.  However, given APRA has already in place a similar model for the supervision of corporate groups including an ADI, the costs associated with training supervisors to be conversant with the proposed group-wide supervision framework for general insurers would not be as great as if there was no other comparable regulatory model already in place.

5.3.2.                                 Policyholders

Benefits

This option would improve the current position of policyholders where their insurers operate within a larger corporate group (i.e. their interests would be better protected).  As set out in section 2 above, more than 90% of personal insurance policyholders in Australia will benefit from this proposal.  This option would assist APRA to ensure that the overall group is financially sound and that group activities and inter-relationships will not unduly impinge on the financial soundness of an Australian insurer in the group.  Accordingly, this enhanced consolidated supervision approach would give policyholders a greater sense of security that their insurer would be able to meet its obligations as they fall due. 

Costs

This enhanced protection could come with a cost to be borne by policyholders of general insurers that operate within a corporate group, as general insurers are likely to pass some (if not all) of the additional compliance costs on to their policyholders in the form of increased premiums.  The scale of these costs and the probability of them occurring are set out in 5.3.3 below under the heading 'costs'.  The major cost identified by most groups appears to be the cost of reporting to APRA which, in the context of the five largest groups in Australia, is a relatively minor cost that would not materially affect the costs of a Level 2 insurance group such that a material increase in premiums would need to be charged.

5.3.3.                                 Insurance groups

Benefits

It is not possible to quantify the benefits applicable to insurance groups. 

Subjecting general insurers and their corporate group to certain minimum prudential requirements to address group issues such as capital adequacy, risk concentrations, intra-group exposures, governance and risk management would assist in enhancing their risk management practices, systems and controls in the long run at both the authorised entity and group levels.  Requirements in these areas for general insurers on a stand-alone basis were significantly enhanced in 2002 and again in 2006, and these have proven to strengthen general insurers’ risk management systems. 

While insurance groups may already have policies, systems and controls in place to address these issues on a group basis, experience with the existing regime suggests that there will be scope for improvement.  Having explicit requirements in place could serve to direct particular attention and resources to these issues.  In addition, this would simultaneously strengthen the risk management standards of the insurance industry as a whole, so that other industry participants would also benefit from such improvement when dealing with each other.

Also, by giving APRA a better perspective on the total capital position of the group, and greater confidence as to the capital resources available to the group, APRA may more readily accept flexibility in the location of that capital.

Costs

The costs that would be incurred by a Level 2 insurance group cannot be quantified as those insurance groups declined APRA's invitation to provide quantified estimates of costs related to the proposals.  As set out below, APRA does not believe the costs would be material in the context of the total costs of an insurance group.

The cost estimate from the one service provider who supplied data totalled $51,090, comprising $1,943 of start-up costs and $49,147 of ongoing costs. No revenue or cost base was provided, however, to gauge the extent of the compliance burden. The relevant total cost base of the insurer or type of insurer referred to by the service provider was not supplied.  This means there is no comparison to the scale of operation.  It is therefore not useful for projecting total costs across the industry. It is important to note that this cost estimate was in relation to early proposals, where the compliance requirements were more substantial than the final proposals to be implemented.  As such, the actual cost would be lower than the value quoted. In any case, for most insurance groups a start-up cost of the total costs quoted by the service provider would be immaterial compared to their total administration costs.

In the consultation process, insurance groups have indicated that the primary cost of the implementation of this policy will be to carry out reporting to APRA in a new statistical collection.  APRA has taken steps in the design of its proposal to minimise these costs and has worked closely with the industry to ensure that APRA’s needs are met in the least burdensome way possible.  It should be noted, however, that Australian insurers with overseas subsidiaries are already required to produce general purpose financial statements on both AIFRS and local GAAP.  And in any case, we propose to utilise elements of existing reporting where suitable. This will mean that in many cases insurance groups will need only transfer data from already prepared accounts into APRA reporting forms.  This cost is not considered material for most insurance groups.

