The Australian Prudential Regulation Authority (APRA) has finalised its position on the proposed general insurance refinements package following industry consultation.

APRA Member John Trowbridge said: "Some of the submissions raised a number of matters of principle as well as some practical issues which have led APRA to reassess some of the proposals.  As a result, APRA has decided to revise those aspects relating to reinsurance recoverables and investment capital factors." 

Now that APRA has finalised its position, the package will be proceeding for implementation as planned, subject to the revisions released today and a short period of consultation on the related amendments to draft prudential standards.

On 19 December 2007, APRA published its second consultation package on refinements to the general insurance prudential framework.  APRA received a substantial number of submissions from the industry on its proposals in that package, mostly concentrating on the proposals relating to reinsurance recoverables and investment capital factors. 

APRA also sought, on a voluntary basis, data submissions from insurers to assess the quantitative impact of the proposals and responses to a related survey from reinsurance brokers.

APRA had proposed no recognition of reinsurance recoverables from non-APRA authorised reinsurers from the second balance date following claim occurrences, except where the recoverables are supported by security arrangements in Australia.  This proposal was to apply to all future new reinsurance arrangements and, after a transition period, to all recoverables from pre-existing reinsurance arrangements. 

APRA is now intending to apply a risk-based scale to the recognition of these reinsurance recoverables, based on reinsurer ratings, in place of the nil recognition previously proposed.

Further, this approach is to apply to future new reinsurance arrangements but existing arrangements will be 'grandfathered', subject to increased scrutiny by companies of the quality of the recoverables for which they already take credit on their balance sheets.

APRA had also proposed to increase the capital factors for listed equity investments from 8 per cent to 25 per cent, and for direct property and other unlisted investments from 10 per cent to 30 per cent.

APRA has now decided, as an initial step, to increase the factors to 16 per cent and 20 per cent respectively, instead of 25 per cent and 30 per cent, and to consider further changes in 2009.  APRA will also proceed immediately with the ‘look through’ proposal for unit trusts and the recognition of derivative and hedging instruments.

Further details are set out in the attachment 'Revisions to APRA's general insurance refinements package'.  Because there are revisions relating to reinsurance recoverables, their introduction is to be deferred to 31 December 2008. APRA will proceed with all the other proposals in the consultation package, including the revised investment capital factors, with effect from 1 July 2008.

Mr Trowbridge said: “APRA is not expecting insurers to respond to these changes with increases in their levels of capital; the industry is already well capitalised, with aggregate industry capital exceeding twice APRA's current minimum requirements. Nevertheless, we see these proposals as important enhancements to APRA's prudential framework for general insurers, in order to reflect better the risks to which insurers and their policyholders are exposed.”

During April, APRA will release, for a short period of public consultation, drafts of the prudential standards incorporating the revised position.  Only the amendments to those draft standards affected by APRA’s revised position will be subject to consultation. This is intended to give the industry an opportunity for scrutiny of the amended draft prudential standards before they are finalised.  The final standards are scheduled for release in early June 2008, and will be accompanied by a paper responding to the industry submissions.

The attachment 'Revisions to APRA’s general insurance refinements package' can be viewed below and on APRA's website at: http://www.apra.gov.au/General/Other-Information-for-GIs.cfm.

Revisions to APRA's general insurance refinements package

The Australian Prudential Regulation Authority (APRA) has finalised its position on the proposed general insurance refinements package following industry consultation.  Now that APRA has finalised its position, the package will be proceeding for implementation as planned, subject to revisions relating to foreign reinsurance recoverables and investment capital factors for property and equities. 

1.  Foreign reinsurance recoverables

In response to industry submissions, APRA has decided to take an approach to foreign reinsurance recoverables that is more risk-based than previously proposed.

Past reinsurance arrangements will be ‘grandfathered’ so that no reinsurance recoverables arising from reinsurance contracts entered into before 31 December 2008 will be affected.  No additional capital requirements will be applied to such recoverables (other than the credit risk counterparty capital charges). APRA’s previous proposal would have applied a five-year transition period to recoverables in respect of existing reinsurance contracts.

With regard to future reinsurance arrangements, a risk-based scale of capital factors will be applied to unsecured recoverables arising from new reinsurance contracts commencing on or after 31 December 2008. 

After the grace period (i.e. on and after the second balance date after a claim event has occurred) a higher capital factor will apply to unsecured reinsurance recoverables based on the ratings of the reinsurers concerned, as set out in the table below.

These counterparty grades are as set out in Attachment B to Draft Prudential Standard GPS114 Investment Capital Charge.  As an example, using the Standard & Poor’s rating scale, Grade 1 corresponds to AAA rated risks, Grade 2 comprises risks rated from AA+ to AA-, Grade 3 comprises risks rated from A+ to A-, Grade 4 comprises risks rated from BBB+ to BBB- and Grade 5 comprises risks rated BB+ and below.  APRA includes unrated risks in Grade 4.

APRA will have the ability, where a reinsurer does not have an external rating (e.g. intra-group reinsurers) or where APRA has any other reason to make its own assessment, to determine the credit grade against which exposure to that reinsurer should be assessed.  The previous position was that all unrated reinsurers would be treated as Grade 4 counterparties.

Where a recoverable has become a receivable (i.e. it is due and payable) and is overdue for more than six months since a payment request was made to the reinsurer, a 100 per cent capital factor will apply irrespective of the counterparty rating.   

APRAwill introduce, however, additional controls in relation to the assessment of recoverables under both existing and new reinsurance contracts.  APRA will require closer consideration by reinsurance administration and accounting staff within companies, and by both appointed auditors and appointed actuaries, of the quality of all reinsurance recoverables for which credit is being taken on the insurer’s balance sheet.  To give effect to this approach, APRA will expect to see more explicit attestations from the appointed actuary, management and the board as to the value of the insurer’s reinsurance recoverables at each balance date. 

2.  Investment capital factors for property and equities

The capital factors for some classes of investments will be changed from 1 July 2008.  The new factor for listed equities will be 16 per cent compared to 8 per cent currently.  For unlisted equities, direct property and investments classified as 'other', the new factor will be 20 per cent in place of the current 10 per cent. 

As already proposed in December 2007, insurers will be able to treat investments in unit trusts on a 'look through' basis where it is administratively practical to do so and will be able to apply the capital factor for equities to net exposures after allowing for derivative positions.

Industry respondents supported the APRA view that the existing factors of 8 per cent for listed equities and 10 per cent for unlisted equities and property are too low but submitted that APRA's proposed factors of 25 per cent and 30 per cent respectively should not be applied.  APRA will consider further changes to the capital required to be held for equity and property investment risks as part of a wider MCR recalibration project to be undertaken in 2009.

The Australian Prudential Regulation Authority (APRA) is the prudential regulator of the financial services industry. It oversees banks, credit unions, building societies, general insurance and reinsurance companies, life insurance, friendly societies, and most members of the superannuation industry. APRA is funded largely by the industries that it supervises. It was established on 1 July 1998. APRA currently supervises institutions holding approximately $3 trillion in assets for 21 million Australian depositors, policyholders and superannuation fund members.

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