Prudential Standard GPS 340 Insurance Liability Valuation
Insurance Act 1973
I, Helen Rowell, a delegate of APRA:
(a) under subsection 32(4) of the Insurance Act 1973 (the Act), revoke Insurance (prudential standard) determination No. 3 of 2018, including Prudential Standard GPS 340 Insurance Liability Valuation, made under that Determination; and
(b) under subsection 32(1) of the Act determine Prudential Standard GPS 340 Insurance Liability Valuation, in the form set out in the Schedule, which applies to:
(i) all general insurers and authorised NOHCs; and
(ii) a subsidiary of a general insurer or authorised NOHC, where that subsidiary is a parent entity of a Level 2 insurance group.
This instrument commences on 1 July 2023.
Dated: 24 May 2023
[Signed]
Helen Rowell
Deputy Chair
Interpretation
In this instrument:
APRA means the Australian Prudential Regulation Authority.
authorised NOHC has the meaning given in section 3 of the Act.
general insurer has the meaning given in section 11 of the Act.
Level 2 insurance group has the meaning given in Prudential Standard GPS 001 Definitions.
parent entity has the meaning given in Prudential Standard GPS 001 Definitions.
subsidiary has the meaning given in Prudential Standard GPS 001 Definitions.
Schedule
Prudential Standard GPS 340 Insurance Liability Valuation, comprises the document commencing on the following page.
Objectives and key requirements of this Prudential Standard<br>This Prudential Standard sets out requirements for the valuation of insurance liabilities of a general insurer or Level 2 insurance group.<br>The ultimate responsibility for the valuation of insurance liabilities rests with the Board of the general insurer or Level 2 insurance group.<br>A general insurer or Level 2 insurance group must value its insurance liabilities in accordance with the principles and methodology set out in this Prudential Standard.<br>For the purposes of the capital standards and reporting requirements under the Financial Sector (Collection of Data) Act 2001 (Collection of Data Act), a general insurer’s or Level 2 insurance group’s insurance liabilities must be valued in accordance with this Prudential Standard.
This Prudential Standard is made under section 32 of the Insurance Act 1973 (the Act).
Application and commencement
2. This Prudential Standard applies to each:
(a) general insurer authorised under the Act (insurer); and
(b) Level 2 insurance group as defined in Prudential Standard GPS 001 Definitions (GPS 001).
3. Where a requirement applies to a Level 2 insurance group, the requirement is imposed on the parent entity of the Level 2 insurance group.
4. This Prudential Standard applies to insurers and Level 2 insurance groups (regulated institutions) and commences on 1 July 2023.
Interpretation
5. Terms that are defined in GPS 001 appear in bold the first time they are used in this Prudential Standard.
Valuation of insurance liabilities
6. An insurer must value its insurance liabilities in accordance with this Prudential Standard, whether or not the insurer is required to have an Appointed Actuary. The valuation must then be used for the purpose of:
(a) calculating the insurer’s prescribed capital amount in accordance with the capital standards; and
(b) completing the insurer’s yearly statutory accounts in accordance with reporting standards made under the Collection of Data Act.
7. Requirements for the measurement and reporting of insurance liabilities for Level 2 insurance groups are set out in Attachment A of this Prudential Standard.
8. An insurer must determine a value for both its outstanding claims liabilities and its premiums liabilities for each class of business underwritten by the insurer.
9. Outstanding claims liabilities relate to all claims incurred prior to the valuation date, whether or not they have been reported to the insurer. The value of the outstanding claims liabilities must include an amount in respect of claims handling expenses. An insurer must determine the outstanding claims liabilities on a prospective basis, reflecting the ultimate payments required to settle outstanding claim obligations, both net and gross of:
(a) reinsurance recoverables; and
(b) non-reinsurance recoveries.
10. Premiums liabilities relate to all future claim payments arising from future events post the valuation date that will be insured under the insurer’s existing policies that have not yet expired including unclosed business. The value of the premiums liabilities must include an amount in respect of claims handling expenses and policy administration expenses and allow for expected premium refunds. In respect of premiums liabilities for which reinsurance has not yet been purchased, allowance must be made for this reinsurance in the premiums liabilities valuation (refer to paragraphs 36 to 44 of this Prudential Standard for further details on the assumptions relating to this reinsurance). Premiums liabilities are to be determined on a prospective basis, both net and gross of:
(a) expected reinsurance recoveries; and
(b) non-reinsurance recoveries.
