APRA reforms released for public comment

A set of proposals released by Australia's prudential regulator APRA clarifies and modifies its regulation of insurers and reinsurers.

Categories of insurer

APRA would regulate insurers according to what category they fall into.:

Category A: Locally incorporated insurers

Category B: Wholly owned subsidiary of a local or foreign insurer

Category C: Foreign insurer operating as a foreign branch

Category D: Association captive

Category E: Sole parent captive.

Foreign insurers and assets in Australia

One of the most important changes is that to the definition of assets in Australia.

Currently insurers are required to hold assets in Australia that exceed their liabilities in Australia, but assets held by foreign custodians are not considered as assets in Australia. Under the APRA proposals, assets held by foreign sub-custodians will likewise not be considered as assets in Australia.

A related change is that to investment risk charges, which are applied to reinsurance recoverables based on the credit rating of the reinsurer. Currently the charge is the same whether the reinsurer is APRA-authorised or foreign.

APRA proposes a higher investment risk charge on reinsurance recoverables relating to foreign reinsurers. This means that foreign reinsurers will attract a higher investment risk charge than APRA-authorised reinsurers with the same credit rating, in effect making foreign reinsurance more expensive.

Reinsurance - ceding a percentage of gross written premiums

Currently the prudential standards indicate that insurers would typically cede no more than a set amount. APRA will emphasise that the total amount of premium that insurers may cede is not expected to exceed the following:

• Locally incorporated insurers: 60 per cent of gross written premium.
• Wholly owned subsidiary of a local or foreign insurer: 60 per cent of gross written premium.
• Foreign insurer operating as a foreign branch: 60 per cent of gross written premium.
• Association captive: 90 per cent of gross written premium.
• Sole parent captive: 90 per cent of gross written premium.

It has also indicated that some degree of fronting is acceptable "subject to cession limits that will be applied across the insurer’s total portfolio".

Association captives and sole parent captives - new minimum capital adequacy rules

Under APRA's proposals:

• The floor for the calculated risk-based minimum capital requirement will be lowered from $5 million to $2 million
• APRA’s expected buffer over the minimum capital requirement will increase from 20 per cent to 50 per cent when the insurer’s minimum capital requirement is less than $5 million
• The MCR consists of: an investment risk capital charge based on the assets of the insurer; plus an insurance risk capital charge based on the insurance liabilities of an insurer; plus a concentration risk capital charge equal to the maximum event retention of the insurer based on a 1-in-250 year event and the cost of one reinstatement of catastrophe cover.

A sole parent captive will also be allowed to lend funds to its parent or related group companies subject to a limit, which would be the lower of 100 per cent of the total capital base and the current limit that applies based on the credit rating of the related company or companies.

Performance analysis and reporting

APRA wants to be able to get a better handle on an insurer's business so that it can spot business problems earlier. It proposes to modify the reporting framework to:

• simplify the current claims development table including reducing the period of claims development captured from ten years to five years;
• require investment income to be allocated between assets supporting insurance liabilities and other net assets; and
• require premiums for bound but not incepted business to be identified as a separate item.

What's still to come?

APRA is also working on further changes: data collection from DMFs will be addressed in a separate discussion paper to be released later in 2007; and Treasury is developing options for limited exemptions for DOFIs.

What now?

APRA is asking for comments on its proposals by 11 September 2007. It plans to have the new regime in operation by 1 July 2008.