Insurance (prudential standard) determination No. 5 of 2012
Prudential Standard GPS 115 Capital Adequacy: Insurance Risk Charge
Insurance Act 1973
 
I, Ian Laughlin, delegate of APRA:
 
(a)        under subsection 32(4) of the Insurance Act 1973 (the Act) REVOKE Insurance (prudential standard) determination No. 11 of 2010, including Prudential Standard GPS 115 Capital Adequacy: Insurance Risk Capital Charge made under that Determination; and
 
(b)       under subsection 32(1) of the Act DETERMINE Prudential Standard GPS 115 Capital Adequacy: Insurance Risk Charge, in the form set out in the Schedule, which applies to
 
(i)               all general insurers and authorised NOHCs; and
(ii)             a subsidiary of a general insurer or authorised NOHC, where that subsidiary is a parent entity of a Level 2 insurance group.  
 
This instrument takes effect on 1 January 2013.
 
Dated: 7 December 2012
 
[Signed]
 
 
Ian Laughlin
Member
 
 
Interpretation
In this Determination:
APRA means the Australian Prudential Regulation Authority.
authorised NOHC has the meaning given in section 3 of the Act.
general insurer has the meaning given in section 11 of the Act.
Level 2 insurance group has the meaning given in Prudential Standard GPS 001 Definitions made by Insurance (prudential standard) determination No. 1 of 2012 or, if that prudential standard is revoked, the meaning given in the replacement prudential standard. 
parent entity has the meaning given in Prudential Standard GPS 001 Definitions made by Insurance (prudential standard) determination No. 1 of 2012 or, if that prudential standard is revoked, the meaning given in the replacement prudential standard. 
replacement prudential standard means any prudential standard made under section 32 of the Act which replaces Prudential Standard GPS 001 Definitions made by Insurance (prudential standard) determination No. 1 of 2012.
subsidiary has the meaning given in Prudential Standard GPS 001 Definitions made by Insurance (prudential standard) determination No. 1 of 2012 or, if that prudential standard is revoked, the meaning given in the replacement prudential standard. 
 
Schedule
 
Prudential Standard GPS 115 Capital Adequacy: Insurance Risk Charge comprises the 6 pages commencing on the following page.
 
Prudential Standard GPS 115
Capital Adequacy: Insurance Risk Charge
Objective and key requirements of this Prudential Standard
This Prudential Standard requires a general insurer or Level 2 insurance group to maintain adequate capital against the insurance risks associated with its activities.
The ultimate responsibility for the prudent management of capital of a general insurer or Level 2 insurance group rests with its Board of directors. The Board must ensure that the general insurer or Level 2 insurance group maintains an adequate level and quality of capital commensurate with the scale, nature and complexity of its business and risk profile, such that it is able to meet its obligations under a wide range of circumstances.
The Insurance Risk Charge is the minimum amount of capital required to be held against insurance risks. The Insurance Risk Charge relates to the risk that the value of the net insurance liabilities is greater than the value determined by the Appointed Actuary or Group Actuary.
 
This Prudential Standard sets out the method for calculating the Insurance Risk Charge. This charge is one of the components of the Standard Method for calculating the prescribed capital amount for general insurers and Level 2 insurance groups.
 
