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About this standard
This standard requires a general insurer or level 2 insurance group to maintain adequate capital against risks linked to insurance concentration in its activities. General insurers and level 2 insurance groups must use the prescribed method to calculate the minimum amount of capital to cover these risks.
This standard supports GPS 110 Capital Adequacy, which is a core standard in the Financial Resilience Pillar. It applies to all general insurers and level 2 insurance groups.
Objectives and key requirements of this Prudential Standard
This Prudential Standard requires a general insurer or Level 2 insurance group to maintain adequate capital against the risks associated with insurance concentration in its activities.
The ultimate responsibility for the prudent management of capital of a general insurer or Level 2 insurance group rests with its Board of directors. The Board must ensure that the general insurer or Level 2 insurance group maintains an adequate level and quality of capital commensurate with the scale, nature and complexity of its business and risk profile, such that it is able to meet its obligations under a wide range of circumstances.
The Insurance Concentration Risk Charge is the minimum amount of capital required to be held against insurance concentration risks. The Insurance Concentration Risk Charge relates to the risk of an adverse movement in the general insurer’s or Level 2 insurance group’s capital base due to a single large loss or series of losses.
This Prudential Standard sets out the method for calculating the Insurance Concentration Risk Charge. This charge is one of the components of the Standard Method for calculating the prescribed capital amount for general insurers and Level 2 insurance groups.
Insurance (prudential standard) determination
No. 6 of 2023
Prudential Standard GPS 116 Capital Adequacy: Insurance Concentration Risk Charge
Insurance Act 1973
I, Helen Rowell, a delegate of :
under subsection 32(4) of the Insurance Act 1973 (the Act), revoke Insurance (prudential standard) determination No. 3 of 2022, including Prudential Standard GPS 116 Capital Adequacy: Insurance Concentration Risk Charge, made under that Determination; and
under subsection 32(1) of the Act determine Prudential Standard GPS 116 Capital Adequacy: Insurance Concentration Risk Charge, in the form set out in the Schedule, which applies to:
all general insurers and authorised NOHCs; and
a subsidiary of a or , where that is a of a .
This instrument commences on 1 July 2023.
Dated: 24 May 2023
[Signed]
Helen Rowell
Deputy Chair
Interpretation
In this instrument:
APRA means the Australian Prudential Regulation Authority.
authorised NOHC has the meaning given in section 3 of the Act.
general insurer has the meaning given in section 11 of the Act.
Level 2 insurance group has the meaning given in Prudential Standard GPS 001 Definitions.
parent entity has the meaning given in Prudential Standard GPS 001 Definitions.
subsidiary has the meaning given in Prudential Standard GPS 001 Definitions.
Schedule
Prudential Standard GPS 116 Capital Adequacy: Insurance Concentration Risk Charge, comprises the document commencing on the following page.
Prudential Standard GPS 116
Capital Adequacy: Insurance Concentration Risk Charge
Authority
This Prudential Standard is made under section 32 of the Insurance Act 1973 (the Act).
Application and commencement
This Prudential Standard applies to each:
general insurer authorised under the Act (insurer); and
Level 2 insurance group as defined in Prudential Standard GPS 001 Definitions (GPS 001).
Where a requirement applies to a Level 2 insurance group, the requirement is imposed on the parent entity of the Level 2 insurance group.
This Prudential Standard applies to insurers and Level 2 insurance groups (regulated institutions) from 1 July 2023.
Level 2 insurance groups
Paragraphs 9 to 59 and Attachment A apply to insurers only. The remaining paragraphs apply to all regulated institutions. Attachment B sets out additional requirements for Level 2 insurance groups.
Interpretation
Terms that are defined in GPS 001 appear in bold the first time they are used in this Prudential Standard.
For the purposes of this Prudential Standard:
‘aggregate reinsurance cover’ includes:
aggregate reinsurance cover that protects the regulated institution from an accumulation of retained losses from multiple events of a certain size; and
aggregate stop-loss reinsurance cover that protects the regulated institution from an accumulation of retained losses from multiple events on a part or totality of its portfolio;
‘natural perils’ are all natural events, including, but not limited to, earthquakes, storms and conflagration as well as fire or surge following a natural peril, that affect property risks and other classes of business to which a regulated institution is exposed; and
‘whole-of-portfolio’ is an estimation approach that takes into account all possible perils in all regions to determine the size of loss that could occur from a single event at a certain exceedance probability for a regulated institution’s portfolio. The time horizon to be considered is one year. For clarity, this does not assume that two or more events occur in the same year.
