Insurance (prudential standard) determination Nos. 1 to 14 of 2012

EXPLANATORY STATEMENT

Prepared by the Australian Prudential Regulation Authority

Insurance Act 1973, paragraphs 32(1)(a) and (b) and subsections 32(4)
Legislative Instruments Act 2003, paragraph 6(d)

Paragraphs 32(1)(a) and (b) of the Insurance Act 1973 (the Insurance Act) provide that APRA may determine, in writing, standards relating to prudential matters that must be complied with by general insurers and authorised non-operating holding companies.  Subsection 32(4) of the Insurance Act gives APRA the power to vary or revoke prudential standards so determined.

Pursuant to paragraph 6(d) of the Legislative Instruments Act 2003 (the Legislative Instruments Act), such prudential standards are legislative instruments for the purposes of the Legislative Instruments Act.  

1.    Background

APRA commenced a review of the regulatory capital framework for general insurers and life companies (LAGIC review) in 2010. The broad aims of the review were to:

• improve the risk sensitivity and appropriateness of the capital standards in general insurance and life insurance (including friendly societies); and
• where appropriate, improve the alignment of the capital standards across the industries that APRA supervises.

APRA has made a range of amendments to its prudential framework to give effect to the findings of the review. As a result of the changes, there is a common capital framework for required capital and eligible capital across general insurers and life companies. An insurer is required to have sufficient capital to absorb unexpected shocks that may arise over a one-year period and be able to meet its liabilities at the end of that period.

The minimum capital requirement is known as the Prudential Capital Requirement (PCR). This comprises a prescribed capital amount plus any supervisory adjustment determined by APRA.

Specifically, in the case of general insurers, the prescribed capital amount includes explicit risk charges for insurance risk, insurance concentration risk, asset risk, asset concentration risk and operational risk as well as an aggregation benefit. The supervisory adjustment is a discretionary amount set by APRA and could be used to address strategic risks, reputational risks, unusual operational risks, or risks related to poor corporate governance or risk management systems.

General insurers must at all times satisfy minimum requirements for the composition of their capital bases and ensure that the capital base exceeds the PCR.

In addition to the quantitative requirements described above, a general insurer is required to have a well documented Internal Capital Adequacy Assessment Process (ICAAP) that is approved by the Board, and is appropriate to the nature, scope and complexity of the general insurer’s activities. The ICAAP involves an integrated approach to capital and risk management and is based on assessing the level of risk in the insurer and matching the capital held to that risk profile.

In addition, general insurers are required to make a range of public disclosures, aimed at assisting market observers to assess the capital adequacy of general insurers and enhancing market discipline.

The changes to prudential requirements in respect of general insurers arising from the LAGIC review are effected through the instruments described in section 2 below.

2.      Purpose of the instruments

The purpose of making the instruments is to introduce new and amended prudential standards and revoke existing prudential standards in relation to general insurers in order to implement the changes arising from the LAGIC review.

On 30 November 2012, APRA made the following determinations (the instruments) under subsections 32(1) and 32(4) of the Insurance Act:

