Archived - Application of the capital framework for COVID-19 related disruptions frequently asked questions

On and from 31 March 2022, the DCL will be determined by the insurer. This will place onus on the insurer to estimate the liability, manage the risks and ensure this is done prudently. 

As at March 2022, there is two years of data on how COVID-19 has impacted claims, in terms of which claims have returned and which claims are more likely to emerge in the future. APRA has observed that the pandemic has affected each insurer, state and region differently. Accordingly, it is appropriate for each insurer to reflect these differences in the DCL calculation for both the regulatory balance sheet and the Capital Adequacy Requirement.

It is also recognised that techniques have evolved to estimate the claims that are more likely to return. Notably, a greater focus on surgical compared to non-surgical claims for hospital treatment and a greater focus on major dental compared to other claims for general treatment, as well as incorporating timeframes since the procedure was expected. 

APRA will continue to monitor each insurer’s approach to calculating the DCL and may discuss this directly with insurers. Where insurers are unable to demonstrate a prudent approach to managing the DCL, APRA may consider taking further action, including the application of a capital adequacy supervisory adjustment. 

Any insurer still developing its own methodology to value the DCL may elect to continue to use its current approach if it believes this remains appropriate.

An insurer that would prefer to use guidance from APRA to calculate the DCL for the Capital Adequacy Requirement may use the approach outlined below. This can be used if an insurer prefers not to develop its own approach to calculate the DCL for the Capital Adequacy Requirement.

These amounts have been calibrated with input from the Actuaries Institute, discussions with insurers and internal analysis.

APRA expects all insurers will prudently manage the calculation and purpose of the DCL. Prudent management includes, but is not limited to:

• clear documentation of the approach to valuing the DCL; 
• required input from the Appointed Actuary; 
• the use of adverse scenarios;
• alignment to, and compliance with, risk management frameworks;
• an understanding of capital implications; and 
• appropriate board sign-offs. 

APRA may request this documentation to support the supervision of the DCL.

All insurers are expected to provide their APRA supervisor with the following items when their quarterly returns are submitted:

(i)    The DCL amount used in the regulatory returns for the Capital Adequacy Requirement
(ii)    The DCL amount if it was calculated as per the simplified option as outlined in FAQ 2.

APRA also expects insurers that have made commitments not to profit from the impacts of COVID-19 to honour these commitments. Insurers are expected to notify APRA of a decision to provide policyholder relief before it is publicly announced. 

The Public Health Orders in place across New South Wales, Victoria, the Australian Capital Territory during the June and September quarters increase the amount of uncertainty in the valuation and are likely to prolong the period until the DCL is completely run-off. The Public Health Orders and infection rates are also likely to result in more deferred claims for these regions.

APRA has observed the following in claims data up to May 2021, before the current restrictions took effect.

• The catch-up experienced continues to vary significantly by state. States that have been experiencing a stronger catch-up in claims have been less affected by COVID-19, notably Western Australia. 
   
• In March 2021, Western Australia recorded claim rates at 108 per cent of 2019 levels. This gives an insight into possible catch-up in claims when personal risks of seeking medical services are low. It further suggests that there may be capacity for services to be provided at rates materially higher than previous years.
   
• Claiming patterns have not immediately reverted to historic levels after Public Health Orders are lifted. The data shows there is a gradual increase in claims, suggesting it takes time for confidence to be fully restored before policyholders seek medical services. Individuals’ willingness to seek medical procedures will be a key factor in determining when deferred claims will materialise. 
   
• The experience in Victoria over September/December 2020 quarters could provide a useful insight into likely behaviour during the current restrictions.

Those seeking further information on the impact of COVID-19 on PHI may wish to review a recent survey of Private Health Insurance Actuaries published by the Actuaries Institute.