APRA
APRA means the Australian Prudential Regulation Authority.
general insurer
general insurer has the meaning given in section 11 of the Act.
authorised NOHC
authorised NOHC has the meaning given in section 3 of the Act.
subsidiary
subsidiary has the meaning given in Prudential Standard GPS 001 Definitions.
parent entity
parent entity has the meaning given in Prudential Standard GPS 001 Definitions.
Level 2 insurance group
Level 2 insurance group has the meaning given in Prudential Standard GPS 001 Definitions.
Insurance Concentration Risk Charge
This Prudential Standard sets out the method for calculating the Insurance Concentration Risk Charge for a regulated institution using the Standard Method to determine its prescribed capital amount.
The Insurance Concentration Risk Charge for a regulated institution is intended to represent the net financial impact on the regulated institution from either a single large event, or a series of smaller events, within a one year period. The determination of the Insurance Concentration Risk Charge is based on the formulae and requirements set out in this Prudential Standard.
Insurance Concentration Risk Charge formula
The ‘Insurance Concentration Risk Charge’ for an insurer is the greatest of the following amounts:
the vertical requirement determined in accordance with paragraphs 18 to 26;
natural perils
‘natural perils’ are all natural events, including, but not limited to, earthquakes, storms and conflagration as well as fire or surge following a natural peril, that affect property risks and other classes of business to which a regulated institution is exposed; and
the natural perils horizontal requirement determined in accordance with paragraphs 27 to 43;
the other accumulations vertical requirement determined in accordance with paragraphs 44 to 52; and
where applicable, the lenders mortgage insurer concentration risk charge determined in accordance with paragraph 53.
[1]
Only a lenders mortgage insurer must calculate (d). The definition of lenders mortgage insurer in GPS 001 includes a reinsurer that writes lenders mortgage insurance. Therefore, a reinsurer that provides reinsurance on lenders mortgage insurance must calculate (d).
An insurer does not need to calculate amounts for each of sub-paragraphs (a) to (d) above if it is able to demonstrate that the amount determined for one or more of those sub-paragraphs is always expected to be materially lower than the amount determined for one of the other sub-paragraphs.
The Insurance Concentration Risk Charge calculated in paragraph 9 must not be less than zero.
An insurer must not make tax adjustments to the amounts calculated in paragraph 9.
Where there is a change in the insurer’s business (for example, due to a material purchase or sale of a portfolio of business) or reinsurance program (for example, due to material cancellations or additions to reinsurance layers), the insurer must recalculate all applicable components of the Insurance Concentration Risk Charge. The insurer must consult with APRA to determine the approach to recalculate the natural perils horizontal requirement in paragraph 9.
Reinsurance arrangements
In calculating potential reinsurance recoverables in any component of the Insurance Concentration Risk Charge, an insurer may take into account potential reinsurance recoverables receivable from a reinsurance arrangement to which it is a party only if the reinsurance arrangement:
[2]
This includes the determination of reinsurance for lenders mortgage insurance in Attachment A.
complies with the inception date and two month rules imposed under Prudential Standard GPS 230 Reinsurance Management (GPS 230);
fails to comply with those rules as at the date of the relevant deadline, but subsequent to the deadline specified under the two month rule, the reinsurance arrangement is documented in accordance with the requirements of the two month rule; or
has been treated by APRA, under GPS 230, as complying with the two month rule.
In calculating potential reinsurance recoverables in any component of the Insurance Concentration Risk Charge, an insurer may take into account potential reinsurance recoverables receivable from a reinsurance arrangement only if the reinsurance arrangement meets the ‘governing law’ and ‘dispute’ requirements of GPS 230.
[3]
This includes the determination of reinsurance for lenders mortgage insurance in Attachment A.
Subject to paragraph 16, an insurer must have, at the inception date of its catastrophe reinsurance program, a contractually agreed reinstatement, of its catastrophe reinsurance arrangements that reduces its natural perils vertical requirement (determined in accordance with paragraph 18). An insurer with multiple inception dates for its catastrophe reinsurance program must consult with APRA to determine the approach to the relevant inception date in this paragraph.
