The Australian Prudential Regulation Authority (APRA) released a Response Paper on Prudential Supervision of General Insurance Groups on 4 October 2006, which refines the original proposals on the draft prudential framework for corporate groups involving authorised general insurers.
The original proposals were outlined in the Discussion Paper of 16 May 2005 (see our News Alert dated 24 May 2005). The proposed refinements will reduce the compliance burden for insurers and help clarify APRA's proposals.
APRA has invited written submissions on its proposals by 31 December 2006. Following the consultation period, APRA intends to release draft prudential standards and practice guides in the second quarter of 2007, taking effect from 1 July 2007, with a transitional period until 1 July 2008.
Issues raised by industry in relation to asset concentration proposals are still under consideration and do not form part of the current proposals in the Response Paper.
Staged implementation of proposals
APRA initially proposed a three-level supervision framework for general insurance groups in relation to capital adequacy. While APRA is not shying away from this principle, it now considers that a staged implementation will ease the compliance burden for general insurers and will enable APRA to introduce corporate group supervision in a series of measured steps.
APRA will now focus on the introduction of Level 2 capital adequacy, which applies to the consolidated general insurance group, incorporating all general insurers (both domestic and international) and the immediate non-operating holding company (NOHC), if any. The capital adequacy requirements will be applied as if the consolidated insurance group is one company conducting all the general insurance business written by all the underlying companies, which have been consolidated.
Changes to Level 1 capital adequacy (which apply to each general insurer in the group on a stand-alone basis) and the implementation of Level 3 requirements (which apply to a corporate group involving general insurers headed by an APRA-regulated entity) are being deferred.
New prudential standards
The three main components of APRA's prudential framework are:
- capital adequacy
A new prudential standard will impose Level 2 capital adequacy requirements on authorised NOHCs and general insurers heading a consolidated insurance group.
- operations – risk management
APRA proposes to introduce a standard that ensures that consolidated insurance groups have appropriate risk management on a group-wide basis. The key requirements of the standard will be largely similar to those contained in the current Prudential Standard GPS 220 Risk Management but will apply on a consolidated insurance group basis. Individual insurers in the group will then not need to comply with requirements applying on a consolidated insurance group basis.
- governance and fit and proper.
The current governance standard (GPS 510) and fit and proper standard (GPS 520) require no amendment to accommodate consolidated insurance group supervision.
Response to Submissions
The Response Paper examines the main concerns raised by the 20 respondents to the 2005 Discussion Paper which, according to APRA, were largely specific to individual business and not applicable to the wider general insurance industry. Set out below is an overview of those areas where APRA has changed or clarified its prudential approach based on the issues raised by the respondents.
Treatment of different group structures
Australian-based insurance groups with international operations expressed concern that the proposals were more onerous on them than on foreign branches and corporate groups operating in Australia, which are headed by either foreign or commercial parents.
These concerns were characterised by the perception that APRA’s standards will apply directly to offshore subsidiaries of these groups. APRA has stated that the consolidated insurance group capital requirements will be applied on a group-wide basis, and not imposed on individual entities within the consolidated insurance group. However, APRA believes that Australian regulated groups do need to be subject to group-wide requirements without requiring overseas subsidiaries themselves to comply with the requirements.
No need to restructure
Some general insurers were concerned that they would need to restructure under the proposed framework, particularly in light of the five potential group structures for general insurers that were outlined in the 2005 Discussion Paper.
APRA has emphasised that the 2005 Discussion Paper was intended only to demonstrate the potential structures available, not to constrain structures.
Given differing accounting requirements in foreign countries, concerns were raised about the ability to report consolidated group-wide assets and liabilities in accordance with APRA’s prudential reporting requirements.
APRA has explained that individual valuation will not be necessary. An actuary will only need to assess whether the value of the liabilities of the consolidated entity (including foreign subsidiaries) are no less than if valued according to Australian requirements. The adoption of IFRS should resolve most issues regarding valuation of assets. However, financial reports of foreign subsidiaries may need to be recast to meet APRA requirements if they would otherwise cause consolidated reports to be misleading.
Financial reporting would initially be on a half yearly basis, but APRA intends to move to quarterly reporting.
Comparison of foreign regulators
It was initially proposed that a foreign corporate group must satisfy APRA that it is subject to regulatory oversight broadly consistent with that applied by APRA to consolidated insurance groups. However, given the difficulty of such an assessment, APRA has wisely abandoned this proposal. APRA will continue to visit foreign parents and will develop Memoranda of Understanding with relevant regulators overseas to enhance the exchange of relevant information.
Duplication of governance, reinsurance management and risk management requirements
To allay concerns about the duplication of reporting requirements at the consolidated insurance group level and individual general insurer level, APRA has explained that Prudential Standard GPS 510 Governance and Prudential Standard GPS 520 Fit and Proper incorporate requirements applying at both levels and need no amendment.
APRA will however, introduce prudential standards for risk management and reinsurance management at the consolidated group level. The compliance obligation will fall on the company, which heads the consolidated insurance group at Level 2.
Intra-group associations and infrastructure
APRA has concluded that risks posed by common branding are not of significant prudential concern in the general insurance industry, and specific requirements on this issue and those relating to counterparty dealings and the distribution of products by related entities are therefore not warranted.
While APRA is not imposing requirements in relation to written outsourcing agreements between related bodies corporate, general insurers should be aware that APRA will review corporate groups’ related-party outsourcing arrangements and reserves the right to increase a consolidated insurance group’s MCR if material prudential risks arise.
The nature of the ring fence – dealing at arm’s length
Ring-fencing will now only apply to dealings with related entities outside the consolidated insurance group. Such dealings must meet the following two principles:
- transactions should be on no worse (for the consolidated group) than an arm’s-length basis; and
- the consolidated insurance group must meet exposure limits.
APRA approval for internal guarantees
APRA will now allow a NOHC to guarantee the obligations of its subsidiaries without prior approval from APRA, provided that the subsidiary is within the Level 2 consolidated insurance group. Guarantees outside of the consolidated insurance group will not be permitted without prior approval from APRA.
An NOHC will only be able to:
- provide executive leadership and administrative support across the consolidated group
- hold investments in subsidiaries
- hold property used by the consolidated group
- raise funds to invest in or support subsidiaries or conduct the NOHC's own limited activities; and
- invest funds on behalf of the consolidated group.
It will not otherwise be able to trade in financial instruments; engage in insurance activities; or guarantee obligations of non-consolidated related companies without APRA approval.
Contact our Corporate Insurance team to discuss the impact of APRA’s proposals on your business or for assistance in responding to these proposals.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.