In response to questions from industry and auditors, ASIC has confirmed that:

It would seem appropriate to treat procedures delayed voluntarily by an insured person due to concerns with COVID-19 in the same manner as procedures delayed due to the suspension of non-essential elective surgery. Similar reasoning would apply to that outlined in the relevant paragraph in ASIC COVID-19 financial reporting FAQ 6 (COVID-19 implications for financial reporting and audit: Frequently asked questions (FAQs) | ASIC - Australian Securities and Investments Commission) given that the insured person is aware of the need for a procedure and is likely to continue their cover.

There continues to be significant uncertainty regarding future claiming patterns and the extent of the catch-up in claims. It is therefore appropriate for the cost of all deferred claims due to COVID-19 conditions regardless of the reason to be incorporated into regulatory returns. This is especially appropriate when valuing the liability at a 98 per cent probability of adequacy for the Capital Adequacy Requirement.

For the September 2021 returns and onwards, insurers may continue using their own valuations for the DCL for both the regulatory liabilities and the prudential liabilities. 

Insurers using their own valuation are expected to have a robust process in place and be able to demonstrate the matters outlined in FAQ 8.

Insurers that are unable to implement a robust process or demonstrate the matters outlined in FAQ 8 should continue to use the ‘prescriptive approach’ outlined in FAQ 5.

Due to the ongoing uncertainty of the DCL and limited data available, APRA’s guidance continues to include a constraint on the minimum valuation of the other liability amount for the purpose of the Capital Adequacy Requirement under HPS 110. APRA has updated these constraints to reflect:

• an additional six months of experience 
   
• industry views and observations.

APRA is requesting that the other liability amount should not be less than 90 per cent of the potential deferred claims for hospital treatment and not less than 70 per cent for general treatment – see Table 1. 

APRA considers that this represents the minimum amount necessary to demonstrate a 98 per cent probability of adequacy for the DCL. It would be difficult to justify that a lower amount can provide the same level of adequacy. Insurers proposing a lower value for the other liability amount are requested to contact APRA before submitting regulatory returns.

Given the unprecedented nature of COVID-19 and the impact on health services, APRA wants to ensure that insurers are able to meet the cost of the deferred medical procedures as they arise.

There are no formal constraints on the valuation for the regulatory balance sheet or profit and loss statement. APRA has set expectations on the risk management and governance of the DCL in FAQ 6 and FAQ 8. APRA expects insurers will be prudent in their approach and incorporate the uncertainty involved.

Table 1: Constraints on the value of the DCL

When determining the ‘claims that did not occur’ this should be considered in the context of all claims that affect the insurer. That is: 

• forecast claims incurred from the insurer and amounts forecast to be paid (or received) through Risk Equalisation
   
• compared to claims incurred, before DCL adjustments.

Insurers may use the forecasts deemed most appropriate, provided they have been reviewed by the Appointed Actuary. 

Insurers may continue to use the prescriptive approach as introduced in the June letter and September 2020 FAQs – see Table 2. APRA has updated assumptions for the claims catch-up to use with this approach. This reflects the additional information gained regarding the impact of the pandemic, alongside items mentioned in FAQ 4. APRA encourages insurers adopting this approach to consider the items mentioned in FAQ 1, FAQ 6, FAQ 7 and FAQ 8, to the extent possible.

Under the prescriptive approach, insurers are be expected to continue to accrue a DCL for the Capital Adequacy Requirement at the levels outlined below.

As noted in FAQ 4, the ‘claims that did not occur’ should be considered in the context of all claims that affect the insurer: that is forecast claims incurred and amounts forecast to be paid (or received) through Risk Equalisation. This is equivalent to ‘Total Benefits’ forecast in the premium applications. Insurers may use the forecasts deemed most appropriate, and adjust them for changes in membership and product mix, provided they have been reviewed by the Appointed Actuary. 

For the regulatory balance sheet, insurers will have the option to:

1. continue to accrue the DCL if claims are below the level expected during the selected forecasts; or
    
2. not accrue additional DCL if they consider claims below the level expected during the selected forecasts are not likely to materialise at a later date.

The date which accrual is halted is at the discretion of the insurer, but should be justified by supporting analysis. 