An insurer that does not have a contractually agreed reinstatement of its catastrophe reinsurance program as required by paragraph 15 must demonstrate to APRA that it is not practical or appropriate given the nature of its reinsurance arrangements. The insurer must set out its approach to the placement of reinstatement of cover in its Reinsurance Management Strategy (ReMS). If APRA is not satisfied with the approach taken by the insurer, APRA may apply a supervisory adjustment to the prescribed capital amount in accordance with paragraph 35 of Prudential Standard GPS 110 Capital Adequacy (GPS 110).
[4]
For the purposes of this requirement, reinsurance from the Australian Reinsurance Pool Corporation can be treated as having a contractually agreed reinstatement.
During the period of the catastrophe reinsurance program, an insurer must review and consider the adequacy of reinstatements of all or parts of its reinsurance program, including the requirements of paragraph 16. This review must also consider the financial and operational implications of not having a sufficient number of contractually agreed reinstatements during the period of cover. Details of this review must be included in the insurer’s ReMS and Internal Capital Adequacy Assessment Process (ICAAP).
Natural perils vertical requirement
The natural perils vertical requirement (NP VR) for an insurer that has exposures to natural perils is calculated as:
the greater of:
‘NP PML’ defined in paragraph 21 less ‘NP reinsurance recoverables’ defined in paragraph 22; and
the ‘net loss’ defined in paragraph 23;
whole-of-portfolio
‘whole-of-portfolio’ is an estimation approach that takes into account all possible perils in all regions to determine the size of loss that could occur from a single event at a certain exceedance probability for a regulated institution’s portfolio. The time horizon to be considered is one year. For clarity, this does not assume that two or more events occur in the same year.
less
‘NP reinstatement premiums’ defined in paragraph 24; plus
‘NP reinstatement cost’ defined in paragraph 25; less
any other adjustments to NP VR in accordance with paragraph 26.
An insurer does not need to calculate amounts for sub-paragraphs 18(a)(i) and 18(a)(ii) if it is able to demonstrate that one of these amounts is expected to be materially lower than the amount determined for the other.
Subject to paragraphs 9 and 12, NP VR must be calculated and reported to APRA as at each reporting date. The calculation of NP VR, at a reporting date, must take into account the reinsurance program in place for the next reporting period. The NP VR calculation at each reporting date must only include potential reinsurance recoverables that were contractually agreed on or before the reporting date.
An insurer must regularly monitor the level of NP VR during the reporting period, including determining the impact of a catastrophic event. Where an event occurs during the reporting period, the insurer must determine the impact of that event on the level of the NP VR. Any changes made to the NP VR as a result of the catastrophic event are then to be applied until the end of the current reinsurance treaty or the occurrence of another event that impacts the NP VR, whichever occurs first.
NP PML
An insurer that has exposures to natural perils must determine a Probable Maximum Loss (PML) for its portfolio (NP PML). NP PML is the gross loss arising from the occurrence of a single event, where that loss is not less than the whole-of-portfolio annual loss with a 0.5 per cent probability of occurrence. NP PML must not include any allowance for potential reinsurance recoverables. The calculation of NP PML must include:
the impact of the event on all classes of business of the insurer;
an allowance for non-modelled perils; and
[5]
Where certain perils are material to an insurer but not included in its computer-based modelling techniques, an allowance for losses in respect of these perils would need to be estimated and added to the NP PML.
potential growth in the insurer’s portfolio.
NP reinsurance recoverables
An insurer that has exposures to natural perils must determine the level of potential reinsurance recoverables should there be the occurrence of the event that gives rise to NP PML (NP reinsurance recoverables). NP reinsurance recoverables must not include any amounts due from .
aggregate reinsurance cover
‘aggregate reinsurance cover’ includes:
aggregate reinsurance cover that protects the regulated institution from an accumulation of retained losses from multiple events of a certain size; and
aggregate stop-loss reinsurance cover that protects the regulated institution from an accumulation of retained losses from multiple events on a part or totality of its portfolio;
Net whole-of-portfolio loss
An insurer that has exposures to natural perils must determine the net loss arising from the occurrence of a single event, where that net loss is not less than the whole-of-portfolio annual net loss with a 0.5 per cent probability of occurrence (net whole-of-portfolio loss).
[6]
The net loss is the gross loss less potential reinsurance recoverables.