11. Reinsurance recoverables and expected reinsurance recoveries should not be reduced for the risk of non-performance of the reinsurer as the risk of non-performance is considered in Prudential Standard GPS 114 Capital Adequacy: Asset Risk Charge (GPS 114).
12. The value of outstanding claims liabilities and premiums liabilities must not include any Government charges imposed such as levies, duties and taxes. Also, acquisition expenses should not be reported as part of the value of outstanding claims liabilities or premiums liabilities valued under this Prudential Standard.
13. Premiums liabilities relating to insurance and reinsurance contracts written on a long-term (or continuous) basis, with the option for the party accepting the risk to cancel the contract prior to the expiry date, must make allowance for future claims anticipated to arise from risks covered up to the next possible cancellation date[1]. For instance, a multi-year contract may be written on the basis that it may be cancelled by the risk carrier on a particular date (cancellation date) or within a particular period (so that the earliest cancellation date may be determined). In this case, the insurer or reinsurer would need to account for premiums liabilities for any unexpired risks which may:
(a) arise up to and including the cancellation date; or
(b) remain after the cancellation date.
14. In determining the value for outstanding claims liabilities and premiums liabilities, an insurer must determine a value for the central estimate and associated risk margin by class of business (subject to considerations of materiality and the professional judgement of the Appointed Actuary). The insurer must therefore calculate and report separately to APRA, and by class of business, central estimates and risk margins for outstanding claims liabilities and premiums liabilities.[2] However, this should not prevent analysis being undertaken on a basis which is more suitable, taking into account the nature of the data and the particular circumstances of the insurer.
15. The valuation of insurance liabilities reflects the individual circumstances of the insurer. In any event, the minimum value of insurance liabilities must be the greater of a value that is:
(a) determined on a basis that is intended to value the insurance liabilities of the insurer at a 75 per cent level of sufficiency; and
(b) the central estimate plus one half of a standard deviation above the mean for the insurance liabilities of the insurer.
16. The principles of this Prudential Standard must be applied to the calculation of both gross and net insurance liabilities.
The central estimate
17. The central estimate is intended to reflect the mean value in the range of possible values for the outcome (that is, the mean of the distribution of probabilistic outcomes). The determination of the central estimate must be based on assumptions as to future experience which reflect the experience and circumstances of the insurer and which are:
(a) made using judgement and experience;
(b) made having regard to available statistics and other information; and
(c) neither deliberately overstated nor understated.
18. Where experience is highly volatile, model parameters estimated from the experience can also be volatile. The central estimate must therefore reflect as closely as possible the likely future experience of the insurer. Judgement may be required to limit the volatility of the assumed parameters to that which is justified in terms of the credibility of the experience data.
19. The central estimate will be measured as the present value of the future expected payments. This measurement process will involve prospective calculations and modelling techniques, and will require assumptions in respect of the expected future experience, taking into account all factors which are considered to be material to the calculation, including:
(a) discount rates;
(b) claims escalation;
(c) claims handling expenses and policy administration expenses; and
(d) claims run-off.
20. In establishing the central estimate assumptions, regard must be given to the materiality of:
(a) the class of business being considered; and
(b) the effect of particular assumptions on the determined result.
21. The assumptions used must be consistent for the estimation of both outstanding claims liabilities and premiums liabilities. Where they are not, the reasons must be documented.
The risk margin
22. The risk margin is the component of the value of the insurance liabilities that relates to the inherent uncertainty that outcomes will differ from the central estimate. It is aimed at ensuring that the value of the insurance liabilities is established at an appropriate and sufficient level. The risk margin does not relate to the risk associated with the underlying assets, such as asset-liability mismatch risk.
23. Risk margins must be determined, for each class of business and in total, on a basis that reflects the experience of the insurer. In any event, the risk margins must be valued so that the insurance liabilities of the insurer, after any diversification benefit, are not less than the greater of a value that is:
(a) determined on a basis that is intended to value the insurance liabilities of the insurer at a 75 per cent level of sufficiency; and
(b) the central estimate plus one half of a standard deviation above the mean for the insurance liabilities of the insurer.