Table 2: Determining the value of the deferred claims liability using APRA’s prescriptive approach

APRA expects all insurers will clearly document their approach to valuing the DCL and any releases. APRA expects this document will be approved by the insurer’s board prior to any releases and before amounts are submitted in regulatory returns.

APRA expects this document will incorporate:

• approvals required for any change to the DCL, specifically including the advice of the Appointed Actuary;
   
• the insurer’s risk appetite, risk management framework and capital management plan, including a scenario where all deferred claims materialise;
   
• the amount of time over which COVID-19 is expected to impact claiming patterns;
   
• how prudence is to be demonstrated, noting the limited data available and that actual claims will not be known for some time;
   
• the matters outlined in FAQ 8, and any other necessary considerations;
   
• the insurer’s approach to any policyholder relief (see FAQ 7); and
   
• the insurer’s approach to informing APRA of the valuation as outlined in FAQ 12.

As outlined in FAQ 1, APRA expects insurers to regularly revalue the DCL as more data materialises and greater confidence builds in its valuation.

APRA recognises that some insurers have made public commitments not to profit from the impacts of COVID-19 and expects insurers to honour these commitments.

APRA expects insurers will conduct business in a prudent way. This extends to any policyholder relief provided. APRA expects that insurers deciding to provide policyholder relief will:

• demonstrate an appreciation for the ongoing uncertainty in the claims landscape (see FAQ 1); 
   
• investigate the impact on performance and capital management;
   
• clearly communicate the relief to be provided, noting the potential for policyholder confusion and reputational risk;
   
• consider the impact on future premium rounds;
   
• have a communication strategy referencing all interested stakeholders; and
   
• any other necessary considerations.

It is expected that insurers will notify APRA where a decision is made to provide policyholder relief. This notification should include the method and amount of the relief. APRA expects relief measures to be considered by the board, taking advice from senior management, the Appointed Actuary and other relevant stakeholders. APRA expects that notification of the decision is provided to APRA before the relief is actioned or announced publicly.

Queries on the mechanisms by which policyholder relief can be provided in compliance with the Private Health Insurance (Complying Product) Rules 2015 and associated legislation should be directed to the Department of Health.

APRA expects insurers will demonstrate a prudent approach in valuing the DCL.

Specifically, APRA expects insurers using their own valuation for the balance sheet liability will demonstrate consideration of: 

• the most recent data available, including claims paid by service month and eligibility checks;
   
• claims that did not occur by category and an estimate of which claims are more likely to be deferred as opposed to cancelled;
   
• experience by state;
   
• potential deferred claims outstanding for members aged over 65; 
   
• the time since medical services were last restricted;
   
• feedback from hospitals and allied health providers on current capacity and usage;
   
• the insurer’s approach to annual limits for general treatment;
   
• the accuracy of forecasting recent claims payments and likely accuracy in the future; and
   
• scenario analysis on the range of ultimate deferred claims amounts and how each scenario would be managed.

Insurers unable to demonstrate these matters may use the prescriptive approach outlined in FAQ 5.

For the purpose of the Capital Adequacy Requirement, APRA expects that insurers will also demonstrate the approach is:

• prudent for APRA reporting;
   
• appropriate for the 98th percentile of the other liability amount in the current environment
   
  • including whether the deferral of medical services due to the pandemic or increased risk of mental health claims would be incorporated in the other liability amount or the stressed net margin estimate;
• assessed by the insurer’s board and Appointed Actuary as appropriate and that they are comfortable the risks are well managed; and
   
• reflective of the constraints in FAQ 4.

Insurers unable to demonstrate these matters, with an explanation acceptable to APRA, may be asked to resubmit their returns. APRA may also consider taking further action, such as applying a capital adequacy supervisory adjustment amount to that insurer. 

This is a decision for each insurer with regards to the regulatory balance sheet. However, for the purpose of the Capital Adequacy Requirement, the answer is ‘yes’ if claims incurred are below the level expected, excluding movements in the DCL. 