NP reinstatement premiums
An insurer that writes reinsurance may receive inwards reinstatement premiums from cedants as a result of the event that gives rise to its NP PML or the net whole-of-portfolio loss determined in paragraph 23, as appropriate (NP reinstatement premiums). NP reinstatement premiums must only be included in NP VR if the reinsurance contract specifically stipulates that offsetting with the cedant will occur at the time of the payment of the reinsurance claim.
NP reinstatement cost
An insurer that has exposures to natural perils must determine the cost (if any) of reinstating all catastrophe reinsurance cover relating to the reinsurance recoverables determined in paragraph 22 or paragraph 23, as appropriate (NP reinstatement cost). In determining this cost, if the insurer does not have contractually agreed rates for the reinsurance cover, the insurer must estimate the cost based on current reinsurance market conditions. The amount must not be less than the full original cost of the cover with no deduction for the expiry of time since the inception of the reinsurance arrangements, unless the insurer is able to demonstrate to APRA that the amount materially overstates the cost that would prevail.
Other adjustments to NP VR
An insurer may apply to APRA to recognise potential reinsurance recoverables from aggregate reinsurance cover. Aggregate reinsurance cover is eligible to be considered for inclusion in the NP VR once the aggregate reinsurance cover has reached its attachment point, or will as a result of the occurrence of NP PML or net whole of portfolio loss, as appropriate. The reinsurance recoverables from aggregate reinsurance cover must then be applied up until the cover has been exhausted by claims by the insurer or the date that the aggregate reinsurance treaty expires, whichever occurs first. The reinsurance arrangements must meet the requirements of paragraphs 13 and 14 to be considered under this paragraph. The insurer must agree with APRA a methodology for the determination of the adjustment that may be made for this type of reinsurance arrangement.
Natural perils horizontal requirements
The natural perils horizontal requirement (NP HR) for an insurer that has exposures to natural perils is calculated as:
the greater of ‘H3 requirement’ and ‘H4 requirement’ defined in paragraphs 29 and 36, respectively; less
‘PL offset’ (if any) defined in paragraph 43.
An insurer does not need to calculate both H3 requirement and H4 requirement if it is able to demonstrate that one of these amounts is expected to be materially lower than the amount determined for the other.
Subject to paragraphs 9 and 12, NP HR must be calculated at the reporting date on or prior to the inception date of the insurer’s catastrophe reinsurance program and then held constant for the remaining duration of the catastrophe reinsurance program. If the catastrophe reinsurance program of an insurer has multiple inception dates, the insurer must agree with APRA the reporting date that will apply to the calculation of NP HR. The NP HR calculation must only include potential reinsurance recoverables that were contractually agreed on or before the relevant reporting date.
[7]
The first reporting period after the effective date of this Prudential Standard may be part way through the catastrophe reinsurance program treaty year. If this is the case, the insurer must determine NP HR as if the requirement to determine NP HR applied at the inception date of the catastrophe reinsurance program (ignoring any events that may have occurred between the inception date of the current catastrophe reinsurance program and the effective date of this Prudential Standard).
H3 requirement
The H3 requirement is calculated as:
the greater of:
three times the ‘H3 loss’ defined in paragraph 30 less ‘H3 reinsurance recoverables’ defined in paragraph 31; and
three times the ‘net H3 loss’ defined in paragraph 32;
less
‘H3 aggregate offset’ defined in paragraph 33; less
‘H3 reinstatement premiums’ defined in paragraph 34; plus
‘H3 reinstatement cost’ defined in paragraph 35.
An insurer does not need to calculate amounts for sub-paragraphs 29(a)(i) and 29(a)(ii) if it is able to demonstrate that one of these amounts is expected to be materially lower than the amount determined for the other.
An insurer that has exposures to natural perils must determine the gross loss arising from the occurrence of a single event, where that loss is not less than the whole-of-portfolio annual loss with a 10 per cent probability of occurrence (H3 loss). This amount must not include any allowance for potential reinsurance recoverables. The calculation of H3 loss must include:
the impact of the event on all classes of business of the insurer;
an allowance for non-modelled perils; and
[8]
Where certain perils are material to an insurer but not included in its computer-based modelling techniques, an allowance for losses in respect of these perils would need to be estimated and added to the H3 loss.
potential growth in the insurer’s portfolio.