 
 Authority
1.             This Prudential Standard is made under section 32 of the Insurance Act 1973 (the Act).
Application
2.             This Prudential Standard applies to each:
(a)           general insurer authorised under the Act (insurer); and
(b)          Level 2 insurance group as defined in Prudential Standard GPS 001 Definitions (GPS 001).
Where a requirement is made in respect of a Level 2 insurance group, the requirement is imposed on the parent entity of the Level 2 insurance group.
3.             This Prudential Standard applies to insurers and Level 2 insurance groups (regulated institutions) from 1 January 2013.
Interpretation
4.             Terms that are defined in GPS 001 appear in bold the first time they are used in this Prudential Standard.
5.             For the purposes of this Prudential Standard the term ‘Actuary’ is a reference to either the Appointed Actuary for an insurer or the Group Actuary for a Level 2 insurance group (as appropriate).
Insurance Risk Charge
6.             This Prudential Standard sets out the method for calculating the Insurance Risk Charge for a regulated institution using the Standard Method to determine its prescribed capital amount.
7.             The Insurance Risk Charge relates to the risk that the value of net insurance liabilities is greater than the value determined in accordance with Prudential Standard GPS 320 Actuarial and Related Matters (GPS 320). It has two components:
(a)           a risk charge in respect of Outstanding Claims Risk; and
(b)          a risk charge in respect of Premiums Liability Risk. 
The total Insurance Risk Charge is the sum of the risk charge for each of the two components.
Outstanding Claims Risk
8.             The risk charge for Outstanding Claims Risk relates to the risk that the value of the net outstanding claims liabilities will be greater than the value determined in accordance with GPS 320.
9.             For the purposes of the Standard Method, the risk charge for each class of business is calculated by multiplying the net outstanding claims liabilities for that class (as determined in accordance with GPS 320) by the relevant Outstanding Claims Risk Capital Factor in Attachment A. The total risk charge for outstanding claims risk is the sum of the risk charges for each class of business. 
Premiums Liability Risk
10.         The risk charge for Premiums Liability Risk relates to the risk that the value of the net premiums liabilities will be greater than the value determined in accordance with GPS 320. It also relates to the risk that ‘material net written premium’, as defined in paragraph 17, will be insufficient to fund the liabilities arising from that business.
11.         For the purposes of the Standard Method, the risk charge for each class of business is calculated by multiplying the sum of:
(a)           net premiums liabilities as determined in accordance with GPS 320; and
(b)          material net written premiums
by the relevant Premiums Liability Risk Capital Factor in Attachment A. The total risk charge for Premiums Liability Risk is the sum of the risk charges for Premiums Liability Risk for each class of business.
Classes of business
12.         For the purposes of the Outstanding Claims Risk Capital Factor and Premiums Liability Risk Capital Factor, all but the ‘other’ direct class of business[1] and ‘other’ reinsurance class of business have been classified into different categories in Attachment A (Table 1 and Table 2 respectively). The ‘other’ class of business must be allocated to a category by the Actuary, in accordance with paragraphs 13 and 14.
13.         For the purpose of calculating the Insurance Risk Charge in respect of any ‘other’ business (whether it is direct business or reinsurance), the Actuary is required to determine the most appropriate category (i.e. category A, B or C) in Table 1 and Table 2 of Attachment A. The choice must be based on the underlying risk characteristics of the business being written. The regulated institution must then apply the corresponding Outstanding Claims Risk Capital Factor and Premiums Liability Risk Capital Factor listed in Attachment A in determining the Insurance Risk Charge. 
14.         If the ‘other’ class of business includes multiple risks with differing risk profiles, the Actuary may subdivide the net outstanding claims liabilities, net premiums liabilities and material net written premiums into more than one category.
15.         The reasons for selecting the specific risk category or categories to which the ‘other’ class of business is assigned must be documented in the Insurance Liability Valuation Report.
Business covering multiple classes
16.         Where a regulated institution underwrites an inwards reinsurance contract which spans multiple classes, the contract must be allocated by using an appropriate method (provided the same method is used for all contracts and all subsequent periods). Appropriate methods include:
(a)           allocating the contract on a pro rata basis to each of the relevant categories; or
(b)          allocating the contract to the category which represents the greatest exposure; or
(c)           allocating the contract to the category representing the greatest premium income.
The regulated institution may use an alternative method from those listed above for allocating inwards reinsurance business that spans multiple classes. The regulated institution must be able to demonstrate that the chosen method is appropriate and is used for all contracts and all subsequent periods. 
Material net written premium
17.         With respect to direct business and reinsurance business where policies incept in the following reporting period and where these policies would have a material impact on capital adequacy, net written premium for exposure that has not been included in the calculation of the premiums liabilities is to be subject to the premiums liabilities risk charge.[2] This premium amount is defined as ‘material net written premium’. The materiality of the business that incepts in the next reporting period should be determined in accordance with the Australian accounting and auditing standards subject to APRA’s discretion.
 