24. When selecting the methodology and assumptions to be used in determining the risk margin for a class of business, consideration should be given to a range of factors, including:
(a) the robustness of the valuation models;
(b) the reliability and volume of the available data and other information;
(c) past experience of the insurer and the general insurance industry; and
(d) the particular characteristics of each class of business.
25. Estimation of a standard deviation above the mean may present technical difficulties when components of the uncertainty in the central estimate do not permit statistical analysis to be undertaken. Estimation of a standard deviation above the mean will generally require both the exercise of judgement and technical analysis.
26. The risk margin must not be used as a tool for smoothing the effect of changes in assumptions or valuation methods.
27. From year to year, risk margins would generally be a similar percentage of the central estimate for each class of business, unless there has been a material change in uncertainty. Changes in uncertainty may derive from changes in a number of elements such as reinsurance arrangements and recoveries, the insurer’s risk profile or volume of business, or external factors (for example, legislative requirements). The Appointed Actuary must document any material changes.
28. The risk margin may include an allowance for diversification. The reporting standards made under the Collection of Data Act require the insurer to report a stand-alone risk margin and a diversified risk margin for each of the insurer’s classes of business. The stand-alone risk margin refers to the risk margin that would be applied to a class of business where no allowance for diversification with other classes of business has been allowed. The diversified risk margin refers to the risk margin that has been applied to the class of business after allowance for diversification across the whole insurance portfolio. The Appointed Actuary must clearly document the justification for and method of determining such diversification allowance (which must be assessed on a holistic basis for the insurer).
29. The allowance for diversification for an insurer must only reflect the insurance portfolio within the insurer. The allowance for diversification for a Level 2 insurance group must only reflect the various insurance portfolios within the group.
Discount Rates
30. The rates to be used in discounting the expected future claims payments of insurance liabilities denominated in Australian currency for a class of business are derived from yields of Commonwealth Government Securities (CGS), as at the calculation date, that relate to the term of the future insurance liability cash flows for that class.
31. Where the term of the insurance liabilities denominated in Australian currency exceeds the maximum available term of CGS, other instruments with longer terms and current observable, objective rates are to be used as a reference point for the purpose of extrapolation. If there are no other suitable instruments, or the Appointed Actuary elects to use an instrument that does not meet this requirement, the Appointed Actuary must justify the reason for using that particular instrument in the insurer’s AVR. Adjustments must be made to remove any allowances for credit risk and illiquidity that are implicit in the yields of those instruments.
32. For foreign insurance liabilities not denominated in Australian currency, the risk-free discount rate must be based on the yields of highly liquid sovereign risk securities with current observable, objective rates, in the currency of the insurance liabilities and with counterparty grade 1. If there are no securities satisfying this requirement, or the Appointed Actuary elects to use an instrument that does not meet this requirement, the Appointed Actuary must justify the reason for using that particular instrument in the insurer’s AVR. Adjustments must be made to remove any allowances for credit risk and illiquidity that are implicit in the yields of those instruments.
Methods for valuing insurance liabilities
33. A method, or methods, must be adopted for valuing an insurer’s insurance liabilities. Comprehensive actuarial analysis and modelling techniques should be employed, subject to considerations of materiality. The appropriateness of any method, or methods, will depend on:
(a) the class of business being considered;
(b) the nature, volume and quality of the available data in relation to the experience of the insurer and the industry;
(c) the circumstances of the insurer; and
(d) considerations of materiality.
34. Approximate methods may be used when valuing an insurer’s insurance liabilities subject to the principles of this Prudential Standard, and where the result is not material or not materially different from that which would result from a full valuation process. The onus for justification of the appropriateness of any valuation method rests with:
(a) the Board of the insurer; and
(b) the Appointed Actuary.
Claims escalation
35. Appropriate allowance must be made for future claims escalation when determining the central estimates of both outstanding claims liabilities and premiums liabilities. Future claims payments may increase over current levels as a result of wages or price increases (inflation) and/or court-awarded interest, other environmental or economic causes (superimposed inflation). Claims payments include third party costs incurred in settling those claims, for example, investigation, medical and legal fees.