An insurer that has exposures to natural perils must determine the level of potential reinsurance recoverables should there be the occurrence of three H3 losses over the catastrophe reinsurance program treaty year (H3 reinsurance recoverables). The reinsurance recoverables must not include any amounts due from aggregate reinsurance cover as this is provided for under paragraph 33.
An insurer that has exposures to natural perils must determine the net loss arising from the occurrence of a single event, where that net loss is not less than the whole-of-portfolio annual net loss with a 10 per cent probability of occurrence (net H3 loss).
[9]
The net loss is the gross loss less potential reinsurance recoverables.
An insurer may reduce its H3 requirement for potential reinsurance recoverables from aggregate reinsurance cover (H3 aggregate offset). The insurer must not allow for any reinstatements of aggregate reinsurance cover unless these have been contractually agreed with the reinsurer(s). If reinstatements are included, the cost of reinstatement must be netted from the offset. The insurer must agree with APRA a methodology for the determination of this adjustment. This methodology may allow for any portion of paid and outstanding claims and premiums liabilities that contribute to the insurer’s retained losses for the purposes of the retention on any aggregate reinsurance cover, provided it does not result in a double-count between this offset and the PL offset determined in accordance with paragraph 43.
An insurer that writes reinsurance may receive inwards reinstatement premiums from cedants as a result of the events that give rise to three H3 losses or three net H3 losses, as appropriate (H3 reinstatement premiums). H3 reinstatement premiums must only be included in the H3 requirement if the reinsurance contract specifically stipulates that offsetting with the cedant will occur at the time of the payment of the reinsurance claim.
An insurer that has exposures to natural perils must determine the cost (if any) of reinstating catastrophe reinsurance cover after the occurrence of the first two H3 losses or the first two net H3 losses, as appropriate (H3 reinstatement cost). The cost (if any) must reflect the cost of reinstating reinsurance cover up to the size of the third event. In determining this cost, if the insurer does not have contractually agreed rates for the reinsurance cover, the insurer must estimate the cost based on the reinsurance market conditions that would prevail after the occurrence of the events. The amount must not be less than the full original cost of the cover, with no deduction for the expiry of time since the inception of the reinsurance arrangements, unless the insurer is able to demonstrate to APRA that the amount materially overstates the cost that would prevail in the market after the occurrence of the events.
H4 requirement
The H4 requirement is calculated as:
the greater of:
four times ‘H4 loss’ defined in paragraph 37 less ‘H4 reinsurance recoverables’ defined in paragraph 38; and
four times the net ‘H4 loss’ defined in paragraph 39;
less
‘H4 aggregate offset’ defined in paragraph 40; less
‘H4 reinstatement premiums’ defined in paragraph 41; plus
‘H4 reinstatement cost’ defined in paragraph 42.
An insurer does not need to calculate amounts for sub-paragraphs 36(a)(i) and 36(a)(ii) if it is able to demonstrate that one of these amounts is expected to be materially higher than the amount determined for the other.
An insurer that has exposures to natural perils must determine the gross loss arising from the occurrence of a single event, where that loss is not less than the whole-of-portfolio annual loss with a 16.7 per cent probability of occurrence (H4 loss). This amount must not include any allowance for potential reinsurance recoverables. The calculation of H4 loss must include:
the impact of the event on all classes of business of the insurer;
an allowance for non-modelled perils; and
[10]
Where certain perils are material to an insurer but not included in its computer-based modelling techniques, an allowance for losses in respect of these perils would need to be estimated and added to the H4 loss.
potential growth in the insurer’s portfolio.
An insurer that has exposures to natural perils must determine the level of potential reinsurance recoverables should there be the occurrence of four H4 losses over the catastrophe reinsurance program treaty year (H4 reinsurance recoverables). The reinsurance recoverables must not include any amounts due from aggregate reinsurance cover as this is provided for under paragraph 40.
An insurer that has exposures to natural perils must determine the net loss arising from the occurrence of a single event, where that net loss is not less than the whole-of-portfolio annual net loss with a 16.7 per cent probability of occurrence (net H4 loss).
[11]
The net loss is the gross loss less potential reinsurance recoverables.
