SOME THOUGHTS ON INSURANCE
IAN LAUGHLIN
Member
Australian Prudential Regulation Authority
Financial Services Accountants Association
Gold Coast
21 May 2012
2
Introductory comments
Some Thoughts on Insurance
from APRA
Ian Laughlin
21 May 2012
Gold Coast
Thank you for the opportunity to talk with you again.
Here are the topics I will be discussing today, some of which will be developments of
comments I made last year.
AGENDA
•
•
•
•
LAGIC – ICAAP, Pillar 2
General matters
Life industry issues
GI industry issues
• Customer
interests
• Risk appetite
• Board support
• Remuneration
• International
developments
3
First, let me comment briefly on the environment for the two insurance industries.
The global economy and investment markets remain in an extraordinary state of
uncertainty and volatility. The situation varies considerably by geographic area, as
highlighted by the sharp contrast between Europe and Asia. Australia has done well
economically and is well placed to benefit from Asia’s growth, but we are not immune to
problems elsewhere in the world. This poses direct risks to insurers’ balances sheets and
to business performance more generally.
With this backdrop, APRA remains on heightened alert and we are closely monitoring our
industries and institutions.
LAGIC (Life and General Insurance Capital review)
LAGIC is very topical of course, as we are entering the home stretch of the long
development process for our proposals, the final versions of which come into force on 1
January 2013.
First, some recent history:
You will recall that, in December 2011, we released a paper to industry setting out
APRA’s response to submissions made as part of our second round of consultation,
together with 14 draft prudential standards.
3
We have been considering the various submissions on that consultation and will provide
APRA’s response this month as planned. At the same time we will release final versions
of the majority of prudential standards that were released in draft form in December –
also as planned.
On 14 March, we wrote to general insurers advising that the formal implementation of
one aspect of the insurance concentration risk charge (the horizontal requirement) would
be deferred until 1 January 2014. More on this shortly.
On 30 March, we wrote to life insurers with APRA’s proposals for an illiquidity premium
for the risk free Interest rate for discounting certain liabilities, including draft prudential
standard wording. Submissions on this proposal close on 1 June.
I will now touch briefly on some of the key areas that generated responses to the
December package.
In addition to those on the ICRC, there was a series of questions and comments were
received about the ICAAP (Internal Capital Adequacy Assessment Process) and Pillar 2
capital adjustments. There also were a number of comments on our proposals on
composition of capital.
These are all important issues and I will comment on each of them in a minute.
Submissions made various other points as shown on this slide.
General points:
• look-through
for certain investments
• need to consult with
APRA for certain
derivatives
• revaluation of
property every three
years when collateral
• counter party grade for
AA rated semis
General insurers:
Life insurers:
• due date for the FCR • products
considered to
and ILVR
be illiquid
• whole-of-portfolio
• offsets between
net loss
statutory funds
• contractually agreed
• treatment of
reinstatements
• when ICRC calculated deferred
acquisition costs
• whole-of-portfolio
(DAC)
for “other
accumulations”
I won’t go into APRA’s responses, but each point has been considered carefully. In some
cases we have agreed with the argument and in others no change is going to be made. In
all cases our final position will be clear.
• ICRC
• ICAAP
• PILLAR 2
• COMPOSITION OF CAPITAL
ICRC (Insurance Concentration Risk Charge)
4
APRA has received considerable feedback from general insurers on the ICRC - in
particular on the impact of the horizontal requirement, the component of the ICRC that
is intended to address a series of material catastrophe events over a year.
The key concerns raised include that it is overly conservative, that reinsurance to offset
the requirement is expensive and not readily available. There also were strong arguments
that more time was needed for insurers to determine and implement a suitable strategy
for meeting the horizontal requirement and to obtain appropriate reinsurance cover or
raise additional capital. Our decision to defer the introduction of the horizontal
component (see above) has relieved much of the concern expressed. Appropriate
transition arrangements (more on this shortly) will help address other issues raised.
• ICRC
• ICAAP
• PILLAR 2
• COMPOSITION OF CAPITAL
ICAAP
Let me now turn to ICAAP.
ICAAP was explained in our previous consultation papers, and in the draft prudential
standards issued in December 2011.
We have had a number of requests for more information on ICAAP and what APRA expects
of insurers. To help with this APRA intends to expand the section on ICAAP in the final
version of the prudential standard to be issued this month.
We also intend to issue a Prudential Practice Guide (PPG) in September.
Let me now explain ICAAP in a little more detail.
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APRA already expects insurers to have in place a process for assessing overall capital
adequacy and setting capital targets, and a strategy for maintaining capital levels. The
proposed ICAAP requirements therefore build on APRA’s current capital management
requirements and guidance for insurers, and the existing requirements for capital
management plans will be subsumed into the ICAAP requirements.