Under the proposed prudential framework, APRA believes Level 2 insurance groups would not be at a competitive disadvantage.  Regardless of APRA’s requirements, a prudently managed insurance group should carry out its own capital assessment, taking into account the capital needs of the various members of the group and the level of mobility for surplus capital.

There are likely to be additional audit costs incurred by insurance groups.  The proposed requirement for limited assurance of APRA reporting is a new cost that will be borne by all insurance groups.  This cost has been minimised through consultation with the industry and by ensuring that AIFRS accounting is used in APRA reporting.  The AIFRS accounting will already have been subject to audit in most circumstances due to financial reporting requirements of the Corporations Act 2001. 

The new actuarial requirement is the preparation of an Insurance Liability Valuation Report (ILVR) on a group basis.  This has been a requirement of Level 1 authorised insurers since 2002 but this proposal will require it for the Level 2 insurance group for the first time.  A number of insurance groups already prepare group ILVRs based on the individual ILVRs so, for these groups, the costs will be minimal.  For those groups that do not prepare group ILVRs, this will be a new cost for which they will have to engage either an internal or external Group Actuary.  It is notable that for the preparation of financial statements in accordance with AIFRS, there has been a liability adequacy test for unexpired risk reserves and a requirement to apply a risk margin for outstanding claims since 2006.  Both of these requirements have resulted in groups, and their auditors, seeking actuarial advice in the production of group financial statements.  Actuaries would already therefore carry out much of the calculation work and the additional work involved will be in putting that within a report with the additional commentary required in an ILVR.  This cost is not likely to be material in the context of the cost base of an insurance group.

5.4.     Option 2 – maintaining status quo

In all instances the benefits in this section are analogous to the costs detailed for each affected group of stakeholders in section 5.3.  Similarly, the costs in this section are analogous to the benefits in section 5.3.

5.4.1.                                 APRA

Benefits

No additional supervisory costs would be incurred under this option, given that no new prudential requirements would be imposed on authorised general insurers that operate within a wider corporate group.

Costs

Under this option, APRA would be limited in its ability to discharge effectively its responsibility of protecting the interests of policyholders of general insurers where the insurers operate within a larger corporate group. 

5.4.2.                                 Policyholders

Benefits

Since under this option no new prudential requirements would be imposed on general insurers operating in a corporate group to address potential contagion risk, no additional compliance costs would be incurred that could be passed on to policyholders in the form of increased premiums.

Costs

This option would not improve the current position of policyholders where their insurers operate within a larger corporate group.  Since the current prudential regime limits APRA’s ability to supervise adequately the potential contagion risks posed to insurers from the activities of other members in the same group, policyholders of these insurers would still be exposed to greater risk of institutional failure resulting from group operations than the risk faced by policyholders of stand-alone authorised insurers.

5.4.3.                                 Insurance groups

Benefits

There would be no increase in compliance costs for insurance groups under this option, given that no new prudential requirements would be imposed on them.

Costs

In the absence of any minimum prudential requirements, some authorised insurers may pay insufficient attention to group risks, increasing their risk of failure over time.

Also, the current ‘incomplete’ approach to the supervision of authorised insurers operating in a corporate group may cause other industry participants and overseas insurers to have a lower confidence in the security of the Australian insurance sector as a whole, since most Australian insurers operate as part of a wider corporate group.  Accordingly, Australian insurers may face higher transaction costs imposed by their counterparties (e.g. other insurers or reinsurers with whom an insurer contracts in respect of reinsurance arrangements).

6              Consultation

APRA’s consultation process began with a discussion paper, Prudential supervision of corporate groups involving authorised general insurers, released in May 2005.  The scope of this paper was greater than the current proposal as it included Level 3 supervision.  Also included in that paper were proposals to revise asset concentration limits at all three levels of supervision.  Twenty submissions were received in relation to that paper.  Level 3 supervision is now being progressed on a cross-industry basis and will be considered separately from these Level 2 proposals.

