Who does this affect?

General insurance groups headed by an APRA authorised insurer or an APRA authorised NOHC.

What do you need to do?

Ensure that you are prepared for a 31 March 2009 start.

Author
Ann Newbrun  
Special Counsel

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Philip Ward  
Partner
T +61 2 9296 2213

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Peter Stockdale  
Partner
T +61 2 9296 2330

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On 17 December 2008, APRA released its final Prudential Standards implementing a framework for supervising general insurance groups for a 31 March 2009 commencement.

The Prudential Standards impose requirements largely consistent with those proposed in the consultation drafts released in April 2008. There is greater flexibility and availability of transitional periods of up to 31 December 2009. The implementation date has been pushed back to allow time for any discussions with APRA as to the composition of Level 2 insurance groups and to enable implementation of new internal policies required to meet the new Prudential Standards. Despite the change in the implementation date, Level 2 general insurance groups will have to report to APRA for the first time for the half-year ending 30 June 2009.

Who does this development affect?

The definition of “Level 2 insurance group” is set out in revised Prudential Standard GPS 001. APRA’s approach to consolidation is now aligned with the requirements of AABS 127 for producing consolidated financial statements. A Level 2 general insurance group is a consolidated group of companies, headed by either an APRA authorised general insurer or an APRA authorised non-operating holding company (NOHC), containing general insurance subsidiaries, whether in Australia or overseas, and other controlled entities which are integral to the group’s general insurance business such as insurance intermediaries and service companies.

APRA has not provided a comprehensive list of the types of entities that are to be consolidated. APRA has discretion to determine additional entities be consolidated such as companies linked by common control and conducting business related to general insurance such as entities providing a financing role to the insurance business.

Material subsidiaries which are operating in other industries and not involved with the Level 2 insurance group’s general insurance business are to be treated as non-consolidated subsidiaries.

Reasons for implementing the group supervision

The new prudential framework is focused on minimising contagion risk: the risk that adverse developments and activities conducted by other group members could affect the soundness of the regulated insurer (or insurers) in the group. APRA states that financial inter-relationships may expose a general insurer to contagion risk from the financial weakness of another entity within the group. Intra-group dealings have a potential to mask the true capital position of a general insurer within the group, for example, intra-group transactions may produce notional profits or artificial capital flows that result in changes being recorded to an insurer’s capital base where there has been no substantive contribution to the insurer’s capital.

APRA points out that benefits include access to a greater pool of resources as well as risk diversification and enhanced protection of Australian policyholders.

Under APRA’s Level 2 supervisory regime, Level 1 insurers within the group may be able to take advantage of the group’s capital strengths and its ability to move surplus capital. That is, the Level 2 general insurance group minimum capital requirement (MCR) would represent the capital necessary to support the risks assumed in the group as a whole, without prescription as to where the capital is held. However this benefit will always be subject to Level 1 general insurers maintaining a suitable buffer above their individual MCR.

The new prudential standards

The general insurance group supervision framework introduces three new Prudential Standards:

• GPS 111: Capital adequacy: Level 2 insurance groups
• GPS 221: Risk management: Level 2 insurance groups
• GPS 311: Audit and actuarial reporting and valuation: Level 2 insurance groups.

Impacts

The board of directors of the parent entity of a Level 2 insurance group:

• must ensure that the group maintains a level and quality of capital commensurate with the risks to which the group is exposed (GPS 111), and
• is responsible for meeting all the requirements specified in GPS 221 (see below) and must take a ‘whole-of-business’ approach in ensuring compliance with the prudential standard, including taking into account general insurance business not only in Australia but also overseas.

Overseas subsidiaries and non-insurance companies such as insurance intermediaries and service companies will now need to be considered.

Specifics

Capital adequacy (GPS 111)

In general, Level 2 insurance groups are subject to the same capital adequacy requirements imposed on Level 1 general insurers. Requirements specific to Level 2 insurance groups include:

• APRA may exclude from the Level 2 insurance group’s capital base, capital arising from intra group transactions if APRA takes the view that the capital does not contribute to the group’s financial strength.
• Individual components of capital measured in the capital base of a locally authorised general insurer comprised within the Level 2 insurance group cannot be upgraded to a higher category of capital in the measurement of the group’s capital base.
• Where a non-consolidated subsidiary is undercapitalised, the under-capitalisation must be assessed by the Level 2 insurance group and details must be included in the Level 2 insurance group’s business plan. A capital deduction will only apply where APRA considers the non-consolidated subsidiary to be material.
• Where a Level 2 insurance group proposes any reduction in its capital base, it must obtain APRA’s prior written consent.
• The board of the parent entity of the group must establish policies on group capital adequacy, ensure that appropriate systems and procedures are in place to identify, assess, measure and monitor capital and group risks on a continuous basis, and ensure that the group has sufficient capital freely available to meet unexpected losses and adverse shocks experienced by the group.
• APRA may adjust a Level 2 insurance group’s MCR where it believes that the amount determined does not adequately reflect the risk profile of the group.
• APRA may require a Level 2 insurance group to hold total eligible capital that exceeds the MCR by a specified proportion of the MCR. This approach provides APRA with flexibility to increase a group’s prudential capital buffer if necessary, without immediately having to rely on increasing the group’s MCR. (APRA intends to introduce this requirement for Level 1 insurers in the future.)
• Additional information must be disclosed annually (there is no obligation that the disclosure be made through the annual report) including: the total capital base of the group, MCR of the group, and capital adequacy multiple of the group.

Risk management (GPS 221)

The Risk Management, Reinsurance Management, Outsourcing and Business Continuity Management Prudential Standards apply to Level 2 insurance groups subject to additional or alternative prudential requirements set out in GPS221. Complying with GPS221 can relieve Level 1 insurers of certain prudential requirements. For example, Level 1 insurers will not need to maintain separate business plans where the Business Plan for the Level 2 insurance group includes sufficient detail about them.

The parent entity of the Level 2 insurance group must have an overarching group-wide risk management framework. However, individual locally authorised general insurers in the group will be able to rely on the group’s risk management strategy as long as the group RMS is sufficient to cover the risk management framework of each insurer.

While it must have a Reinsurance Management Strategy (REMS), a Level 2 insurance group is not required to complete a reinsurance declaration. Material levels of reinsurance recoverables from undocumented reinsurance contracts may result in APRA increasing the MCR of the group (April 2008 discussion paper).

Level 2 insurance groups will be required to provide, as part of their risk management declaration, an attestation that each of their overseas subsidiaries comply with local capital requirements.

A Level 2 insurance group may apply to adjust or exclude a specific prudential requirement from applying to a specific entity.

Audit and actuarial reporting and valuation (GPS 311)

A Group Auditor and Group Actuary must be appointed. APRA will not be mandating who the Group Actuary may be, however the Prudential Standard (GPS 311) provides a set of eligibility criteria that the Group Actuary must satisfy in order to be appointed to the role. Fit and proper criteria apply with some specific additional requirements.

Audit and actuarial reporting and valuation requirements apply to Level 2 insurance groups but in certain respects these are less detailed and require less assurance than the requirements for individual locally authorised general insurers within the group.

The Group Actuary's primary role is to provide advice on the valuation of the group's insurance liabilities.

Streamlined reporting requirements have been implemented.

APRA may adjust or exclude a specific requirement from applying to the group.

Next development

APRA is now working on Level 3 group supervision which will apply to conglomerate groups involving authorised Australian insurers and containing one or more APRA authorised institutions operating in more than one regulated industry.