1. Insurance (prudential standard) determination No. 1 of 2012, which revokes Prudential Standard GPS 001 Definitions made on 23 September 2011 (the existing GPS 001) and determines a new Prudential Standard GPS 001 Definitions (GPS 001);
2. Insurance (prudential standard) determination No. 2 of 2012, which revokes Prudential Standard GPS 110 Capital Adequacy made on 18 June 2010 (the existing GPS 110) and determines a new Prudential Standard GPS 110 Capital Adequacy (GPS 110);
3. Insurance (prudential standard) determination No. 3 of 2012, which revokes Prudential Standard GPS 113 Capital Adequacy: Internal Model-based Method made on 18 June 2010 (the existing GPS 113) and determines a new Prudential Standard GPS 113 Capital Adequacy: Internal Model-based Method (GPS 113);
4. Insurance (prudential standard) determination No. 4 of 2012, which revokes Prudential Standard GPS 114 Capital Adequacy: Investment Risk Capital Charge made on 18 June 2010 (the existing GPS 114) and determines a new Prudential Standard GPS 114 Capital Adequacy: Asset Risk Charge (GPS 114);
5. Insurance (prudential standard) determination No. 5 of 2012, which revokes Prudential Standard GPS 115 Capital Adequacy: Insurance Risk Capital Charge made on 18 June 2010 (the existing GPS 115) and determines a new Prudential Standard GPS 115 Capital Adequacy: Insurance Risk Charge (GPS 115);
6. Insurance (prudential standard) determination No. 6 of 2012, which revokes Prudential Standard GPS 116 Capital Adequacy: Concentration Risk Capital Charge made on 18 June 2010 (the existing GPS 116) and determines a new Prudential Standard GPS 116 Capital Adequacy: Insurance Concentration Risk Charge (GPS 116);
7. Insurance (prudential standard) determination No. 7 of 2012, which makes Prudential Standard GPS 117 Capital Adequacy: Asset Concentration Risk Charge (GPS 117);
8. Insurance (prudential standard) determination No. 8 of 2012, which makes Prudential Standard GPS 118 Capital Adequacy: Operational Risk Charge (GPS 118);
9. Insurance (prudential standard) determination No. 9 of 2012, which revokes Prudential Standard GPS 120 Assets in Australia made on 18 June 2010 (the existing GPS 120) and determines a new Prudential Standard GPS 120 Assets in Australia (GPS 120);
10. Insurance (prudential standard) determination No. 10 of 2012, which revokes Prudential Standard GPS 220 Risk Management made on 23 June 2008 (the existing GPS 220) and determines a new Prudential Standard GPS 220 Risk Management (GPS 220);
11. Insurance (prudential standard) determination No. 11 of 2012, which revokes Prudential Standard GPS 230 Reinsurance Management made on 23 June 2008 (the existing GPS 230) and determines a new Prudential Standard GPS 230 Reinsurance Management (GPS 230);
12. Insurance (prudential standard) determination No. 12 of 2012, which revokes Prudential Standard GPS 310 Audit and Actuarial Reporting and Valuation made on 18 June 2010 (the existing GPS 310) and determines a new Prudential Standard GPS 310 Audit and Related Matters (GPS 310);
13. Insurance (prudential standard) determination No. 13 of 2012, which makes Prudential Standard GPS 320 Actuarial and Related Matters (GPS 320); and
14. Insurance (prudential standard) determination No. 14 of 2012, which revokes the following prudential standards:

(a)          Prudential Standard GPS 111 Capital Adequacy: Level 2 Insurance Groups made on 23 September 2011 (GPS 111);

(b)          Prudential Standard GPS 221 Risk Management: Level 2 Insurance Groups made on 9 September 2011 (GPS 221); and

(c)          Prudential Standard GPS 311 Audit and Actuarial Reporting and Valuation: Level 2 Insurance Groups made on 23 September 2011 (GPS 311).

The instruments will take effect on 1 January 2013.

3.      Operation of the instruments

The following instruments introduce new requirements to implement the revised capital framework under the LAGIC review:

Insurance (prudential standard) determination No. 1 of 2012

GPS 001 defines key terms referred to in other prudential standards applicable to general insurers and Level 2 insurance groups.

Insurance (prudential standard) determination No. 2 of 2012

GPS 110 requires a general insurer or Level 2 insurance group to maintain an adequate level and quality of capital commensurate with the scale, nature and complexity of its business and risk profile. A general insurer or Level 2 insurance group is also required to have a documented ICAAP, comply with any supervisory adjustment to capital imposed by APRA, obtain APRA’s written consent before reducing its capital, and inform APRA of any significant adverse changes to its capital position.

Under GPS 110, a general insurer or Level 2 insurance group is required to maintain required levels of capital, and determine its prescribed capital amount having regard to a range of risk factors that may adversely impact the insurer’s ability to meet its obligations. These factors include insurance risk, insurance concentration risk, asset risk, asset concentration risk and operational risk.

Insurance (prudential standard) determination No. 4 of 2012

GPS 114 sets out the method for calculating the Asset Risk Charge, the minimum amount of capital a general insurer or Level 2 insurance group must hold against the asset risks associated with its activities. The Asset Risk Charge is one of the components of the Standard Method for calculating the prescribed capital amount, and relates to the risk of adverse movements in the value of a fund’s on-balance sheet and off-balance sheet exposures.

Insurance (prudential standard) determination No. 5 of 2012

GPS 115 sets out the method for calculating the Insurance Risk Charge, the minimum amount of capital a general insurer or Level 2 insurance group must hold against the insurance risks associated with its activities. The Insurance Risk Charge is one of the components of the Standard Method for calculating the prescribed capital amount, and relates to the risk that the value of the net insurance liabilities is greater than the value determined under GPS 320.

Insurance (prudential standard) determination No. 6 of 2012

GPS 116 sets out the method for calculating the Insurance Concentration Risk Charge, the minimum amount of capital a general insurer or Level 2 insurance group must hold against insurance concentration risks. The Insurance Concentration Risk Charge is one of the components of the Standard Method for calculating the prescribed capital amount, and relates to the risk of an adverse movement in the capital base due to a single large loss or series of losses.

Insurance (prudential standard) determination No. 7 of 2012

GPS 117 sets out the method for calculating the Asset Concentration Risk Charge, the minimum amount of capital a general insurer or Level 2 insurance group must hold against asset concentration risks. The Asset Concentration Risk Charge is one of the components of the Standard Method for calculating the prescribed capital amount and relates to the risk of a concentration in exposures to a particular asset, counterparty or group of related counterparties resulting in adverse movements in the general insurer’s or Level 2 insurance group’s capital base.