The ICAAP is fundamentally an internal process that must be overseen by the insurer’s
Board and adapted to the specific nature of that insurer’s business and structure.
At a minimum the ICAAP must include the items on this slide:
ICAAP
• Policies, procedures, systems, controls and personnel
• Strategy for ensuring adequate capital is maintained
• Monitoring capital requirements and targets/ triggers
• Stress testing and scenario analysis
• Reporting on the ICAAP and outcomes
• Capital impact of material risks not covered by PCR
• ICAAP summary statement.
APRA’s guidance will assist insurers, but will not replace the need for management and
Boards to give serious consideration to how best to develop and implement the ICAAP
requirements for their company.
Many insurers will already be doing much of what would be required in a well-developed
ICAAP in their current capital management processes, and so will have a solid foundation.
Insurers who are more advanced in their implementation work have already taken steps
such as development of detailed project plans, engagement of Board and senior
management in the process (e.g. through board workshops) and discussion with APRA.
The December package distinguished two documents that need to be produced: the
ICAAP summary statement and the ICAAP report.
The ICAAP summary statement is intended to be a roadmap, briefly describing and
summarising the capital assessment and management processes of the insurer. This
document is expected to be developed and available to APRA from 1 January 2013.
The ICAAP report is an annual report that will summarise the outcomes from the
operation of the ICAAP over the last year and give an overview of expected capital
management actions and issues for the coming period. It should include details of actual
capital levels and capital management actions during the previous period, and projected
capital levels and planned capital management actions. It should also summarise any
changes to capital targets or other aspects of the ICAAP. The first ICAAP report will be
due four months after the first balance date after 1 January 2013 - at the end of October
2013 for June balancers and in April 2014 for December balancers.
APRA expects that the ICAAP will be developed by the insurer’s senior management with
input from relevant areas and experts. However, the ICAAP is fundamentally the
responsibility of the Board: the Board should be actively engaged in the development of
the insurer’s ICAAP and its implementation, and must ultimately approve the ICAAP.
6
We strongly encourage insurers to ensure they are well prepared for the ICAAP
commencement date of 1 January 2013. We recognise that the ICAAP itself and the
required documentation may undergo refinement over the first 12-24 months and we
expect that practice in relation to ICAAP will improve over time as industry gains
experience with the requirements.
APRA acknowledges that some insurers may wish to complete their annual ICAAP report
at a date other than year end. Therefore, the prudential standard has been amended to
give insurers the flexibility to complete their ICAAP report at a time other than year end,
for example, as part of the annual business planning cycle.
APRA expects stress
appetite and in the
integral part of the
insurer’s reinsurance
and scenario testing to be used both in setting the insurer’s risk
insurer’s ongoing capital management. It therefore should be an
insurer's ICAAP. It should also play a key role in determining an
strategy.
Rigorous, forward-looking stress testing supports capital and reinsurance management by
assessing the impact of severe events, including a series of compounding events or
changes in market conditions that could adversely impact the insurer.
APRA reviews the approach taken by insurers to stress and scenario testing as part of its
regular supervision activities. APRA has also previously undertaken surveys of industry
practice in this area. There is a range of practice from poor to quite good. Some of the
areas for improvement include the nature of the stresses and scenarios considered, in
particular their severity and the adequacy of the reporting to the board. APRA intends to
develop cross-industry guidance on stress testing in due course. In the meantime,
requirements and guidance on stress testing are being included as part of ICAAP.
Finally, insurers should not await the release of APRA’s PPG on ICAAPs before engaging
with their Board and with APRA.
• ICRC
• ICAAP
• PILLAR 2
• COMPOSITION OF CAPITAL
Pillar 2
A number of insurers have expressed concern about the possible impost of additional
capital requirements by APRA under Pillar 2.
To remind you: Pillar 2 is the supervisory review process which includes APRA’s
assessment of the risk management and capital management practices of insurers.
Under Pillar 2, APRA may increase the prescribed capital determined under Pillar 1 if we
are of the view that this amount does not adequately account for all of an insurer’s risks.
Such an adjustment may increase the total required capital amount and/or strengthen
the composition of the insurer’s capital base (i.e. the insurer may have to hold an
increased proportion of higher quality capital).
7
Because of the risk-sensitive nature of LAGIC and its fairly comprehensive coverage of
types of risks, we do not expect many insurers will need a Pillar 2 adjustment just
because of the peculiar nature of the risks to which they may be exposed. However,
there may be other reasons for such an adjustment. All supervisory adjustments will be
made in the context of a supervision and decision-making process that insurers are
already familiar with. The power to require a supervisory adjustment to capital is one
tool in a broader supervisory toolkit for addressing prudential concerns.