 
 
 
 
18.         The value of material net written premium calculated in paragraph 17 must also reflect the full premium revenue for inwards proportional reinsurance for the full term of the current reinsurance contract where the treaty extends beyond the end of the current reporting period but the revenue has not yet been recognised.[3] 
Securitisation
19.         If a regulated institution securitises insurance liabilities, the net insurance liabilities may reduce. The regulated institution must apply to APRA for approval to include the securitisation transaction in the Insurance Risk Charge.
Adjustments and exclusions
20.         APRA may, by notice in writing to a regulated institution, adjust or exclude a specific requirement in this Prudential Standard in relation to that regulated institution.
Transition
21.         On application by a regulated institution, APRA may grant transitional relief from the obligation for the regulated institution to comply with any requirement in this Prudential Standard. Any relief granted by APRA under this paragraph will have effect until no later than 31 December 2014.
Determinations made under previous prudential standards
22.         An exercise of APRA’s discretion under a previous version of this Prudential Standard does not continue to have effect under this Prudential Standard. For the purposes of this paragraph, ‘a previous version of this Prudential Standard’ includes:
(a)           Prudential Standard GPS 115 Capital Adequacy: Insurance Risk Capital Charge (GPS 115) made on 18 June 2010;
(b)          GPS 115 made on 23 June 2008;
(c)           Prudential Standard GPS 111 Capital Adequacy: Level 2 Insurance Groups  (GPS 111) made on 23 September 2011; and
(d)          GPS 111 made on 17 December 2008.
 
Attachment A
Table 1:  Direct insurance business
Category
Class of business
Outstanding
Claims Risk
Capital Factor
(%)
Premiums Liability Risk Capital Factor
(%)

A
Householders
Commercial Motor
Domestic Motor
9.0
 
13.5

B
Travel
Fire and ISR
Marine and Aviation
Consumer Credit
Other Accident
11.0
16.5

C
Mortgage
CTP
Public and Product Liability
Professional Indemnity
Employers’ Liability
14.0
21.0

 
Table 2:  Inwards reinsurance business

Category
Class of business
Reinsurance type
Outstanding Claims Risk Capital Factor
(%)
Premiums Liability Risk Capital Factor
(%)

A
Householders
Commercial Motor
Domestic Motor
Proportional
 
10.0
15.0

Non-proportional
 
12.0
18.0

B
Travel
Fire and ISR
Marine and Aviation
Consumer Credit
Other Accident
Proportional
 
12.0
18.0

Non-proportional
14.0
21.0

C
Mortgage
CTP
Public and Product Liability
Professional Indemnity
Employers’ Liability
Proportional
 
15.0
22.5

Non-proportional
 
17.0
25.5

 

[1]           The other class of business is as defined in paragraph 1(k) of Attachment B of GPS 001.
[2]         This requirement is based on the principle that an insurer should be able to meet its insurance obligations at all times, not just at the quarterly reporting date. With regards to written contracts for which insurers are not on risk in the current reporting period, APRA has not defined how far into the subsequent reporting period the capital requirement applies. APRA expects that at the reporting date, insurers will hold sufficient capital for all general insurance contracts for which the general insurer is committed, regardless of when the contract incepts.
[3]         For the avoidance of doubt, the reinsurance revenue for inwards reinsurance business should be recognised for the full term of current reinsurance contracts, usually 12 months from the inception of the contract, and not any shorter period. For reinsurance contracts that are continuous but cancellable at regular intervals or on specified dates, the term of the contract can be measured to the earliest cancellation date that is not less than 12 months from the previous cancellable date.