Basis of preparationBasis of preparation

Basis of preparation

Unless specified otherwise, general insurers are requested to follow the Australian accounting standards regarding the definition, recognition and measurement of assets, notably AASB 1023 ‘General Insurance Contracts’ (AASB 1023).

Definition of insurance business

Insurers are to follow the definition of insurance business provided in section 3 of the Act.

Inside Australia

Section 28 of the Act requires all general insurers to maintain assets in Australia (excluding goodwill and other amounts excluded by Prudential Standard GPS 120 Assets in Australia) of a value that equals or exceeds the total amount of the general insurer’s liabilities in Australia.

• Requirement to maintain assets Inside Australia

This requirement is designed to ensure that the total value of assets held within the jurisdictional reach of APRA and the Australian courts is sufficient to meet a general insurer’s Australian liabilities. It assists in the application of subsection 116(3) of the Act, which provides that in the winding up of a general insurer, the assets in Australia shall not be applied in the discharge of its liabilities other than its liabilities in Australia unless all the Australian liabilities have first been discharged.

Reinsurance

The Act permits certain reinsurance assets to be regarded as assets in Australia. For the purposes of the Act, an amount is taken to be an asset in Australia of a general insurer if:

(a) the insurer expects to recover the amount under a contract of reinsurance entered into with a person outside Australia; and

(b) the amount relates to claims in respect of liabilities in Australia of the insurer, whether or not the claims have been paid by the insurer; and

(c) under the terms of the contract, payments by way of reinsurance are to be made in Australia.

• Reinsurance Assets due from non-APRA-authorised reinsurers

Different treatment is accorded to certain reinsurance assets[7] due from a ‘non-APRA-authorised reinsurer’[8] as specified in GPS 114.

The applicable investment risk charge is calculated in accordance with GPS 114 based on whether the amount is recoverable from ‘APRA-authorised reinsurers’[9] or ‘non-APRA-authorised reinsurers’. Different investment risk charges apply for reinsurance recoverables due from ‘non-APRA-authorised reinsurers’ on and from the second balance date after the end of the financial year in which the event giving rise to the recoverables occurred. These risk charges apply only to the extent that the reinsurance recoverables are not supported by collateral, guarantee or a letter of credit. This treatment applies to reinsurance recoverables from non-APRA authorised reinsurers under reinsurance contracts incepting on or after 31 December 2008.

Where reinsurance recoverables are supported by collateral, guarantee or a letter of credit, only the risk charges applying to the counterparty providing the support will be applied as calculated in GRF 130.3 Off Balance Sheet Business – Credit Support Received.

For the purposes of determining the amount of reinsurance recoverable, if there is an offsetting arrangement between the insurer and the reinsurer that results in premium being withheld by the insurer in lieu of claim payments, the withholding of that premium is taken to be payment. However, if there is a requirement for offsets to be approved by the reinsurer the date of the offset request is taken to be the date of the request for payment.

• Limited Risk Transfer Arrangements

An insurer must submit to APRA details of all proposed limited risk transfer arrangements[10] for approval prior to entering into such arrangements. APRA may approve a limited risk transfer arrangement as either a reinsurance arrangement or a financing arrangement.

APRA will generally consider a limited risk transfer arrangement to be a reinsurance arrangement where the purpose and effect of the arrangement is to genuinely transfer significant insurance risk from the insurer to another re(insurer).

A limited risk transfer arrangement that is approved by APRA as a reinsurance arrangement must be treated accordingly by the insurer for prudential purposes.

A limited risk transfer arrangement that is approved by APRA as a financing arrangement must be accounted for by the insurer so that:

(a) the arrangement has a legitimate purpose and effect; and

(b) the arrangement will not misrepresent, or is not designed to disguise, a material risk to the insurer’s current or continuing profitability, solvency or capital adequacy from any party.

The terms and conditions of the financing arrangement will determine the appropriate accounting treatment for prudential purposes.

Where APRA determines that a limited risk transfer arrangement is to be treated as a financing arrangement, the insurer must not treat the arrangement as reinsurance for the purpose of determining the MCR under the Capital Standards[11] or as reinsurance for any other purpose.

• Deferred reinsurance expense

Insurers should capitalise the cost of reinsurance at inception as deferred reinsurance expense (DRE), and expense that capitalised amount over the life of the reinsurance coverage. The establishment of the DRE will be associated with the establishment of a liability to pay a reinsurance premium; the liability will be reduced as payments are made. The payment of the premium occurs according to the reinsurance contract, and the expensing of the DRE occurs in accordance with the expected pattern of the incidence of risk.