If an insurer currently has an increased capital requirement imposed by APRA, we will
consider whether there is an ongoing need for that adjustment under LAGIC. Some
adjustments will be in place to address risks which will now be adequately captured
under the standard method for calculating the prescribed capital amount. In such cases,
there may be no ongoing need for the adjustment. Insurers should also note that APRA is
unlikely to apply a supervisory adjustment to capital just because the ICAAP and its
documentation are being refined during 2013, so long as a well-considered and developed
ICAAP is in place from 1 January 2013.
Pillar 2 provides a powerful tool for APRA to reflect an insurer’s inadequate quality of
risk management in its capital requirements if needed.
Insurers are encouraged to discuss the application of the Pillar 2 process with their APRA
supervisor.
• ICRC
• ICAAP
• PILLAR 2
• COMPOSITION OF CAPITAL
Composition of capital
APRA outlined in the December response paper its proposed criteria and limits for the
composition of the capital base of insurers. The proposals are intended to substantially
align these requirements with the proposed requirements for authorised deposit-taking
institutions (ADIs) under APRA’s implementation of the Basel III capital framework.
APRA’s practice for many years has been to maintain consistency of capital definitions for
ADIs and general insurers.
The proposed criteria for capital instruments to qualify as Common Equity Tier 1,
Additional Tier 1 and Tier 2 capital are the same as proposed for ADIs. The proposed
limits are expressed as a percentage of required, rather than total, capital. This is
consistent with the proposed limits for ADIs which are expressed as minimum percentages
of risk-weighted assets rather than as a proportion of capital base. The proposed limits
for insurers have also been set to broadly align with the proposed minimum requirements
for ADIs, so that the proportion of minimum required capital represented by the different
components of capital is similar.
8
Some insurers are concerned that the limits are unduly constraining, will require changes
to the mix of capital instruments issued and will increase the cost of capital for the
industry. Some insurers have also raised questions in relation to the treatment of current
capital instruments that do not meet the revised criteria for regulatory capital.
We have considered these issues closely and will respond to them later this month. In the
meantime, APRA is happy to discuss any concerns, and appropriate transitional
arrangements, with individual insurers.
Transition arrangements
Which brings me to the topic of transition more generally.
We understand that a number of insurers are likely to seek transition arrangements. This
may be because they may be affected by the new requirements on quality of capital as
just discussed or because they will have increased minimum capital requirements under
LAGIC. As we have previously indicated, we are open to requests for transition
arrangements on a case-by-case basis where insurers have compelling arguments
supported by capital projections.
We encourage insurers to initiate discussions with their supervisor as early as possible
and well before the cut off date of 30 Sept.
In the meantime APRA will continue over 2012 to work to the plan outlined in the
December 2011 Response Paper.
Insurance capital review (LAGIC)
• Dec 2011 – Response paper & 14 draft standards released
• Prudential Standards
o May 2012 – Final capital & draft non-capital standards released
o September 2012 – Final non-capital standards released
• Reporting Standards
o June 2012 – Draft reporting standards released
o October 2012 – Final reporting standards released
• 1 January 2013 – New capital framework effective
29
The remaining key milestones in the project timetable for this year are shown on this
slide.
The new capital framework will be effective from 1 January 2013.
9
General matters
•
•
•
•
•
Customer interests
Risk appetite
Board support
Remuneration
International developments
Customer interests – APRA’s approach
The primary responsibility for looking after the interests of customers rests with the
insurer – its board and management - and not, in particular, with APRA. In meeting this
responsibility, the insurer must address three core issues:
• Capital management – the more capital the better the protection for customers
• Risk Management – the better the RM, the better the protection for customers; and
• Governance - a robust foundation of good governance is critical.
Now, while the primary responsibility for customer interests lies with the board and
management, in its Mission APRA sets out to ensure that “under all reasonable
circumstances, financial promises made by institutions we supervise are met”.
So of course APRA takes a very keen interest in how management and board tackle their
responsibilities in the three areas of capital management, risk management and
governance.
And this is reflected in our prudential standards.
Customer interests - APRA
Prudential Standards Risk
management
Governance
Capital
management
Other
15
Most of APRA’s prudential standards can be broadly grouped into these three areas, thus
aligning our focus with the company’s responsibilities to look after customer interests.
However, APRA does much more than just set prudential standards.
10
Customer interests - APRA
Prudential Standards Risk
management
Governance
Capital
management
PLUS
Supervision
Other
16
In particular, we actively supervise our industries. In doing so, we rely on a strong
understanding of our industries and their evolving risks, together with a thorough working
knowledge of each of our entities. And we adopt a risk-based approach to our
supervision.
Risk-based supervision is a structured and methodical process. It is designed to identify
and assess those areas of greatest risk to a regulated institution (or to the financial
system as a whole) and then direct supervisory resources and attention to those risks.
Under this approach, more supervisory resources are devoted to those regulated
institutions that have higher risk profiles or identified risk management weaknesses, or
that pose a potential systemic threat.