An insurer may reduce its H4 requirement for potential reinsurance recoverables from aggregate reinsurance cover (H4 aggregate offset). The insurer must not allow for any reinstatements of aggregate reinsurance cover unless these have been contractually agreed with the reinsurer(s). If reinstatements are included, the cost of reinstatement must be netted from the offset. The insurer must agree with APRA a methodology for the determination of this adjustment. This methodology may allow for any portion of paid and outstanding claims and premiums liabilities that contribute to the insurer’s retained losses for the purposes of the retention on any aggregate reinsurance cover, provided it does not result in a double-count between this offset and the PL offset determined in accordance with paragraph 43.
An insurer that writes reinsurance may receive inwards reinstatement premiums from cedants as a result of the event that gives rise to four H4 losses or four net H4 losses, as appropriate (H4 reinstatement premiums). H4 reinstatement premiums must only be included in the H4 requirement if the reinsurance contract specifically stipulates that offsetting with the cedant will occur at the time of the payment of the reinsurance claim.
An insurer that has exposures to natural perils must determine the cost (if any) of reinstating catastrophe reinsurance cover after the occurrence of the first three H4 losses or the first three net H4 losses, as appropriate (H4 reinstatement cost). The cost (if any) must reflect the cost of reinstating reinsurance cover up to the size of the fourth event. In determining this cost, if the insurer does not have contractually agreed rates for the reinsurance cover, the insurer must estimate the cost based on the reinsurance market conditions that would prevail after the occurrence of the events. The amount must not be less than the full original cost of the cover, with no deduction for the expiry of time since the inception of the reinsurance arrangements, unless the insurer is able to demonstrate to APRA that the amount materially overstates the cost that would prevail in the market after the occurrence of the events.
PL offset
The Appointed Actuary of the insurer must determine the portion of the net premiums liability provision which relates to catastrophic losses (PL offset). PL offset by class of business is determined by:
[12]
Catastrophic losses are those that give rise to a relatively significant number of claims and occur no more frequently than every three months. The Appointed Actuary needs to consider historical data over an appropriate period of time.
calculating the amount of the insurer’s net premiums liability central estimate provision that relates to catastrophic losses;
[13]
Net premiums liability central estimate provision will be determined in accordance with Prudential Standard GPS 340 Insurance Liability Valuation (GPS 340).
annualising the amount from sub-paragraph (a);
adding the diversified risk margin to the amount from sub-paragraph (b); and
[14]
The diversified risk margin will already be determined in accordance with GPS 340 and does not need to be split into a catastrophic and attritional loss component. The diversified risk margin will be a dollar amount determined by applying the percentage risk margin to the amount determined in sub-paragraph (b).
adding the Premiums Liability Risk Charge to the amount from sub-paragraph (c).
[15]
The Premiums Liability Risk Charge will be the prescribed ‘Premiums Liability Risk Capital Factor’ for that class of business from Prudential Standard GPS 115 Capital Adequacy: Insurance Risk Charge multiplied by the amount determined in sub-paragraph (c).
The Appointed Actuary must then sum the outcomes from sub-paragraph (d) by class of business to determine the total PL offset. The Appointed Actuary must provide this determination to the insurer in a timely manner that allows the insurer to lodge reporting forms to APRA within the timeframes specified by the Reporting Standards made under the Financial Sector (Collection of Data) Act 2001. The Appointed Actuary must include details of the determination of the PL offset for the reporting year and the estimated PL offset to be utilised in the upcoming year in the Actuarial Valuation Report (AVR).
Other accumulations vertical requirement
The other accumulations vertical requirement (OA VR) for an insurer that has exposures to other accumulations is calculated as:
‘OA PML’ defined in paragraphs 47 and 48; less
‘OA reinsurance recoverables’ defined in paragraph 49; plus
‘OA reinstatement cost’ defined in paragraph 52.
An insurer must regularly monitor the level of its OA VR, including determining the impact of the occurrence of an event. Where an event occurs during the reporting period, the insurer must determine the impact of that event on the level of OA VR. Any changes made to the OA VR as a result of the event are then to be applied until the end of the current reinsurance treaty or the occurrence of another event that impacts OA VR, whichever occurs first.
Subject to paragraphs 9 and 12, OA VR must be calculated and reported to APRA at each reporting date. The calculation of OA VR, at the reporting date, must take into account the reinsurance program in place for the next reporting period. The OA VR calculation at each reporting date must only include potential reinsurance recoverables that were contractually agreed on or before the reporting date.
