At a glance: APRA's proposed stage 2 reforms

On 20th November, APRA released its latest discussion paper on the second round of reforms aimed at further strengthening the prudential regulatory framework. Essentially, APRA proposes several new regulatory and disclosure requirements, consolidation of some standards and clarifies a number of definitions.

Revision of prudential standards

·          Insurers will need to have Capital Management Plan (CMP) in place, setting out the strategy to monitor capital.

·          Comments will be sought on treatment of capitalised expenses due to differences between APRA's reporting requirements and Accounting Standards.

·          Reinsurance recoveries from reinsurance contracts that are not formally documented or legally binding cannot be deducted from gross insurance liabilities for MCR purposes. Reinsurance Management Strategy must document processes & controls to ensure appropriate documentation is in place.

·          Comments sought on treatment of capital risk charges for inter-group exposures (reinsurance arrangements). Some insurers want concessions but APRA prefers status quo.

·          APRA identifies 4 alternative ways to treat direct credit substitutes (surety bonds & contingent liabilities) for investment risk capital charge. APRA prefers that only instruments that meet the legal definition of 'insurance business' be valued as insurance.

·          Comments sought on treatment of premiums and premium liabilities from proportional reinsurance contracts as reinsurers believe that premiums and premium liabilities arising after reporting date should not be recognised as an asset or liability respectively.

Governance standards

·          APRA will add three new prudential standards - Governance, Audit and Fit & proper. GPS 220 will only relate to risk management.

·          A focus on independence of directors - Board of locally incorporated insurer be comprised of a majority of 'independent' ' non-executive' directors to reduce conflict of interest.

·          APRA defines captives as a wholly owned company with a group of related companies performing the function of insurer to that group and permits captives to apply to APRA for exemptions to Board composition requirements.

·          A focus on independence of chairperson - The chairperson of the board should be an independent non-executive and must not have been, at any time, the CEO of the insurer.

·          Director not serve as a director of another general insurer (or parent company) outside the group.

·          Within 14 days of resignation or removal of a director, an insurer must advise APRA in writing setting out the reasons of resignation or removal.

·          Board Audit Committee of locally-incorporated insurer be comprised of at least 3 members. All members should be non executive directors and a majority independent. Chairperson not permitted to sit on Board Audit Committee.

·          Insurers to establish a Board Risk Committee to develop, set and monitor adherence to risk management strategies. Can combine with Board Audit Committee. May exempt smaller insurers if they can demonstrate appropriate mechanisms are in place.

·          Insurers need to have procedures for assessing performance of board, directors and senior management.

·          Directors will be elected for a fixed period, preferably not exceeding 3 years, directors can seek re-election.

·          Approved auditors and actuaries to will need to advise APRA when they do not continue to meet eligibility criteria or when information provided to APRA in their application is no longer correct.

·          To enhance the independence of the approved auditor and actuary, APRA proposes rotation of audit partners and audit firms, restrict services provided by auditors, rotation of actuary, formalising peer review of auditor/actuary work, increase scrutiny of audit & actuarial firms and separation of audit & actuarial firms for an insurer.

·          Create a new prudential standard that requires Approved Actuary to prepare a Financial Condition Report that includes an assessment of liabilities, capital adequacy, premium setting, risk management and reinsurance arrangements.

·          For foreign insurers, include Senior Officer from outside Australia in the definition of senior manager.

·          Board declaration will be extended to attest that quarterly and annual financial information submitted to APRA and Approved Auditor and Approved Actuary truly represent the transactions and financial position of insurer.

·          Improve consistency of Risk Management Strategy (RMS) by ensuring all insurers address RMS objectives, framework and review provisions. Also, that the "Risk Matrix" identify risk categories, risk, owner, components, impact, probability, inherent risk, control, residual risk and relevant procedures. Risk areas to be extended to cover operational risk, new business initiatives and concentration exposures.

·          Strengthen diligence; approval and on-going monitoring of outsource providers.

·          Strengthen the requirements in relation to Business Continuity Plan.

·          Reinsurance Management Strategy (REMS) renamed Reinsurance Management Statement and to be lodged annually. Extended to include responsibility for reinsurance purchasing and recovery, describe control mechanisms to monitor placement and recovery, intra-group reinsurance arrangements, trend analysis, documentation of MER calculations/details.

·          Insurers will be required to disclose more information about their reinsurance arrangements.

·          Insurers will be required to confirm that reinsurance arrangements are in place within 2 months of taking effect and detail any gaps.

·          Insurers to seek APRA's approval before entering into non-risk transfer arrangements (financial reinsurance) and include details in REMS.

Other Matters

·          Remove requirements for Lenders Mortgage Insurers (LMI's) to operate as mono-line insurers.

·          Develop a prudential standard applicable to general insurers in run-off to include APRA approval required if reducing capital, funds invested in local ADI's. RMS to include how insurer is managing run-off. Some exemptions may apply.

·          Additional details will be required in actuarial report covering transfer or amalgamation of insurer business.

·          Policyholders of a non-current policy affected by a proposed scheme of transfer will be entitled to the same notification provisions as a holder of a current policy holder.

Revisions of a minor nature

·          When measuring capital base (GPS 110), capital profits reserves and foreign currency translation reserves included as tier 1 capital. Asset revaluation reserve included as tier 2 and have two classes.

·          Excess technical provisions included in tier 1 must be net of reinsurance and other recoveries.

·          When calculating after tax earnings for the purpose of obtaining approval from APRA to reduce capital, calculation must be based on APRA reporting definitions not Australian Accounting Standards.

·          When calculating the investment concentration charge, group exposures are to be sub-aggregated by 'grade'

·          Unlimited exposure to an individual counterparty will not be permitted, except when they relate to a statutorily defined coverage of an insurance contract.

·          When a rating is not available from a rating agency for counterparty grades, the insurer should apply the lowest rating available from the other rating agencies.

·          PML and MER calculations should be performed based on 'single events' at a minimum.

·          Loans to directors of insurer or a related entity or directors spouse or unsecured loan to employee will be excluded from calculation of assets in Australia.

·          Where a custodian holds assets of an insurer and insurer has contractual right against the custodian, the asset will be considered as in Australia.

·          Approved Actuary's report will need to contain sufficient information relating to assumptions and methods of valuation.

·          Although an insurer can value its insurance liability other than in accordance to GPS 210, an insurer must value in accordance with GPS 210 i.e. at minimum of 75 percent level of sufficiency.

·          Levies of charges, imposed by government, should not be included in the calculation of premium liability.

·          A Senior Manager need not be an employee of an insurer.

·          Additional information relating to business plans will be required each year including proposed activities, scale of operations, staffing and offices. In addition business plan needs to contain balance sheet, cash flow, earnings, key financial and prudential ratios.

·          Minor changes made to information provided to APRA on application for approval of actuaries and auditor.

·          Additional disclosure will be required of pecuniary interests of approved auditors and actuaries.

·          Internal audit requirements will be strengthened and made clearer. Locally incorporated insurers will require a comprehensive and independent internal audit process to test internal controls and risk management systems.

·          Internal Audit function will report to the Board Audit Committee and not management with operational responsibilities.