A successful risk-based approach is characterised by high-quality and astute analysis
leading to the early identification of key risks and issues, a capacity to escalate the
intensity of supervision rapidly, and the ability and willingness to intervene promptly and
assertively as and when required.
The essential building blocks of APRA’s risk-based approach to supervision are set out in
the APRA Supervision Blueprint (published in January 2010). In summary, the building
blocks are:
• A forward-looking supervisory action plan for each regulated institution that
addresses the key risks facing the institution;
• A structured risk assessment and decision-making process to ensure that the risk
judgments that underpin supervisory action plans are rigorous and consistent, and
that supervisory interventions are targeted and timely; and
• A ‘thematic’ or industry-wide approach to the analysis of risks that identifies the
main emerging risks and supervisory issues for each APRA-regulated industry.
One important aspect of APRA’s supervision is its engagement with boards. Boards have
primary responsibility for ensuring the prudent management of regulated institutions and
APRA’s prudential standards make boards accountable for a range of prudential matters.
In recent times APRA has increased its engagement with boards on matters such as risk
appetite and remuneration. As APRA has learned, direct access to the board, and an
effective relationship built on mutual trust and respect in good times, can be crucial in
managing situations when times turn sour. More face-to-face contact helps to strengthen
relationships and, at the same time, allows APRA to properly test board capabilities and
director contributions.
11
Assurances, assessments, attestations etc.
In addition to supervision, APRA relies on assessments or assurances from experts (and
management) in a number of areas.
Customer interests - APRA
Prudential Standards Risk
management
Governance
Capital
management
PLUS
Other
PLUS
Supervision
Assessments
& assurances
17
APRA receives assessments or assurances from:
• Appointed Actuary – who has specific roles and responsibilities for insurers. In
particular, the Appointed Actuary provides an assessment of the overall financial
condition of the company, advice on the valuation of its policy liabilities and an
assessment of the suitability and adequacy of the risk management framework.
• External audit - who perform the external audit and provide the audit report which
indicates the extent APRA can rely on the accounts for its capital requirements.
They also review and test systems, processes and controls designed to address
compliance with prudential requirements. And they perform routine and non
routine
engagements
for
APRA
on
a
range
of
matters.
• Internal audit – who evaluate the effectiveness of the risk management framework
and control processes.
APRA also requires CEO and CFO attestations as part of its risk management
arrangements.
I want to stress the importance of these assessments and assurances. They can add
greatly to our understanding of an institution and its issues. But there is room for
improvement. For example,
• we would like to get far more insight into issues external auditors may find in their
work (it is worth noting that qualifications from external auditors are rare); and
• the assessment of the risk management framework by appointed actuaries in many
cases could be more comprehensive and informative.
So we will be working with auditors (internal and external) and actuaries to improve the
value to us of the work they perform.
12
General matters
•
•
•
•
•
Customer interests
Risk appetite
Board support
Remuneration
International developments
Risk appetite – are we there yet?
Risk appetite – are we there yet?
• Last year: APRA supervisors – 16 principles
• Useful catalyst
o More board engagement
o Better RASs
Continued focus by APRA
28
The Board is primarily responsible for an insurer’s risk management framework and risk
management strategy. An integral part of this is setting the company’s risk appetite,
which should be a clear statement of the degree of risk the insurer is willing and able to
take in pursuing its objectives. A clear and considered risk appetite statement sets robust
foundations for the company’s overall risk management.
At this conference last year, I set out the approach APRA was intending to take in
assessing insurers’ formulation and management of risk appetite. You might recall that
following a review of a range of risk appetite statements we decided there was a need
for significant improvement. As a first step we decided to use 16 principles in our
assessments of insurers’ practices.
This seems to have been an effective catalyst, and we are quite pleased with the
progress that has been made across much of the insurance industry. Many of the boards
we have met with have been quite engaged in their risk appetite work, and
improvements have been marked in the quality of the statements themselves.
Nonetheless, we are not there yet, and much work still needs to be done. Those that are
well advanced should continue this development work; those that have done little work
to date must give the matter serious attention.
APRA expects there to be a clear link between an insurer’s risk appetite and its risk and
capital management frameworks, including the target capital levels determined as part
of the insurer’s ICAAP. APRA expects that target capital levels will be set in accordance
with the insurer’s risk appetite and not solely by reference to APRA’s minimum capital
requirements.
13
APRA is also continuing to provide feedback to insurers and intends to issue industry
guidance on this topic in due course.
General matters
•
•
•
•
•
Customer interests
Risk appetite
Board support
Remuneration
International developments
Board support
We sometimes get feedback from boards that we are expecting too much of them. They
argue that they’re being over-burdened with regulatory requirements and we’re
confusing the role of the board with that of senior management.
Under LAGIC it might be argued that the board’s responsibilities are becoming even more
demanding.