Insurance (prudential standard) determination No. 8 of 2012

GPS 118 sets out the method for calculating the Operational Risk Charge, the minimum amount of capital a general insurer or Level 2 insurance group must hold against operational risks. The Operational Risk Charge is one of the components of the Standard Method for calculating the prescribed capital amount and relates to the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.

The following instruments are revised with amendments that are in the main consequential to the revised capital framework under the LAGIC review along with a small number of other amendments as set out below, to enhance readability and address minor prudential matters:

Insurance (prudential standard) determination No. 3 of 2012

GPS 113 sets out the requirements that a general insurer or Level 2 insurance group must meet to use an Internal Model-based Method (IMB method) for calculating the prescribed capital amount of the general insurer or Level 2 insurance group, both at the time of application and subsequently.

The existing GPS 113 is updated with the requirement that general insurers or Level 2 insurance groups that use the IMB Method must comply with the disclosure requirements in GPS 110. References to Prudential Standard GPS 112 Capital Adequacy: Measurement of Capital are also updated, including the eligibility of capital base components.

Insurance (prudential standard) determination No. 9 of 2012

GPS 120 specifies certain assets that are excluded from being treated as ‘assets in Australia’ by a general insurer for the purposes of section 28 of the Insurance Act.

The treatment of dividends for Category C insurers in the existing GPS 120 is aligned, so that only dividends that have been declared are deducted from adjusted net assets.

Insurance (prudential standard) determination No. 10 of 2012

GPS 220 sets out the requirements for a general insurer and a Level 2 insurance group to maintain a risk management framework and strategy that is appropriate to the nature and scale of its operations.

Additional paragraphs are added to the existing GPS 220 to clarify that the requirements for the risk management framework and the ICAAP should be combined to produce an integrated approach to risk and capital management. The list of material risks covered under the risk management framework is aligned under the revised capital framework, to facilitate closer alignment between capital management and risk management. Clarifications are also made where certain requirements can be satisfied on an insurance group basis.

Insurance (prudential standard) determination No. 11 of 2012

GPS 230 requires a general insurer and a Level 2 insurance group to maintain, as part of its overall risk management framework, a specific reinsurance management framework to manage the risks arising from its reinsurance arrangements.

Reinsurance requirements under the existing GPS 230 are combined for general insurers and Level 2 insurance groups. This includes clarification on when  certain requirements can be satisfied on an insurance group basis, matters to be addressed in the Reinsurance Management Strategy, the requirement for consistency between the reinsurance management framework and the ICAAP, and the timing of the reinsurance declaration.

Insurance (prudential standard) determination No. 12 of 2012

GPS 310 sets out the roles and responsibilities of the Appointed Auditor and Group Auditor (Auditor), and the obligations of a general insurer or Level 2 insurance group to ensure that the Auditor can undertake those roles and responsibilities.

The requirements under the existing GPS 310 are combined for general insurers and Level 2 insurance groups. Specific adjustments to the prudential standard for Level 2 insurance groups are set out in Attachment B of GPS 310.

Insurance (prudential standard) determination No. 13 of 2012

GPS 320 sets out the roles and responsibilities of an Appointed Actuary and Group Actuary (Actuary), and the obligations of an insurer or Level 2 insurance group to make arrangements to enable its Actuary to fulfil those roles and responsibilities.

The requirements in relation to actuarial matters contained in the existing GPS 310 have been set out in GPS 320, with combined requirements for general insurers and Level 2 insurance groups. Changes to the requirements include additional responsibilities for Actuaries, the revised timing of the Insurance Liability Valuation Report and Financial Condition Report, and updates to the risk-free discount rates to be used.  

Insurance (prudential standard) determination No. 14 of 2012

This determination revokes a number of existing prudential standards which, due to the changes made as a result of the LAGIC review, will be obsolete from 1 January 2013.

4.      Consultation

APRA undertook consultation on the LAGIC review between May 2010 and October 2012, including four rounds of industry consultation, three technical papers and two quantitative impact studies.