APRA’s proposals were further refined in a response paper, Prudential supervision of general insurance groups, released in October 2006. These proposals were reduced in scope to only the Level 2 proposals and the asset concentration proposals were put on hold.  The response paper contained responses to submissions received in relation to the 2005 paper.   Five submissions were received in relation to this 2006 paper, all of which raised the issue of a possible compliance burden from the need to report on a group basis.    

APRA then set about developing the reporting framework so that the industry’s concerns about the reporting burden could be discussed.  In early 2007, APRA provided early drafts of the proposed reporting forms to the industry via the Insurance Council of Australia.  APRA conducted a separate consultation process on reporting requirements for consolidated group supervision and released a separate discussion paper on these requirements, Consolidated group reporting for general insurers, in August 2007.

The August 2007 discussion paper elicited a number of submissions that were useful in developing the prudential framework for Level 2 general insurance groups. Specific issues included in the prudential framework as a result of feedback from this discussion paper include:

• enhanced flexibility in the scope of insurance liability valuations by actuaries;

• enhanced flexibility in the scope of audit assurance; and

• redefinition of deconsolidated entities to make it clear that deconsolidation would not ordinarily be required unless a subsidiary is from another regulated industry or is a commercial operation unrelated to general insurance business.

In April 2008, APRA released a response paper and draft prudential standards addressing submissions received in relation to the October 2006 and August 2007 papers.  Prior to this there were informal consultations with insurance groups via the Insurance Council of Australia.  The major issues addressed in this paper and the draft prudential standards were (further detail on all of these points can be found in 5.3.3):

• competitive neutrality;
• measures to further address the perceived reporting burden;
• possibility of dual regulatory requirements due to the new group risk management, governance and fit and proper requirements;
• APRA approval of internal guarantees (based on submissions received APRA has removed this requirement in the final proposal); and
• APRA’s discretion to determine the composition of Level 2 insurance groups (APRA maintained this discretion as it is not likely to apply to existing group arrangements but the discretion is important in relation to possible future structures).

APRA received eight submissions in relation to this paper.  The key issues identified which have been addressed in the final proposals are the need for:

• further refinement of the definition of a Level 2 insurance group to more closely align to the accounting requirements for consolidated financial reporting;
• further refinement of the definition of non-consolidated subsidiaries;
• a clearer statement of the requirements for actuarial advice regarding half-yearly reporting;
• more flexibility in publishing the group’s MCR (that is, not confining the groups to including this figure in their published annual reports);
• refinement of business continuity management requirements;
• less prescription in relation to who can be appointed as the Group Actuary; and
• less prescription about the internal use of the group ILVR.

Further refinement of the proposals occurred through informal consultation with Insurance Groups on revised draft reporting forms and instructions in September and October 2008.

APRA's use of the consultation process to minimise key costs were outlined in section 5.3.3.  Some more detail is provided here about how issues raised in consultation were addressed.

During consultation a concern was expressed that the approach may cause Australian insurance groups to be uncompetitive in international insurance markets. Competitive disadvantage was thought possible as Australian insurance groups would be the only insurance groups which have to meet group capital adequacy requirements and group risk management requirements.  The costs of capital and compliance costs were seen as the major source of possible competitive disadvantage.  Three possible outcomes were stated to arise from this perceived disadvantage:

• Australian-based insurers could be at a competitive disadvantage compared to foreign-owned insurers operating in Australia;

• there may be an incentive for locally incorporated insurers to move offshore; and

• there may be a barrier to Australian insurers expanding offshore.

Under the proposed prudential framework APRA believes Level 2 insurance groups would not be at a competitive disadvantage.  Regardless of APRA’s requirements, a prudently managed insurance group should carry out its own capital assessment, taking into account the capital needs of the various members of the group and the level of mobility for surplus capital. Currently, Level 1 insurers maintain capital levels well above the levels required by APRA.  Under APRA’s Level 2 supervisory regime, Level 1 insurers within a group may be able to take advantage of the group’s capital strength and its ability to move surplus capital.  This may result in Level 1 insurers within the group maintaining less capital than current levels.  Additionally, should foreign supervisors choose to recognise APRA’s regime, groups stand to benefit further from additional capital mobility and potential regulatory efficiencies.  Furthermore, consistent with the requirements of ICP 17, it is likely that foreign supervisors will introduce similar requirements in the near future removing any perceived disadvantage to Australian insurance groups.