However the role of the board in protecting policyholders’ interests is critical. We
believe, therefore, that the obligations placed on boards through APRA’s prudential
standards are entirely appropriate.
We also believe that APRA’s prudential standards empower boards because they give a
frame of reference for good practice. Management too has a role to play here. It has an
obligation to recognise the difficult role the board has and to make it as easy as possible
for the board to meet its responsibilities.
There is much that management can and should do to support boards in meeting their
regulatory responsibilities. This includes:
• ensuring the board is well aware of their regulatory obligations – perhaps through
simple and readily accessible summaries;
• ensuring regulatory obligations are woven into normal management, governance
and board reporting;
• helping the board think ahead, with a plan to meet regulatory requirements; and
• providing tools to complement reports - for example sensitivity tables or graphs in
capital management considerations.
Stronger support of boards by management will give APRA more confidence that boards
are meeting their regulatory obligations and lead to lower intensity of supervision by
APRA.
14
This approach, in turn, helps APRA and we get a virtuous circle like that shown on the
chart.
Board
More
confidence
Stronger
support
APRA
Management
Lower intensity
General matters
•
•
•
•
•
Customer interests
Risk appetite
Board support
Remuneration
International developments
Remuneration – is it worth it?
Remuneration - is it worth it?
•
•
•
•
APRA requirements in place from April 2010
Good progress, but more needed
Regulated subs a particular concern
Recent APRA letter to all boards
23
As you may recall, in April 2010 APRA introduced new requirements in relation to
remuneration. The requirements aim to ensure that regulated institutions’ remuneration
arrangements promote prudent risk-taking in the management of their business, and that
there is effective governance of remuneration matters.
Since then, APRA’s supervision teams have monitored progress on implementation as part
of their normal ongoing activities. APRA has also met with the Board Remuneration
Committees of a number of large institutions to discuss their oversight of remuneration
arrangements for senior executives and how policy is translated into practice.
15
Generally we were quite pleased with the processes adopted by these institutions.
However, APRA did identify a number of issues warranting further consideration. Based
on this experience, we then wrote to all ADIs, general insurers and life insurers asking
them to consider specific questions to see whether improvements could be made to
current remuneration policies and practices. Some of the issues to be considered
included those shown on this slide:
• Remuneration Committee well-established?
• Strong linkages between remuneration and risk management?
• Primacy of the Board in setting remuneration arrangements?
• KPIs adequately reflect potential risk-taking?
• Appropriate weight being given to risk-related KPIs?
• Quality of risk management explicitly taken into account in KPIs?
We expect to see industry remuneration practices evolve over time, partly in response to
these considerations, and will continue to engage with boards and senior management to
ensure ongoing improvement.
General matters
•
•
•
•
•
Customer interests
Risk appetite
Board support
Remuneration
International developments
– SIIs
– IAIGs
– Living wills
Recovery plan
Resolution plan
– IFRS
International developments
G-SIIs
There continues to be much work underway internationally on the identification of global
systemically important financial institutions and appropriate regulatory and supervision
measures for such institutions. This work is being driven by the Financial Stability Board
(FSB).
Banks were the initial centre of attention, but much work has now been done on
insurers.
This has proved to be quite a challenging issue in the insurance world with the industry
arguing vigorously that there is no such thing as a systemically important insurer.
Nonetheless, the IAIS is currently considering various possible methodologies and
scenarios for the determination of global systemically important insurers (G-SIIs for
short). The intention is to publish final G-SII methodologies and appropriate policy
measures in late 2012.
16
It is quite unlikely that there will be any Australian G-SIIs. However, as is the case in
banking, it is likely that this work will flow in due course to consideration of domestic SIIs
and appropriate policy measures for them. APRA will continue to actively participate in
the work of the IAIS in this area and consider its implications for Australia as it develops.
IAIGs
Work also has continued at the IAIS on the development of what is called “ComFrame”.
This is a common framework for the supervision of internationally active insurance
groups (or IAIGs for short) – that is, those that operate in more than one jurisdiction.
Australia probably will have some IAIGs. The intention here is that there is a consistent
and co-operative approach to the regulation of insurers that operate internationally.
Much of this work will also be complete by the end of 2012. This will influence our
approach to regulation of such companies in due course.
Living wills
In recent years, in the wake of the GFC and at the instigation of the Financial Stability
Board (FSB), the concept of living wills for financial institutions has evolved. There are
two components to living wills:
• Recovery plans, which are measures that would enable a financial institution to
survive a destabilising event (e.g. strategies for raising additional capital or
disposing of a core business). The Recovery Plan is the institution’s responsibility.
• Resolution plans, which are measures that would enable a cost-effective resolution
to be implemented by the authorities where recovery is not possible (e.g.
simplifying complex group structures to facilitate resolution). The Resolution Plan
is the supervisor’s responsibility.
