APRA releases latest round of reforms

Following its last package of refinements to the general insurance prudential framework on 31 July, APRA has released another set of reforms, including some responses to submissions on the last package. In this Alert we'll concentrate on some of the more noteworthy aspects of APRA's proposals, reinsurance recoverables, capital charges and kangaroo bonds.

Reinsurance recoverables

Originally APRA had proposed that reinsurance recoverables could only be recognised as part of an insurer’s capital base if

• it was more than 12 months since the date of accident
• they are from an APRA-authorised reinsurer, or
• they are otherwise supported by assets in Australia that are guaranteed to be available to the insurer when required.

Although the underlying rationale for the change was queried by some submissions, APRA is going ahead with this proposal, albeit in a slightly different form and with a longer transition period:

• the reinsurance recoverables charge will be calculated using a 100 percent capital factor on and after the second balance date after the date of loss unless the recoverables are from APRA-authorised reinsurers or are otherwise supported by suitable security arrangements in Australia
• proposal would become operative on balance dates on and after 30 June 2010 in respect of recoverables under reinsurance arrangements entered into on and after 30 June 2008
• transition arrangements would apply to reinsurance arrangements entered into before 30 June 2008
• no effect upon the minimum capital requirement until 30 June 2012 and then only if no security arrangements are entered into in the intervening four years
• new contractual terms required for contracts between local insurers and foreign reinsurers ie. the reinsurance contract to be subject to Australian law and any disputes be heard in an Australian court; and the recoverables under the reinsurance contract to be payable to the insurer in Australia, with no other payment mechanism to be substituted for convenience.
• intra-group reinsurance arrangements which occur between an APRA-authorised insurer or reinsurer and another company in the same corporate group which is not located in Australia would be covered.

Investment capital factors

APRA proposes

• the existing investment risk capital factors applying to reinsurance assets to be increased by 50 per cent for reinsurance assets from non-APRA-authorised reinsurers
• a 25 percent investment capital factor for listed equity instruments and units in listed trusts where a look through approach is not practical
• units in listed property trusts have an investment capital factor of 25 percent
• an investment capital factor of 30 percent for unlisted equity instruments and direct holdings of real estate by an insurer
• insurers to be able to treat investments in unit trusts on a ‘look-through’ basis , that is, the capital factors for investments in a trust will be determined based on the underlying assets of the trust where it is administratively practical to do so - if it's not, the investment capital factor will be 30 percent.
• the investment capital factor apply to the effective net exposure after allowing for the hedging effect of equity and commodity derivatives via a charge on the market risk of derivatives. This charge can be negative, thereby offsetting the charge on the physical portfolio. The capital charges arising would be in addition to the counterparty credit risk charge for derivatives.

Kangaroo bonds

APRA will now allow kangaroo bonds to be treated as an asset in Australia if

"(a) the underlying bond is owned by Austraclear's nominee and is registered on Austraclear; and

(b) the separate register recording the Austraclear nominee’s ownership of the legal interest in the underlying bond is kept in Australia; and

(c) the bond is created by a deed poll under seal and the deed poll is kept in Australia; and

(d) the debt under the bond is expressed to be solely payable in Australia.

Note: If there is a custodian between Austraclear and the locally incorporated insurer, the requirements of paragraph 16 and 17 will also have to be complied with in order for the interest in a kangaroo bond not to be excluded from being an asset in Australia."

Other changes / proposals

APRA is also proposing

• two modifications to the proposed categorisation of insurers (an insurance group captive would be a Category E insurer, and certain non-wholly owned subsidiaries to be Category B)
• APRA's informal capital buffer of 20 percent above the MCR will be formalised in a prudential practice guide
• a future review of the possibility of further aligning APRA's general insurance reporting framework with AASB reporting requirements.
• A number of proposals remain unchanged however, such as those applying to sub-custodian arrangements and corporate agents.

Now what?

APRA intends to have all of this ready for a 1 July 2008 starting date. Comments on this package must be made by 22 February 2008.