Australia: APRA keeps insurers on their toes: Refinements to the prudential framework for general insurance discussion paper

The Australian Prudential Regulation Authority (APRA) has released a discussion paper (the paper) entitled Refinements to the prudential framework for general insurance groups identifying 'a small number of areas' where the prudential and reporting framework for general insurance groups domiciled in Australia (Level 2 groups) require refinement.

APRA proposes to align aspects of the reporting framework between Level 2 groups and individual APRA authorised general insurers (Level 1 insurers). The proposals are separate to the proposals relevant to Level 2 groups that were outlined in APRA's March 2011 response to submissions on the review of capital standards for insurers.

APRA's approach

During 2008 and 2009, APRA implemented its prudential framework for Level 2 groups. APRA's approach is focussed on contagion risk, that being the risk that adverse developments in activities conducted by one group member could affect the financial wellbeing of the regulated insurer (or insurers) in the group.

According to the paper, APRA's fundamental objective is:

As such, APRA's approach is to treat the Level 2 group as one economic entity and apply prudential standards to the group, in the same way that they apply to Level 1 insurers.

The prudential standards

The paper includes proposed amendments to the Level 2 group prudential standards. In summary, those proposals are:

• the definition of a Level 2 group: APRA proposes to give itself the ability to capture, as a Level 2 group, legal structures where there is a single Level 1 insurer and other insurance-related entities in Australia (see Draft GPS 001 paragraph 6);
• intra-group transactions: APRA proposes to give itself the ability to request a Level 2 group to report on- and off-balance sheet intra-group transactions (see Draft GPS 111 paragraph 50);
• the Group Actuary: APRA proposes to restrict the Group Actuary from being the Chief Executive or director of any entity within the Level 2 group (see Draft GPS 311 paragraph 9);
• actuarial peer review: APRA proposes to give itself the discretion to have the Group Actuary's advice subjected to peer review (See Draft GPS 311 paragraph 17);
• reinsurance arrangements and governing law requirements: APRA is proposing to require Level 2 groups to deduct from capital any reinsurance assets that do not meet any relevant governing law requirements in a foreign jurisdiction (See Draft GPS 111 paragraph 56); and
• share-based employee remuneration schemes: APRA proposes to amend GPS 111 to ensure that new ordinary shares must be issued under the scheme in order for the reserves to be included in the capital base (See Draft GPS 111 paragraph 14).

The reporting framework

The paper details proposed refinements to the reporting framework for Level 2 groups. APRA's proposals aim to align aspects of the reporting framework for Level 2 groups with the current framework for Level 1 insurers. In summary, those proposals are:

• Deferred reinsurance expense and expected reinsurance recoveries: APRA proposes to implement the Level 1 treatment of reinsurance costs for Level 2 groups (See Draft GPS111 paragraph 40); and
• Bound but not incepted business: As per Level 1 insurers, APRA proposes to require Level 2 groups to hold capital for any material exposure to bound but not yet incepted business, but only in the calculation of capital requirements and not in the income statement or statement of financial position (See GPS 111 paragraph 29).

APRA proposes to make a number of further changes to the reporting framework. The proposed changes include:

• reinsurance assets risk charge to be based on balance sheet reinsurance assets;
• explicit asset items for current tax assets and deferred levies and charges;
• inclusion of commission expense as a separate item on reporting forms;
• inclusion of net incurred claims that is current period net claims expense, replacing the concept of gross and net prior period releases; and
• amounts transferred to reserves, now included with amounts transferred from reserves.

Moving forward

While APRA anticipates that all Level 2 groups will be affected to varying degrees by these proposals, it does not expect the effects to be significant.

However, the proposals relating to deferred reinsurance expense and governing law requirements may raise some issues for insurers.

APRA has released the following timetable of key milestones in the refinement process:

Accompanying the paper are detailed draft prudential standards, reporting forms and reporting instructions which contain the full details of the proposed amendments. APRA is inviting comments on the proposals in the paper. Gadens Lawyers can assist with the preparation of submissions to APRA.

Review the discussion paper here.

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