This is considered to be prudent as the impacts of COVID-19 remain unclear. From June 2021 to September 2021, Public Health Orders affected many regions of Australia. Some areas also experience the formal restriction of medical services. In addition to preventing some services, the Public Health Orders may deter policyholders from seeking medical treatment that is available. This may result in further deferred claims– see FAQ 1 for insights from data.

In assessing whether the other liability amount in HPS 110 should increase, insurers are requested to compare claims incurred to those in the selected forecasts. As mentioned in FAQ 3, these forecasts can be based on more up-to-date data where available, but only where the forecasting process is comparably robust to that adopted at the premium round. This forecast may include reasonable adjustments for membership volumes and mix. 

APRA’s view is that forecasts considered reasonable by the insurer and Appointed Actuary in November 2020 are within the 98th percentile for claims that may still occur in the future.

APRA’s expectations and guidance regarding the DCL will cease to be required once the environment is more predictable. In March 2021, APRA relaxed the guidance on the DCL for the balance sheet as the environment moves closer to that point. In September 2021, the guidance has been further updated to reflect the developments of the pandemic and its impact on private health insurance claiming patterns.

APRA is taking a prudent approach to valuing the DCL at the 98th percentile for the Capital Adequacy Requirement. The aim is to ensure that funds are able to pay the cost of claims that did not occur. 

The situation and the total quantum of the DCL is being closely monitored. APRA expects to provide a further update in March 2022.

Payment of deferred claims is expected to reduce the liability, as outlined in APRA’s June 2020 letter. 

Insurers are expected to use a similar approach to release the DCL as that used to establish it. That is, the unwind should have regard to the claim payments above those ordinarily expected based on experience in prior periods.

Insurers may adopt their own run-off pattern for the balance sheet DCL provided the insurer demonstrates the analysis, risk management and governance as outlined in these FAQs. 

Insurers may similarly adopt their own run-off pattern for the Capital Adequacy Requirement subject to any constraints at the time. 

For the purposes of forecasts submitted during the premium round, insurers may use their own estimate of the 98th percentile from March 2022 when the current constraints will be reviewed.

In accordance with the requirements of Prudential Standard CPS 320 Actuarial and Related Matters, APRA expects the insurer’s Appointed Actuary to calculate the value of the DCL and provide advice on its release. An insurer must notify APRA if it does not accept the advice of the Appointed Actuary in a material respect.

Only if the insurer adopted their own valuation and is not adopting the prescriptive approach as outlined in FAQ 5. Insurers are expected to provide APRA with a summary of their DCL approach and revised amount on or before the due date of the regulatory returns. 

This notification should include:

• approvals for the adopted valuation process, including that from the board and Appointed Actuary.
   
• a summary of the DCL approach and value adopted for both Capital Adequacy purposes and the Balance Sheet.
   
• a summary of adopted assumptions including estimated percentage of claims to catch-up by hospital and general treatment.
   
• approach to any policyholder relief.

If an insurer intends to adopt a DCL valuation approach or revised DCL amount that does not align with the guidance provided in these FAQs, the notification should be provided as soon as possible. Notification should include supporting documentation on the approach taken and rationale for the deviation (see FAQ 6). 

Where APRA views that a prudent approach has not been adopted, an insurer may be requested to resubmit its returns. APRA may also consider taking further action, such as applying a capital adequacy supervisory adjustment amount to that insurer. 

It is also expected that insurers notify APRA where a decision is made to provide policyholder relief. APRA expects this notification to align with what is described in FAQ 7. This notification should be provided to APRA before the relief is actioned or announced publicly. 

Auditors are expected to assess whether insurers have applied the considerations in FAQ 8 when revaluing the DCL. The application of professional scepticism and professional judgement is expected when testing the DCL and evaluating the results of this testing.

APRA encourages auditors to consider the documentation outlined in FAQ 6 and any additional discussions with key stakeholders who are responsible for its preparation.