Investment Risk Capital Charge
- This Guidance Note details the calculation of the Investment Risk Capital Charge for an insurer using the Prescribed Method to determine its Minimum Capital Requirement (MCR).
- The capital charge for investment risk is in response to the risk of an adverse movement in the value of an insurer’s on-balance sheet assets and/or certain off-balance sheet obligations. Investment risk derives from a number of sources. These include:
(a) credit risk the risk of an adverse movement in the value of an asset owing to changes in the credit quality of the issuer of that asset (including the default of the issuer);
(b) market/mismatch risk the risk of an adverse movement in the value of an asset, which is not offset by a corresponding movement in the value of liabilities; and
(c) liquidity risk the risk that the reported asset value will not be readily realised in certain circumstances.
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It is not possible to devise a simple capital framework that takes all of these risk factors into an account in an accurate fashion. The capital charge for Investment Risk attempts to cover these risks by requiring insurers to hold an amount of capital against each asset that is proportional to the value of that asset. The capital factors assigned to assets reflect broad judgements by APRA for capital adequacy purposes only, and should not be taken as a substitute for individual company assessments of the risks associated with particular assets. Over and above the minimum capital requirements required by this Standard, the Board and senior management of an insurer have primary responsibility for ensuring that adequate systems are in place to individually assess the risks in an insurer’s operations, to allocate the appropriate amount of capital to cover that risk and to suitably value the transactions that give rise to that risk.
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To calculate the capital charge for Investment Risk, each of an insurer’s assets (and certain off-balance sheet exposures) is assigned to one of nine categories. The Investment Risk Capital Charge is determined by multiplying the balance sheet value of each asset by the appropriate Investment Capital Factor for its category (subject to any thresholds in the case of assets exceeding the specified thresholds detailed in paragraphs 16-18). The total capital charge for Investment Risk is the sum of the Investment Risk Capital Charges for each individual asset. The Investment Capital Factors to be applied to each asset are presented in Attachment 1 to this Guidance Note.
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For the purpose of applying the capital factors, the term ‘debt obligations’ refers to all loans, deposits, placements, interest rate securities and other payables. Where reference is required to credit/counterparty ratings, these should be applied in accordance with Attachment 2.