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Letter to industry - Response to submissions: consultation on draft prudential practice guides and information paper

​In September 2012, APRA released for consultation two draft prudential practice guides (PPGs) and a draft information paper to assist APRA-regulated institutions in complying with prudential requirements, and to provide guidance on APRA’s view of good practice. The consultation was split into two packages: one for authorised deposit-taking institutions (ADIs) and the other for general insurers, Level 2 insurance groups and life companies (including friendly societies) (collectively ‘insurers’).

APRA consulted on the following guidance material:

  • draft Prudential Practice Guide CPG 110 Internal Capital Adequacy Assessment Process and  Supervisory  Review  (CPG 110),  applicable  to ADIs  and insurers, which  assists regulated institutions in developing their Internal Capital Adequacy Assessment Process (ICAAP) and understanding APRA’s supervisory review process;
  • draft  Prudential  Practice  Guide  GPG  116  Insurance  Concentration  Risk  (GPG  116) applicable to  general  insurers and  Level  2  insurance  groups,  which assists  these institutions in  complying with prudential requirements in  relation to the Insurance Concentration  Risk  Charge  (ICRC)  and  to  outline prudent practices in relation  to insurance concentration risk; and
  • draft information paper, Asset Risk Charge, applicable to insurers, providing additional information to assist in the calculation of the Asset Risk Charge.

APRA received seven submissions on the consultation package, four from the ADI industry and three from the insurance industry. These submissions predominantly provided commentary on CPG 110. Submissions broadly supported the proposed content of the PPGs and the information paper, noting that the guidance material provided useful information to assist institutions in complying with prudential requirements. Submissions received from both ADIs and insurers requested further information and clarification on certain aspects of the guidance material. This letter sets out APRA’s response to issues raised and details consequential amendments made to the guidance material. Accompanying this response to submissions, and available on APRA’s website, are final versions of CPG 110, GPG 116 and the Asset Risk Charge information paper. This guidance material is effective immediately and replacesany previous guidance material on the relevant topics.

Prudential Practice Guide CPG 110 Internal Capital Adequacy Assessment Process and Supervisory Review (applicable to ADIs and insurers)

Trigger levels and related actions to manage the capital position

Submissions considered that linking trigger levels with related actions to manage the capital position would  lead  to  overly  rigid and  inflexible  capital  management  processes.  As  an alternative,  submissions  suggested  that  a  range  of  actions  be  allowed  in  responding  to particular triggers to accommodate flexible and responsive reactive measures.

APRA maintains that prudent capital management will involve trigger levels and related actions to manage an institution’s capital position. APRA has, however, amended the wording within CPG 110 to allow for sets of potential actions that will vary according to the nature of the stress. Changes to product pricing have also been added to the range of actions that may be available to protect the capital position.

Non-viability trigger event

Submissions also requested that APRA provide guidance on the definition of a non-viability trigger event.

APRA has considered whether it would be helpful to provide broad guidance. However, it is not possible to  define in  advance all  the  circumstances or  factors that  would  lead  to  APRA triggering the non-viability provisions. Consequently, APRA will not, at this time, provide any further guidance in relation to non-viability trigger events.

Strategy for maintaining adequate capital over time (ADI only)

Submissions from ADIs noted that severe stress scenarios would involve circumstances in which losses could be absorbed by the capital conservation buffer and, if it has been applied, the countercyclical capital buffer. Submissions argued that severe stress scenarios need not be considered when ensuring adequate immediate and projected capital coverage under a range of market and economic conditions.

APRA considers it reasonable for a regulated institution to consider severe levels of stress. However, guidance contained in CPG 110 has been included to allow ADIs to take into account both the capital conservation buffer and any countercyclical buffer when evaluating potential severe stress scenarios.

ICAAP report and ICAAP summary statement

A number of submissions considered that the information contained in the ICAAP report and ICAAP summary statement was too detailed to be meaningful to Boards, and recommended that the suggested contents be reviewed.

APRA maintains that the typical level of detail in the ICAAP report and ICAAP summary statement, as specified in CPG 110, would ensure that both documents provide both the Board and APRA with adequate information on a regulated institution’s ICAAP. As a result, there will be no amendments to the suggested content of these documents. APRA has, however, provided an example of how the ICAAP report can include a description of the current regulatory capital instruments.

Supervisory adjustments

Submissions queried the definition of ‘minimally compliant’ with respect to circumstances in which a Pillar 2 supervisory adjustment may be considered, suggesting a regulated institution is either compliant or non-compliant.

APRA has amended CPG 110 to ensure that it captures institutions that are not operating within the spirit or intent of applicable prudential standards.

Target audience for CPG 110

APRA notes that not all of the practices outlined in CPG 110 will be relevant for every regulated institution, and that some aspects may vary depending on the size, complexity and risk profile of the institution. The guidance contained within CPG 110 should be tailored to the individual regulated institution and its particular risk exposures.

Prudential Practice Guide GPG 116 Insurance Concentration Risk (applicable to general insurers and Level 2 insurance groups)

Submissions requested further guidance on the calculation of the premiums liability offset (PL offset). Submissions queried whether future reinsurance costs should be included in the PL offset calculation, noting that doing so introduces an unintended material difference in capital requirements based on reinsurance renewal date.

APRA has clarified that the PL offset includes all components of the central estimate and risk margin, with the exception of future reinsurance costs.

Submissions queried whether the diversified risk margin used to calculate the PL offset could be split between catastrophic and attritional loss components.

APRA affirms its position set out in GPS 116 that the Appointed Actuary does not need to split the risk margin into a catastrophic and attritional loss component. APRA expects that if such a split is made the PL offset would not increase as a result.

Submissions also queried whether an economic downturn should be considered a plausible scenario when calculating the Probable Maximum Loss (PML) component of the other accumulations vertical requirement (OA VR), considering that the impact of an economic downturn may already be captured within other risk charges of the capital framework.

APRA accepts this overlap may be applicable in some circumstances. Therefore, GPG 116 now specifies that where an insurer wishes to adjust or omit a scenario from the determination of the OA VR on this basis, the insurer is expected to demonstrate the rationale for the decision, including discussion of the capital held within its prescribed capital amount for the relevant scenario.

APRA has also clarified the calculation of reinsurance reinstatement costs in Scenario 1 of Attachment 1.

Asset Risk Charge information paper (applicable to insurers)

Submissions requested further information on the practical application of the default stress.

APRA  has  clarified the  treatment of  exchange-traded and  over-the-counter derivatives to ensure that assets of this type are appropriately stressed. APRA has also clarified that any post- stress default risk, while not allowed for in the calculation of the default stress, should be assessed in an insurer’s ICAAP.

APRA has clarified that where derivatives are used for hedging purposes, they can reduce the impact of the asset risk stresses and it has provided information on the preferred treatment of convertible preference shares. APRA has also clarified the recognition of tax benefits for general insurance.

For further information please contact

Yours sincerely

Neil Grummitt, General Manager
Policy Development