We are currently looking closely at the role living wills could play in our supervisory
activities.
While it is difficult to argue with the concept of recovery and resolution plans, not all
regulated institutions are the same and so the scope, complexity and value of living wills
will vary. APRA supervises large banks, credit unions and building societies, foreign banks
subsidiaries, foreign bank branches, large life and general insurers, specialist insurers,
branch insurers, reinsurers, and superannuation trustees of various shapes and sizes
(public offer, corporation etc).
Our challenge is to decide how the living will concept should be applied. And a second
challenge is to decide how comprehensive and detailed a plan needs to be.
Inevitably, a resolution plan will be executed when a recovery plan has failed, but we
need to understand how recovery plans might unfold to be able to adequately plan for a
resolution. There is no point assuming that a failed institution can be resolved by, for
example, selling a major business arm to recapitalise the remaining business if that
business arm has already been sold as part of the (inadequate) recovery efforts.
So work on institution-specific resolution plans inevitably follows from developing good
recovery plans.
APRA has begun its own work in this area. Our initial priority is recovery planning in the
ADI industry. In the latter part of 2010/11, APRA established a pilot program for a
number of the larger ADIs, requiring them to prepare a comprehensive recovery plan that
17
sets out the specific actions they would take to restore themselves to a sound financial
condition in the face of a major depletion of capital and associated liquidity pressures.
Finalised plans for these ADIs will be required by mid-2012 and APRA intends to extend
its recovery planning program to a wider set of ADIs in 2012/13.
Recovery planning is also likely to be extended to the larger general insurers and life
insurers in due course, modified to suit the nature of their business.
APRA will also be undertaking an assessment of institution-specific resolution planning,
but only after it is satisfied that substantial progress
has been made on recovery
planning.
This slide shows how ICAAP and living wills relate to each other using the earlier diagram.
PCR,ICAAP
Ladder of
supervisory
intensity
Capital base
Living Will
Target
PCR
Liabilities
Recovery
Plan
Resolution
Plan
7
The box on the right shows how the Living Will would complement the LAGIC capital
requirements and the ICAAP process. Clearly the insurer’s ICAAP, Recovery Plan and
Resolution Plan would have to be consistent with each other.
IFRS: Review of insurance contracts standard
The IASB and FASB continue to work towards a common Insurance Contracts model with
considerable attention devoted to the measurement of the insurance contract liability.
A review draft or a revised Exposure Draft (ED) is expected in the second half of this year
at the earliest.
The current proposals suggest this standard is not likely to represent a significant change
to Australian insurers’ practices, and in any event there is likely to be a long lead time
for implementation.
18
The slide shows how the IASB is approaching the measurement of the insurance contract
liability in the Insurance Contracts project, as outlined in its July 2010 Insurance
Contracts Exposure draft.
The building blocks of the new measurement model
Source: IASB Snapshot:
Insurance Contracts July 2010
Residual margin contract profit (reported over
life of contract)
Risk adjustment - Assessment of uncertainty
about amount of future cash flows
Total
Time value of money - Adjustment that uses an interest
insurance rate to convert future cash flows into current amounts
liability
Current estimate of future cash flows
The amounts the insurer expects to collect from premiums
and pay out for claims, benefits and expenses, estimated
using up-to-date information.
The FASB builds upon the basic IASB model below but supports the
use of a composite margin instead of a residual margin and risk
adjustment. Disclosures are intended to reconcile any differences.
The FASB supports the use of a single composite margin.
Any differences in the two approaches are likely to be addressed through disclosures.
There are other refinements to the previous proposals. For example, the discount rate is
expected to be a current rate that is updated each reporting period (i.e. not a “locked
in” rate for each insurance contract).
There is also further consideration being given to the use of other comprehensive income
for presenting the effects of changes in certain assumptions on the insurance contract
liability.
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Life industry issues
Life industry issues
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Group life insurance
Disability income
Mortality
Direct life
Must do better
Déjà vu?
Could it get worse?
New business; old problems?
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In the current uncertain economic and investment environment, the Life industry
continues to undergo significant change. Forces at work include:
• FOFA;
• Stronger Super;
• Merger and acquisition activity; and
• APRA’s LAGIC and associated changes to prudential standards.
At the same time, we have some specific areas of concern.
APRA has been expressing concern about the group life market for some time.
mentioned it at this conference last year.
I
There are a few reasons for this:
• a very competitive market, which puts pressure on pricing and underwriting and
operational practices;
• poor data for pricing;
• some poor pricing practices; and
• an inadequate skills base (e.g. claims management) in a growing market.
There are some signs of poor claims experience emerging – possibly because of these
points.
We are seeing some signs of improvement in practices (eg in pricing by some insurers,
with better governance, justification of assumptions etc), but the industry can do much
better.
