Life Insurance (Prudential Rules) Determination No. 7 of 2005: Prudential Rules No. 50 Applying To Life Companies Other Than Friendly Societies
Explanatory Statement
This statement is issued by the authority of the Australian Prudential Regulation Authority (‘APRA’) under:
- Life Insurance Act 1995, subsection 252(1)
Legislative background
Under subsection 252(1) of the Life Insurance Act 1995 (‘the Act’), APRA has the power to determine (in writing) prudential rules prescribing all matters required or permitted by the Act that must be complied with by all life companies registered under the Act. Such prudential rules are ‘legislative instruments’ within the meaning of the Legislative Instruments Act 2003.
Divisions 5 and 6 of Part 4 of the Act provide for the allocation and distribution of profits of the statutory fund. The basis of allocation differentiates operating profit based on the category of business from which it is sourced. Allocation is then to appropriate ‘accounts’ of retained profit which reflect the source of that profit.
The accounts are identified in the Act as:
- Australian policy owners’ retained profits;
- Overseas policy owners’ retained profits;
- Shareholders’ retained profits (Australian participating);
- Shareholders’ retained profits (Overseas and non-participating);
- Shareholders’ capital.
Section 61 of the Act provides APRA with the power to make prudential rules defining the term ‘starting amount’ for a statutory fund in relation to the above five ‘accounts’ for life companies other than friendly societies. The broad intention of setting the starting amounts is to establish a balance in the retained profit/capital pools equal to that which would exist had the Act requirements for allocation of operating profit and distribution of retained earnings been in place from the commencement of the business of the fund.
The Determination
The purpose of Life Insurance (Prudential Rules) Determination No. 7 of 2005 (‘the Determination’) is to make the new Prudential Rules No. 50 (PR 50) for the purposes of subsection 61(1) of the Act. The Determination will take effect upon registration on the Federal Register of Legislative Instruments.
PR 50 specifies how adjustments are to be made to the above ‘accounts’ on first time adoption of IFRS.
Background to the Requirements
Australian reporting entities are adopting Australian equivalents of International Financial Reporting Standards (IFRS) for reporting periods commencing on or after 1 January 2005. The accounting standards are available from the Australian Accounting Standards Board (AASB) website (www.aasb.com.au).
As there will be adjustments to retained profits in general purpose financial statements on first time adoption of IFRS, it is appropriate that equivalent (though not necessarily identical) adjustments be made to the retained profits and shareholders’ capital under the regulatory financial statements. PR 50, have been developed to set out how these adjustments are to be made for regulatory reporting purposes, consistent with the requirements of Divisions 5 and 6 of Part 4 of the Act. PR 50 also provides for a reconciliation of retained profits immediately before first time adoption of IFRS with retained profits following first time adoption of IFRS.
Explanation of Key Requirements
Separate adjustments are required to retained profits of Australian policy owners, overseas policy owners, shareholders (Australian participating) and shareholders (overseas and no-participating), together with shareholders capital in respect of all statutory funds of a life company. PR 50 does not apply to the retained profits in the shareholders’ fund, which will be subject to standard accounting requirements on first time adoption of IFRS.
As the adjustments will be once-off, it is convenient to make adjustments to the starting amount, as defined in Prudential Rules No 27 (PR 27), as this was also, in effect, a once off adjustment to retained profits which is then able to be carried through into subsequent periods. The format and requirements of PR 50 are therefore similar to those of PR 27.
In particular, due to the long and complex history of some statutory funds and the complex business mixes within some statutory funds, it was necessary for some flexibility to be granted in the method for determining starting amounts under PR 27. PR 27 therefore provided, in addition to the prescribed basis for determination of starting amounts, a mechanism whereby the Appointed Actuary could apply to the regulator for approval of starting amounts determined on a basis which differed from the prescribed basis.
A key principle on first time adoption of IFRS is that results should be materially the same as if IFRS had always applied. It is conceivable that, had IFRS applied when starting amounts were originally determined, the outcome of applying the alternative, non-prescriptive basis at that time would have led to a different result. There may therefore be a case for adopting a change to the retained profits and shareholders’ capital which is not the same as simply applying the prescribed allocation of the change in net assets at the current time. PR 50 therefore allows similar flexibility to PR 27 for that case to be made.
The need for PR 50 arose from consultation with industry in relation to proposed changes to Prudential Rules No. 35 (PR 35). Comment was sought from key respondents to that earlier consultation on a draft version of PR 50. However, due to the urgency of its development broader consultation was not undertaken.
Implementation
These new prudential rules will apply at the start of the first financial year of the life company commencing on or after 1 January 2005. The data will be required to be provided to APRA at the same time as the life company provides data in respect of that period under PR 35.
As section 61 of the Act does not apply to friendly societies, PR 50 does not apply to friendly societies.