APRA Update: Stage 2 Reforms

In November 2003, APRA released a discussion paper titled “prudential supervision of general insurance - stage 2 reforms” to ‘further strengthen’ the regulatory regime. 

This is a summary of an APRA discussion paper dated May 3, 2005 which provides an update on APRA’s position to various matters and provides an overview of the proposed changes made to the prudential standards and guidance notes.

Level of detail and prescription: Whilst industry raised concerns over level of detailed guidance, APRA wants to build on the level of information requiring submission to APRA to ensure insurers regularly focus and continue to strengthen these areas.

Interaction of documentation: APRA required a number of documents to be submitted annually eg, Risk Management Strategy (RMS), Reinsurance Management Strategy (REMS), Business Plan (BP), Business Continuity Plan (BCP), Financial Condition Report (FCR), Capital Management Plan (CMP) and Liability Valuation Report (LVR).

APRA does not require a separate CMP and financial information can be included in BP.  Risk information can be included in RMS.  Similarly, the FCR could incorporate LVR.

Separate BP, RMS and REMS are still required.

Application to ‘groups’: Industry argued that some documents (RMS, REMS, BP) should be submitted at a group level.  APRA allows such practices as long as documentation adequately covers the operations of each licensed insurer.

Risk management in general: APRA is making some changes to terminology to reflect industry practice and risk management responsibilities now include board and operational management.

Capital management: Requirements to include an insurer’s strategy for setting and monitoring capital reserves over time and above the minimum requirements.  Insurers are required to establish and monitor ‘trigger ratios’ in line with the Board’s risk profile to avoid possible breaches of the MCR and proactively establish alternative strategies to achieve MCR.

Board Declaration: APRA’s proposal to extend the Board Declaration to cover the financial information submitted and the Approved Auditor and Approved Actuary was ‘strongly opposed’ by industry. 

APRA now proposes that CEO and CFO provide a financial information declaration annually to APRA. This declaration will based on the insurer having adequate systems and controls supporting the financial information.

Risk Management Strategy: The RMS will need to be reviewed and submitted annually to APRA and it should be more closely aligned to the BP.

Business Plan: The BP will still need to be reviewed and submitted annually to APRA and it should include future financial projections.

Reinsurance management in general: There are a number of structural changes proposed to the prudential standards and guidance notes for clarity and constancy.

Treatment of proportional reinsurance treaties: Whilst industry response was mixed on the treatment of premium and premium liabilities for proportional reinsurance contracts, APRA will not change the liability valuation requirements on proportional reinsurance treaties.

Reinsurance Management Strategy: The REMS will need to be reviewed and submitted annually to APRA within 10 days after board approval.

Reinsurance arrangements: APRA proposed the REMS include more information with respect to actual reinsurance arrangements.  Whilst the response was mixed, APRA will proceed with the proposal to increase the level of detailed reporting for reinsurance arrangement as it is consistent with HIH Royal Commission recommendations.

Confirmation that reinsurance arrangements are in place: APRA proposed that reinsurance documentation be strengthened by stronger documentation and certification requirements and sought industry input. 

APRA proposes a two-stage process involving a sign-off process at the inception of reinsurance arrangements or at least within two months of inception (that some minimum agreed level of documentation is in place), followed by a six-month declaration requiring the insurer to attest that it holds the final signed contracts relating to all its reinsurance arrangements.

Reinsurance contracts that do not satisfy the two- and six-month documentation tests will not be able to be taken into account for purposes of capital adequacy calculations.

Non-risk transfer products: APRA will introduce a new guidance note for Limited Risk Transfer Arrangements requiring insurers to seek APRA’s approval before entering into limited risk transfer arrangements.  APRA will also adopt a broad, principles-based definition which focuses on whether the insurer could realise a significant loss from the arrangement.  Only those contracts that involve a material transfer of risk can be treated as reinsurance and used in minimum capital requirements (MCR) calculations.

Audit & actuarial in general: APRA will restructure the prudential standards and propose a new prudential standard (GPS310 Audit and Actuarial Reporting and Valuation) and 2 new guidance notes (GGN310.1 Financial Condition Report and GGN 10.2 Liability Valuation).

Specific aspects of the standard include:

- More details about statutory requirements under the Insurance Act 1973 such as the time within which insurers must submit all certificates and reports to APRA.

- The criteria to be met by an insurer before it may be exempt from appointing an actuary have been clarified and strengthened in the revised standard.

- Generally, there have been no major changes to the roles and responsibilities of Approved Auditors.  Only the manner in which annual audit certificates and reports are to be prepared has been clarified.

- Clarification of the requirements for audit reporting to more clearly align them with auditing standards and to confirm APRA’s requirements.

- Generally, there have been no major changes to the principles underlying the requirements for the valuation of insurance liabilities. There are some technical and drafting amendments to note.

- APRA has the power to instigate special purpose reviews to the Approved Actuary.

Independence of auditors and actuaries - rotation and the use of in-house actuaries: Due to unanimous industry concerns, APRA no longer proposes to rotate the Approved Actuary

Independence of auditors and actuaries - peer review: APRA believes that that peer review of an Approved Actuary’s work and reports is a valuable tool in maintaining and strengthening the quality of actuarial reporting and proposes a peer review of the LVR by a reviewing actuary before submitting to APRA.  The FCR will not be part of the peer review (except to the extent that it includes the LVR).

The Reviewing Actuaries will be subject to the same eligibility criteria as the Approved Actuary, with additional criteria relating to independence to be satisfied.

Role of Approved Actuary - Financial Condition Report: APRA proposes that the FCR to be prepared on an annual basis (APRA can change frequency of preparation) and in doing so an Approved Actuary must have regard to professional standards and guidance issued by the IAAust. The standard outlines the scope of the FCR.