Group life insurance – must do better
APRA:
• Reviewing pricing reports
• Talking to Appointed Actuaries and Institute
• Talking to insurer boards and management
• SPS 250: trustees must maintain adequate records for
prospective insurers
• Considering other ideas
We want to see a significant improvement during 2012/13
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We are therefore maintaining our focus on this business. We have taken a number of
steps so far:
• discussions with industry committees;
• discussions with all Appointed Actuaries (through the Actuaries Institute);
• discussions with individual insurers, with strong messages to boards and senior
management; and
• in superannuation prudential standard SPS250 , a specific requirement for trustees
to maintain good quality data so that the incumbent insurer and insurers involved in
a tender have a robust foundation for pricing.
We are also considering the need for guidance on tendering processes.
We are looking for significant improvement over the next one to two years.
Disability income – deja vu?
• Some poor experience emerging
• Not uniform
• Why?
o Underwriting?
o Claims management?
o T & C?
Why is this happening again?
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Morbidity experience appears to be worsening but, anecdotally at least, this does not
appear to be across the board. So only some insurers seem to be impacted.
Why is this? Is it poor or liberal underwriting? Or perhaps it is poor claims management.
Or could it be the regular addition of product features, often at no cost?
Whatever the reason, each insurer needs to carefully analyse, understand and actively
manage their disability business.
Mortality – could it get worse?
Breaking a long term trend ...
• Some poor experience emerging
• Not uniform
• Why?
o Underwriting?
o Claims management?
o T & C?
Are the chickens coming home?
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For the first time in many years, we are seeing some evidence of deteriorating mortality
experience.
As with disability experience, it could be due to any of underwriting, claims management
or terms and conditions, but it is not at all clear what the driving force is.
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Again, each insurer should be carefully analysing and understanding its own experience.
Unfortunately, for some insurers this will be difficult because of inadequate data (for
example, original underwriting terms for each insured).
Direct life – new business, old problems?
• High growth rates
• Quality of the products and of the business being written?
o Some expensive products
o Some high discontinuance rates
• Governance and reputational risk?
Discussions with boards and with ASIC
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Direct life insurance business has been growing at a high rate and is now a significant
proportion of the retail market.
We are concerned that the quality of the products and of the business being written may
be poor in some cases. We see example of expensive products and high discontinuance
rates.
This raises concerns about governance and reputational risk – for the company and for
the industry and we are actively discussing this with boards.
There are also issues with market conduct, about which we have had discussions with
ASIC.
GI industry issues
General insurance issues
The general insurance industry has been through an extraordinary period, with a
debilitating series of natural disasters and associated political backlash. Even though it
has been subject to criticism for its flood coverage and its claim handling, the industry by
and large has managed its way through this situation well. Its strong capital position and
comprehensive reinsurance arrangements have stood it in good stead, and it has
remained in good financial health. It has responded promptly to the various criticisms
with a series of changed practices.
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GI industry capital
As this graph shows, the general insurance industry remains well capitalized. At 31
December 2011 the industry held close to 1.8 times the minimum capital requirements
set by APRA and surplus capital of close to $12bn. Capital coverage of the industry did
reduce a little over 2011 but still remains very strong.
The industry has also maintained its profitability over the last four years,
notwithstanding the pressures it has faced on underwriting results and from lower
investment returns.
However pressures remain and it will be challenging for insurers to sustain their
profitability and maintain a sound financial position over the coming years. This
continuing uncertain environment heightens the need for sound risk and capital
management by insurers so that they are well positioned to respond to developments as
they unfold.
General insurance issues
• Key areas of current APRA focus
• reinsurance counterparty & placement risks
• use of catastrophe models
• adequacy of pricing & reserving processes
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APRA will, as always, maintain its proactive and risk-based approach to supervision, to
ensure that it is on top of the material factors that will impact the strength and
performance of the industry.
There are, however, some areas on which APRA will be placing particular focus over the
coming year or so. Some of these areas were also on APRA’s radar in 2010 and 2011,
while others are coming into sharper focus for 2012.
Reinsurance is, not surprisingly, an area that we have been monitoring closely for the last
few years given its importance to the financial strength of the industry.
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Reinsurance counterparty risk
In early 2011, APRA undertook a data collection to assess whether the failure or
significant downgrade of a major reinsurer was a material risk for the industry.
Pleasingly, the information provided showed that the industry is well diversified in terms
of reinsurance counterparties from a geographical standpoint and across APRA and nonAPRA-authorised reinsurers. In excess of 90% of the reinsurers utilised are also rated
APRA grade 3 (S&P A-rated) or higher. APRA is considering whether to make this data
collection permanent so that it can more readily monitor reinsurer counterparty
exposure.