During consultation, some respondents noted that there was a possibility of dual regulatory requirements being imposed on overseas operations through APRA’s group risk management, fit and proper and governance requirements adding materially to the requirements applied by host regulators of overseas entities.   APRA's group requirements are principles-based and are intended to be flexible enough to allow for a wide range of situations. It is difficult to envisage a significant clash between APRA’s requirements at the group level and local risk management requirements in foreign jurisdictions. APRA acknowledges that there may be some limited additional prudential obligations at both the overseas entity and group level. If local obligations are more stringent, that is a cost of that local regime. It is possible that APRA’s group requirements would exceed local requirements in some respects.

Other costs that the industry believe will be incurred are:

• the costs of staffing a compliance function which will have a new set of compliance obligations to monitor.  Again, APRA has worked with the industry to minimise the effort required to develop familiarity with these compliance obligations by maintaining a close linkage between the requirements for Level 1 authorised insurers and Level 2 insurance groups.  In fact, the proposed prudential standards for Level 2 Insurance Groups will be comparatively short and will reference the Level 1 authorised insurer standards.  The linkage to AIFRS will also minimise compliance obligations, other than reporting, as existing management reporting processes can be used for monitoring compliance with APRA’s requirements;

• there is potentially a need for some insurance groups to restructure their capital and as a result because this proposal may impose a new capital requirement on these groups.  Other groups will not be affected and may instead benefit from greater flexibility in the utilisation of capital around the group; and

• a group risk management framework is a new requirement that insurance groups will need to put in place.  Most well managed insurance groups already have a group risk management framework and complying with the new requirements will involve little effort.  For the minority of insurance groups that have not implemented group-wide risk management there will be costs involved in establishing a risk management framework and maintaining that framework.

7              Conclusion and recommended option

The recommended option is option 1.  The HIH Royal Commission recommended that group supervision be implemented.  APRA already has a model for group supervision used in its supervision of ADIs.  Option 1 is an adaptation of that approach that is tailored for the general insurance industry.  Option 1 also ensures that APRA observes IAIS’s ICP 17 which was the one gap in APRA’s prudential framework.

APRA has worked closely with the insurance industry over a protracted consultation period to ensure that costs are minimised while still achieving APRA’s objectives.  This consultation process has been one of the most extensive that APRA has undertaken.  APRA believes that a good balance between costs and benefits has been achieved through this extensive consultation process.

Option 2 is not viable in the modern financial services industry.  International expectations are quickly evolving towards prudential supervisors considering the risks inherent in corporate groups, not just legal entities conducting prudentially supervised business.  In addition, option 2 would mean that the government’s stated policy of implementing the recommendations of the HIH Royal Commission would not be fulfilled.

8              Implementation and review

Final prudential standards will be determined in December 2008.  These will be effective on 31 March 2009.  This will give time for APRA and insurance groups to work together to implement Level 2 insurance group supervision.  APRA's supervisory approach is one of working with industry to assist with interpretation and implementation of new requirements.  If necessary, the proposed standards have adequate transition provisions to enable tailored transition to deal with the unique circumstances that may be faced by individual insurance groups. 

As is usual APRA practice, the standards will be reviewed within three years of determination.  APRA will conduct this review through a consultation process.  Level 2 supervision is very much tied to existing Level 1 supervision so as that evolves so will Level 2 supervision.  APRA has a history of evolving its standards and always involves the industry through the opportunity for consultation on both a formal and informal basis.

APPENDIX 1

Summary of the proposed prudential standards for the supervision of general insurance groups

[1] Half Yearly General Insurance Bulletin, June 2007 published 25 February 2008