This is an article I recently wrote for Complinet.
The HIH Royal Commission recommended that Australia develop a framework for the effective supervision of corporate groups that include general insurers.
APRA’s response began with a discussion paper, Prudential supervision of corporate groups involving authorised general insurers, released in May 2005.
After a lengthy consultation process, on 17 December 2008 APRA published four prudential standards:
• GPS 001 Definitions;
• GPS 111 Capital Adequacy: Level 2 Insurance Groups;
• GPS 221 Risk Management: Level 2 Insurance Groups; and
• GPS 311 Audit and Actuarial Reporting and Valuation: Level 2 Insurance Groups.
Until now APRA supervised general insurers on a solo basis only. APRA did not have a framework for supervising general insurers on a group basis.
There was an inconsistency in APRA’s supervision of insurance groups compared to banking groups.
The HIH Royal Commission found that being part of a wider insurance group can alter the risk profile of a stand-alone general insurer. Financial inter-relationships may expose the general insurer to contagion risk from the financial weakness of another entity within the group and mask the true capital position of a general insurer within the group. Management and policy decisions at the group level may influence the type and level of risks assumed at the entity level. Subsidiaries may end up bearing risks beyond those that they would normally assume if they were operating as independent entities.
As has been seen recently with AIG, financial weakness in one part of a group can have adverse consequences for the whole group.
Definitions
The levels at which supervision may apply are:
• Level 1 – APRA’s existing framework, in which supervision is applied to the individual APRA-authorised general insurers (Level 1 insurers) on a stand-alone basis;
• Level 2 – consolidated general insurance groups (Level 2 insurance groups) that incorporate all general insurers, both domestic and international, within the group. The group may be headed by an APRA-authorised insurer (Level 1 insurer) or an APRA-authorised non-operating holding company(NOHC). Level 2 supervision is the subject of the new standards; and
• Level 3 – conglomerate groups involving Australian insurers. This level would encompass the entire conglomerate group headed by an APRA-regulated entity and containing APRA-authorised institutions operating in more than one regulated industry. Level 3 supervision is now being discussed on a cross-industry basis and will be considered separately from the new Level 2 standards.
How the standards will work
The objective of Level 2 general insurance group supervision is to ensure that groups which contain authorised general insurers are financially sound and that group activities and inter-relationships do not adversely affect the financial soundness of those authorised general insurers within the group.
The foundation of APRA’s approach to Level 2 supervision is that general insurance groups should meet essentially the same minimum capital requirements on a consolidated basis as apply to individual authorised general insurers.
Group supervision will be undertaken on a consolidated basis across a Level 2 general insurance group, which will include subsidiaries located outside Australia. It is not APRA’s intention to require overseas subsidiaries of an Australian general insurance group to meet Australian prudential standards on a stand-alone basis.
In assessing the capital adequacy of the group:
• the Minimum Capital Requirement (MCR) of the Level 2 group will be determined using the prescribed approach or via an internal model. Responsibility for capital management will rest with the Board of Directors of the parent entity;
• the capital base will be assessed on a group basis. The effect of intra-group transactions will be assessed at the group level. This may result in capital instruments within entities of the general insurance group which are eligible as capital on a Level 1 assessment being excluded from the capital base of the group as a whole on a Level 2 assessment;
• material subsidiaries operating in other industries, unrelated to the general insurance business, will need to be deconsolidated from the Level 2 general insurance group and their value will be deducted from the Level 2 group’s capital base; and
• APRA will not prescribe where the surplus capital of the group can be held. However, Level 1 general insurers within the group will continue to be required to meet the MCR on an individual basis.
This approach to Level 2 supervision is consistent with that applied to authorised deposit-taking institutions.
A group-wide risk management framework will be required. This will include reinsurance management, business continuity management and policies relating to outsourcing arrangements.
The Level 2 group will need to appoint a Group Auditor and Group Actuary. The Group Auditor may be the Appointed Auditor of any Level 1 insurer within the group or a responsible auditor of the authorised NOHC. The Group Actuary may be the Appointed Actuary of any Level 1 insurer within the group or, where the parent entity is a NOHC, an actuary who is responsible for providing actuarial services to the Board of the NOHC, including reporting to the Board of the NOHC on actuarial matters relating to the group.
Semi-annual reporting will be required based on existing group accounts prepared in accordance with Australian equivalents of International Financial Reporting Standards (AIFRS). Initially reports would need to be submitted to APRA within twelve weeks of each half–year end. The Level 2 group annual accounts, as reported to APRA, will be subject to a limited assurance review by the Group Auditor.
The Insurance Liability Valuation Report (ILVR) prepared by the Group Actuary will need to be submitted within four months of the end of year balance date.
Impact on general insurance groups
Insurance groups indicated to APRA that the primary cost of the implementation of these standards will be to carry out reporting to APRA in a new statistical collection.
There are likely to be additional audit costs incurred by insurance groups. The new actuarial requirement is the preparation of an Insurance Liability Valuation Report (ILVR) on a group basis. This will be a new cost for which they will have to engage either an internal or external Group Actuary.
During consultation, some insurers noted that there was a possibility of dual regulatory requirements being imposed on overseas operations through APRA’s group risk management, fit and proper and governance requirements adding materially to the requirements applied by host regulators of overseas entities.
There is also concern that the new standards may cause Australian insurance groups to be uncompetitive in international insurance markets.
Timetable
The new prudential standards will be effective from 31 March 2009. Level 2 general insurance groups will have to report to APRA for the first time for the half-year ending 30 June 2009.The standards will be reviewed within three years.
Compliance tips
There will be a new set of compliance obligations to monitor. The linkage between the requirements for Level 1 authorised insurers and Level 2 insurance groups and to AIFRS will minimise compliance obligations, other than reporting, as existing management reporting processes can be used for monitoring compliance with APRA’s requirements.