OA PML
An insurer that has exposures to accumulations of losses arising from a common dependent source or non-natural perils (other accumulations) must determine a PML for its portfolio (OA PML). OA PML is the gross loss arising from the occurrence of a single event, where that loss has 0.5 per cent probability of occurrence over 12 months. An insurer must consider all classes of business and all business underwritten in those classes in determining the largest loss. OA PML must not include any allowance for potential reinsurance recoverables.
[16]
The determination of OA PML must consider the nature of products provided, losses that may lead to an aggregation of multiple per-risk or per-policy losses arising from a common dependent source, the potential for multiple classes of insurance and/or portfolios to be impacted from this common dependent source and whether the upper limit of reinsurance cover purchased is sufficiently high to cover the OA PML.
An insurer that has exposures to other accumulations may reduce OA PML for any losses within the other accumulations scenario that are already specifically allowed for in the premiums liability of the insurer. This amount must be determined by the Appointed Actuary and included in the AVR. APRA may require the insurer to modify the adjustment to OA PML.
[17]
‘Premiums liability’ is determined in accordance with GPS 340.
OA reinsurance recoverables
An insurer that has exposures to other accumulations must determine the level of potential reinsurance recoverables should there be the occurrence of OA PML (OA reinsurance recoverables). OA reinsurance recoverables may include any amounts due from aggregate reinsurance cover if the cover has reached its attachment point, or will as a result of the occurrence of OA PML. The reinsurance recoverables must then be applied up until the cover has been exhausted by claims by the insurer or the date that the aggregate reinsurance treaty expires, whichever occurs first.
[18]
For the purposes of this paragraph, ‘potential reinsurance recoverables’ include reinsurance assets receivable from the Commonwealth Government in respect of:
a high cost claim indemnity as defined under the Medical Indemnity Act 2002 (Medical Indemnity Act); and
amounts payable under the High Cost Claims Protocol as defined under the Medical Indemnity Act.
[19]
The attachment point in this calculation may allow for any portion of paid and outstanding claims and premiums liabilities that contribute to the retained losses. APRA may require the insurer to modify the adjustment made in accordance with this paragraph.
An insurer may discount the retention on any aggregate reinsurance cover for the time value of money if the retention is fixed and not indexed for inflation. The discount period must not be greater than the average period of discount in determining the premiums liability provision. The discount rate must be the relevant risk-free discount rates used by the Appointed Actuary in the AVR.
An insurer must only apply the premiums liability adjustment in paragraph 48 or paragraph 49. The insurer must not apply the adjustment from both paragraphs 48 or 49 as this will result in the premiums liability provisions being deducted twice.
OA reinstatement cost
An insurer that has exposures to other accumulations must determine the cost (if any) of reinstating all catastrophe reinsurance cover relating to the reinsurance recoverables determined in paragraph 49 (OA reinstatement cost). In determining this cost, if the insurer does not have contractually agreed rates for the reinsurance cover, the insurer must estimate the cost based on current reinsurance market conditions. The amount must not be less than the full original cost of the cover, with no deduction for the expiry of time since the inception of the reinsurance arrangements, unless the insurer is able to demonstrate to APRA that the amount materially overstates the cost that would prevail.
Lenders mortgage insurer concentration risk charge
A lenders mortgage insurer must determine the lenders mortgage insurer concentration risk charge (LMICRC) by applying Attachment A.
Use of alternative capital and risk mitigants
If an insurer is considering the use of protections including alternative capital or risk mitigants to reduce the Insurance Concentration Risk Charge, the insurer must apply to APRA for approval to include that mitigant in the calculation of the Insurance Concentration Risk Charge. This includes, but is not limited to, the use of securitisation and catastrophe bonds.
Catastrophe models
It is common practice for an insurer to use computer-based modelling techniques, developed either in-house or by external providers, to estimate likely losses under different catastrophe scenarios. If an insurer uses such a model, the model must be conceptually sound and capable of consistently producing realistic calculations. An insurer must be able to demonstrate:
that the model has been researched and tested;
that the insurer has taken measures to ensure that the data used to estimate its losses is sufficiently consistent, accurate and complete, and there is appropriate documentation of any estimates of data used; and
an understanding of the model used in estimating losses, including;
perils and elements that are not included in the model;
assumptions and any estimates used in the modelling process; and
the sensitivity of the model outputs as a result of the factors in (i) and (ii).