APRA released the following consultation materials:

• May 2010 – Discussion paper ‘Review of capital standards for general insurers and life insurers’[1];
• July 2010 – Technical papers ‘Review of capital standards for general insurers and life insurers – Asset risk capital charge’[2] and ‘Review of capital standards for general insurers and life insurers – Capital base and insurance risk capital charge for life insurers’[3];
• September 2010 – Technical paper ‘Review of capital standards for general insurers and life insurers – Insurance concentration risk capital charge for general insurers’[4];
• Late 2010 – APRA invited insurers to participate in the first quantitative impact study[5];
• March 2011 – Response paper ‘Review of capital standards for general insurers and life insurers’[6];
• April 2011 – APRA invited insurers to participate in the second quantitative impact study[7];
• December 2011 – Response paper ‘Review of capital standards for general insurers and life insurers’[8], draft prudential standards;
• March 2012 – Letter to all CEOs (or equivalent) and Appointed Actuaries of life insurers ‘Illiquidity premium’[9];
• May 2012 – Response paper ‘Review of capital standards for general insurers and life insurers’[10], final versions of the capital adequacy standards, draft versions of the composition of the capital base and non-capital prudential standards containing amendments that are in the main consequential to the revised capital framework;
• June 2012 – Discussion paper ‘Review of capital standards for general insurers and life insurers – proposed revisions to reporting requirements’[11], draft versions of reporting forms and instructions, reporting standards and capital adequacy calculation workbooks and instructions;
• August 2012 – Letter to insurers ‘Additional proposed changes to the reporting standards’[12];
• September 2012 – Letter to all CEOs (or equivalent) of life insurers ‘Solvency standard requirements under the Life Insurance Act 1995’[13];
• September 2012 – Letter to insurers ‘Consultation on draft prudential practice guides and information paper’[14], draft versions of prudential practice guides and an information paper[15];
• October 2012 – Response paper ‘Review of capital standards for general insurers and life insurers’[16], final versions of all prudential standards amended as a result of the LAGIC review; and
• October 2012 – Response paper ‘Review of capital standards for general insurers and life insurers – reporting requirements’[17], final versions of all forms and instructions and reporting standards.

APRA has considered both formal and informal feedback from industry throughout the above multi-year process. APRA has also considered feedback from the authorised deposit-taking (ADI) industry in relation to requirements for the composition of the capital base which are common to insurers and ADIs.  Submissions made by industry were broadly supportive of the changes. Issues considered to be significant or to have merit were incorporated into the revised capital framework.

5.      Regulation Impact Statement

A Regulation Impact Statement is required. It has been prepared and is attached as supporting material.

6.      Statement of compatibility prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

The legislative instruments the subject of this explanatory statement do not engage any of the applicable rights or freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011. Accordingly, in APRA’s assessment, these legislative instruments are compatible with human rights.

[1] http://www.apra.gov.au/CrossIndustry/Documents/GLI_DP_RCSGILI_032010_v7[1].pdf

[2] http://apra.gov.au/CrossIndustry/Documents/GLI_TP_LGICR_062010_ex%5B1%5D.pdf

[3] http://apra.gov.au/CrossIndustry/Documents/GLI_TP_CBIRCC_072010_v8%5B1%5D.pdf

[4] http://apra.gov.au/CrossIndustry/Documents/Insurance-Conc-Risk-charge%5B1%5D.pdf

[5] http://www.apra.gov.au/GI/PrudentialFramework/Pages/Review-Cap-Stds-QIS1-QIS2-TechSpecs.aspx

[6] http://apra.gov.au/CrossIndustry/Documents/GLI_RS_RCSGILI_032011_ex_r%5B1%5D.pdf

[7] http://www.apra.gov.au/GI/PrudentialFramework/Pages/Review-Cap-Stds-QIS1-QIS2-TechSpecs.aspx

[8] http://apra.gov.au/GI/PrudentialFramework/Pages/General-and-Life-Insurance-Capital-Review-Consultation-on-Draft-Prudential-Standards.aspx

[9] http://apra.gov.au/lifs/PrudentialFramework/Documents/120330_LTI_LAGIC_LI_illiquidity_premium_consultation.pdf

[10] http://apra.gov.au/CrossIndustry/Pages/Life-and-General-Insurance-Capital-Review-Consultation-May-2012.aspx

[11] http://www.apra.gov.au/CrossIndustry/Consultations/Pages/LAGIC-Reporting-Requirements-June-2012.aspx

[12] http://www.apra.gov.au/CrossIndustry/Consultations/Documents/120806-letter-to-industry-LAGIC-proposed-changes-to-reporting-standards.pdf

[13] http://apra.gov.au/CrossIndustry/Consultations/Documents/120912_LAGIC_letter_life_insurance_temporary_solvency_standard.pdf

[14] http://www.apra.gov.au/CrossIndustry/Consultations/Pages/LAGIC-Prudential-Practice-Guides-September-2012.aspx

[15] Final versions of the prudential practice guides and information paper will be released in 2013.

[16] http://www.apra.gov.au/CrossIndustry/Pages/Life-and-General-Insurance-Capital-Review-October-2012.aspx

[17] http://www.apra.gov.au/lifs/ReportingFramework/Pages/LAGIC-final-reporting-requirements-LI-October-2012.aspx