Placement risk
The catastrophe events in Australia and New Zealand in 2010 and 2011 led to some
reinsurers reducing or restructuring the cover they are willing to provide in the region, or
requiring significant price increases for some types of cover. Consequently, some insurers
may retain greater catastrophe risk on their balance sheet, in turn increasing the
volatility of their capital position and also their capital requirements.
For insurers with material property exposures, APRA has been undertaking targeted
reviews of their reinsurance strategy and its alignment with their risk and capital
management strategy. APRA will continue its targeted reinsurance reviews throughout
2012 and provide feedback to individual insurers and the industry on the outcomes.
APRA has also been looking at changes made to reinsurance arrangements and capital
triggers, the robustness of stress-testing for catastrophe events and the use of
catastrophe models. These reviews are intended to provide APRA with a better overall
view of the impact on industry from the recent catastrophe events and the changes
occurring in the reinsurance market. It is also highlighting areas of good practice and
where there is room for improvement.
Reinsurance and the use of modelling
One such area is in relation to catastrophe models where poor governance practices in
the use of these models can have a significant impact on an insurer.
Reinsurance & use of models
• Reinsurance management
o Reinsurance arrangements statement
o Future stress testing
• Reinsurance modeling
o Use of & reliance on models
o Model uncertainty
o Model governance
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The series of catastrophe events over 2010/2011 and into 2012 had, and will continue to
have, a significant impact on the general insurance industry. The events highlighted
several issues that warrant close attention from both industry and APRA.
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For example, each insurer needs to better articulate in their Reinsurance Arrangement
Statement (RAS) what their actual reinsurance arrangements are and how they operate,
including worked examples. The schematics in the RAS need to accurately reflect the
words (and vice versa).
Also, insurers should make greater use of stress testing as part of establishing their
reinsurance arrangements. In particular, APRA has suggested that insurers should
consider the potential impact of a series of events similar to those of 2010/2011, the
erosion of lower layers and back up covers, and further reinstatements being unavailable.
As you know, APRA sets a minimum standard based on 1 in 250 (soon to be 1 in 200)
probability.
Obviously it is not a simple matter to assess the cover to meet this standard, and models
are used extensively for this purpose. However, we are concerned that there may be an
over-dependence on these models in setting reinsurance catastrophe cover.
Some insurers accept the model outputs blindly and use this for the purchase of their
catastrophe cover. Others rely heavily on their reinsurance brokers and their models to
the same extent. Some insurers use multiple models to set their cover. But they may
then choose the lowest of the results produced.
The models can be something of a black box to the insurers of course, which might
encourage this blind acceptance of the model’s results.
Our concern stems from the degree of error in the models and whether boards and
management understand this and take it into account in setting their cover.
All models have limitations. The output is dependent on the data provided, the
assumptions in the model, the reliance on known history, which perils are modelled, the
sophistication of the modelling engine etc. The relevance of the result of course is then
subject to the vagaries of the real world (e.g. an unknown earthquake fault!).
The net result is that at best a model gives an estimate and its results are subject to a
significant margin of error.
It is dangerous to ignore this.
And so we are urging management and boards to recognize the limitations of models, and
to challenge and debate the model outputs and in the process to recognize the inherent
errors in these outputs. They should then consider their risk appetite for having
inadequate catastrophe cover, and set their cover taking all of this into account. APRA’s
minimum requirement - and it is just a minimum - should be only one factor in this
consideration.
APRA is currently considering whether we could provide some guidance for boards and
management on this issue. In the meantime we are reviewing catastrophe modelling
reports of a number of insurers to better understand the processes followed.
Pricing processes
Sound pricing practices and processes are fundamentally important for insurers for the
maintenance of a sound and profitable business. Review of insurer pricing processes and
controls forms a core part of APRA’s supervision activities, and we see heightened risk in
this area at present for a number of reasons. These include increased competition within
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the industry (including from aggregators), likely increases in reinsurance retentions and
costs, low interest rates and the deterioration in the profitability of some classes of
business that may have been masked by the release of reserves in recent years.
Further, APRA’s reviews of pricing processes and controls suggest that there is room for
improvement in the development of technical prices, and in the management of actual
versus technical prices.
Adequacy of reserving
Reserve releases have been a feature of general insurers’ results in recent years and, as
noted above, have the potential to mask deterioration in profitability. This is also an
area that is looked at on a regular basis by APRA. However the current challenging
environment for the industry heightens the risk of reserve releases being used to boost
apparent profitability.
APRA is undertaking an internal review of the reserving strength of a range of insurers,
focusing on the underlying assumptions and methodologies used across key classes of
business. APRA will look to provide specific feedback to individual insurers once the
review is completed and will also consider publishing any general observations on
industry practice that may emerge from the review.
Conclusion
Let me finish now.
I have covered a lot of ground this morning and hopefully given you some insights into our
current thinking and concerns.
Thank you for your time.
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