More reporting and supervision on the way for insurers

Following industry submissions and consultation, APRA's follow-up to its 2003 discussion paper "Prudential Supervision of General Insurance - Stage 2 Reforms" has now been released. A discussion paper and draft prudential standards for general insurers set out new requirements, including an increased reporting regime and a crackdown on non-risk transfer arrangements.

Comments must be in by 5 August, and the new standards would come into operation in January 2006.

Reinsurance arrangements and documentation

Here and internationally, reinsurance arrangements are under scrutiny by regulators to ensure that real risk transfer has occurred. APRA's approach has changed somewhat from the 2003 paper.

Insurers would still be required to provide an annual Reinsurance Management Strategy, including a Reinsurance Arrangements Statement to help APRA assess the adequacy of those arrangements. The two month notification period for reinsurance arrangements has however been altered. Verification would now be in two stages:

• two months after the arrangements have taken effect, the insurer must declare that the reinsurance has been fully placed and that it holds the final contract wording of the reinsurance arrangements as detailed in the Reinsurance Arrangements Statement previously lodged with APRA, or a detailed placing slip, a slip wording or cover note (conditions attach to the use of a placing slip or cover note)
• within six months of inception, the insurer would have to attest that it holds the final signed contracts relating to all its reinsurance arrangements.

There is a practical effect to non-compliance; reinsurance recoveries cannot be used when calculating minimum capital requirements unless the reinsurance contract has been fully documented.

APRA also identified non-risk transfer arrangements as requiring clearer regulation. It previously proposed the inclusion of these arrangements in the annual Reinsurance Management Strategy. It has now significantly gone beyond this proposal. The discussion paper suggests adopting a broad definition of "limited risk transfer arrangements" which would focus on whether:

• the insurer may realise a significant loss from the arrangements
• there is a significant range of possible adverse outcomes negated under the arrangements, or
• there are requirements placed on the insurer to mitigate losses experienced by the reinsurer.

Insurers could only enter into these arrangements with APRA's approval, and they will be treated as reinsurance only if there is a material transfer of risk.

Audits, actuarial arrangements, and the new Financial Condition Report

Approved Auditors' role is unchanged, but a new standard expands some of the requirements, including the manner in which annual audit reports are to be prepared. The 2003 suggestion that they be rotated has been dropped, as has the ban on in-house actuaries being appointed as the Approved Actuary.

Approved Actuaries will be required to produce a Financial Condition Report, which must include general background information about the insurer, recent experience, key points of the Liability Valuation Report, an assessment of the insurer's asset and liability management, capital management and capital adequacy, premium adequacy and reinsurance arrangements.

Risk management

APRA wants annually:

• a Financial Information Declaration by the CEO and Chief Financial Officer, stating that the financial information given to APRA has been prepared in accordance with all relevant laws, and that the information provided to APRA, the Approved Auditor and Approved Actuary is correct
• more detailed three year business plans, detailing the existing and proposed activities, locations and staff, and financial projects.

Rationalising the paperwork

In 2003 APRA proposed that insurers should provide a Capital Management Plan every year, but it has now eliminated this. Instead, insurers' approaches to capital management should be dealt with in their Business Plan and Risk Management Strategy.

Although the obligation to provide an annual Liability Valuation Report still exists, APRA will accept it folded into the new Financial Condition Report.

Outsourcing

Outsourcing must still be formalised in written agreements, but the new prudential standard would also require those arrangements to detail service levels, performance requirements, default arrangements and termination provisions, and pricing and fee structures.

Details would have to provided to APRA within three months of the new standard's coming into operation, and APRA notified of any changes within 20 business days. Insurers would also be required to develop an outsourcing policy as part of their risk management frameworks.

The compliance perspective

APRA appears to have listened to industry concerns and some of the proposals in this paper are less prescriptive and more flexible than APRA's original proposals set out in 2003 discussion paper.

Nevertheless, the stated purpose of the proposed reforms remains the same. It is to strengthen the prudential supervision framework for general insurance. As a result, in general terms, the reforms are likely to increase the overall compliance burden on the industry.

Coming up next

The drafts are an attempt to balance clear regulation with a realistic compliance burden, but important additional standards are yet to be developed. APRA is expected to release details of its approach to governance, disclosure and capital issues later this year, with the new regime in place by mid-2006.