Review and reporting
An insurer must document in its ReMS the process and methodologies for setting and monitoring its Insurance Concentration Risk Charge. This must also include justification for any adjustments or assumptions made, such as all allowances made for aggregate reinsurance cover and adjustments to OA VR. GPS 230 sets out further details on this requirement.
In addition to the requirements of paragraph 56, an insurer that writes lenders mortgage insurance business must outline in its ReMS how it manages the exposures and mitigants in place for the risk in relation to future placement of reinsurance arrangements.
The Appointed Actuary of an insurer must review and comment on the adequacy of the calculation of the Insurance Concentration Risk Charge as part of the Financial Condition Report. For an insurer that has other accumulations exposures, the Appointed Actuary must consider the impact on the Insurance Concentration Risk Charge of the occurrence of multiple events in a year.
An insurer must inform APRA within 20 business days of any material changes to its Insurance Concentration Risk Charge that results from any changes in its ReMS, risk profile, classes of business underwritten or reinsurance program.
Adjustments and exclusions
APRA may, by notice in writing to a regulated institution, adjust or exclude a specific requirement in this Prudential Standard in relation to that regulated institution.
Previous exercise of discretion
A regulated institution must contact APRA if it seeks to place reliance, for the purposes of complying with this Prudential Standard, on a previous exemption or other exercise of discretion made by APRA under a previous version of this Prudential Standard.
Attachment A – Lenders mortgage insurer concentration risk charge
This Attachment applies to a lenders mortgage insurer (LMI) for the purposes of determining the lenders mortgage insurer concentration risk charge (LMICRC).
For the purposes of this Attachment:
‘Loans’ are loans secured by an insured mortgage over residential or other property;
‘Sum insured’ is the original exposure amount for an LMI as stated in the mortgage insurance policy;
‘Loan-to-Valuation Ratio’ (LVR) is the ratio of the amount of the loan to the value of the secured residential property, as at the date of origination of the loan. Where the mortgage insurance premium is capitalised in the loan amount, the LVR must be calculated including the premium; that is, the loan amount must be increased by the amount of the capitalised premium, irrespective of whether the premium is insured. The inclusion of a First Home Owners Grant in the deposit for a mortgaged property will not otherwise increase the LVR of a loan;
‘Probability of default’ (PD) is the risk of default by the borrower;
‘Loss given default’ (LGD) is the loss to the LMI upon default by the borrower;
‘Age’ is the length of time from the date of origination of the loan to the date of calculation for the purposes of determining the seasoning factors in Table A of this Attachment;
A ‘standard loan’ is a loan predominantly secured by residential property and meets the following criteria:
the LMI or lender has formally verified the borrower’s income and employment; and
the borrower passes standard credit checks and income requirements as documented in the LMI or lender’s underwriting or credit policies and procedures;
A ‘non-standard loan’ is a loan predominantly secured by residential property which does not meet the criteria in paragraph 2(g) of this Attachment;
A ‘commercial loan’ is a loan that is not predominantly secured by a registered mortgage over residential property;
‘Coverage type’ refers to whether the ‘LMI policy’ of insurance provided is for 100 per cent of the loan or pool amount, or less than 100 per cent of the loan amount or pool amount. The latter is referred to as top cover for ‘individual LMI policies’ and partial cover for ‘pooled LMI policies’;
‘Individual LMI policy’ is lenders mortgage insurance underwritten and issued in respect of an individual loan. Bulk and/or tranche transactions associated with securitisations, where each loan is individually insured, falls into this category;
‘Pooled LMI policy’ is lenders mortgage insurance underwritten and issued in respect of a pool of loans. For clarity, each loan is not individually insured;
‘Premiums liability’ is calculated in accordance with Prudential Standard GPS 340 Insurance Liability Valuation (GPS 340). ‘Net premiums liability’ is the premiums liability after netting of reinsurance recoverables and non-reinsurance recoveries. Net premiums liability is also calculated in accordance with GPS 340; and
‘Outstanding claims liabilities’ are as calculated in accordance with GPS 340.
PML and Prescribed Stress Scenario
For the purpose of this Attachment, the ‘Probable Maximum Loss’ (PML) is assumed to arise from a catastrophic event such that the size of loss from the three year event is equal to a loss with a 0.5 per cent probability of occurrence. APRA requires the PML to be determined on the basis of a Prescribed Stress Scenario as defined in paragraph 4 of this Attachment.