Estimation of reinsurance recoverables
36. The estimation of the value of the insurance liabilities may be undertaken on a gross basis, with a separate estimate of the value of reinsurance recoveries (that is, amounts expected to be recovered under the insurer’s reinsurance arrangements), or on a net basis. In either case, the principles of this Prudential Standard must be applied. Where the process is undertaken on a net basis, it is still necessary to value separately the estimates of the gross insurance liabilities and the reinsurance recoverables and expected reinsurance recoveries.[3]
Documentation of reinsurance arrangements
37. For the purpose of calculating an insurer’s insurance liabilities, it must be assumed initially that:
(a) reinsurance arrangements are fully documented;
(b) reinsurance arrangements are 100 per cent placed, that is, there are no gaps in the insurer’s reinsurance arrangements; and
(c) reinsurance recoverables and expected reinsurance recoveries will be received in full.[4]
Where reinsurance arrangements are not fully documented or are not fully placed, or there is a material risk that reinsurance recoverables and expected reinsurance recoveries will not be received from a reinsurer, the insurer will either not be able to recognise the reinsurance recoverables and expected reinsurance recoveries or will be required to hold capital against these risks.[5]
Assessment and comment by the Appointed Actuary
38. The Appointed Actuary[6] must make a specific assessment of and comment on the recoverability of reinsurance recoverables and expected reinsurance recoveries from non-APRA authorised reinsurers. The Appointed Actuary must consider all relevant matters, including:
(a) quality of information and data available on potential reinsurance recoverables;
(b) credit risk;
(c) willingness to pay;
(d) documentation and placement of contracts; and
(e) any legal or other issues that may create an impediment to the insurer realising the reinsurance asset.
39. Aggregate reinsurance recoverables and expected reinsurance recoveries must be separated into subsets which identify those that derive from documented and non-documented reinsurance arrangements, those that derive from reinsurance arrangements that are fully placed and not fully placed, and those likely to be recoverable and those not likely to be recoverable from reinsurers. In providing this advice, the Appointed Actuary must consider the materiality of reinsurance recoverables and expected reinsurance recoveries. If they are material, the Appointed Actuary must assess the potential range of amounts not recoverable from reinsurers, based on the uncertainty of individual and aggregate gross losses. For the purposes of GPS 114, the reinsurance recoverables due from non-APRA-authorised reinsurers for each accident year must be identified in the AVR.
Treatment of reinsurance expenses
40. APRA maintains a consistent approach in allowing for the cost of all types of reinsurance arrangements. The principle is that APRA requires an insurer to ensure in all prudential reporting that reinsurance coverage matches the risk exposures in the underlying portfolio, irrespective of the type of reinsurance contract.
41. For the calculation of premiums liabilities, the premiums liabilities must include the future cost of any reinsurance arrangements required to fully cover the exposure period for premiums liabilities. This may include an additional cost for existing reinsurance contracts where the expense is yet to be recognised under Australian Accounting Standards as well as an additional reinsurance purchase cost for any part of the premiums liabilities not covered by current reinsurance arrangements[7]. To the extent that a cost for current reinsurance arrangements covering premiums liabilities has already been recognised under Australian Accounting Standards, insurers are not required to also include that same cost in the premiums liabilities.
42. For any part of the current reinsurance arrangements that cover future business that has not been written, that portion of the associated cost of reinsurance cannot be used to reduce premiums liabilities calculated under this Prudential Standard. The cost of reinsurance for future business can be used to increase the surplus (or decrease the deficit) in premiums liabilities calculated in accordance with GPS 112 if the reinsurance arrangements meet the requirements of Prudential Standard GPS 230 Reinsurance Management (GPS 230) and if the cost has already been recognised under the Australian Accounting Standard. This revised surplus (or deficit) is included as part of adjusted net assets in Australia for Category C insurers and the capital base for all other insurers.
Allowance for future reinsurance expense
43. The estimation of expected reinsurance recoveries in respect of premiums liabilities for which reinsurance has not yet been purchased can assume that the necessary reinsurance related to those liabilities will be purchased and documented. Allowance must be made for the purchase cost of this future reinsurance expense in the premiums liabilities valuation. This assumption must only be made when:
(a) existing reinsurance arrangements are documented;
(b) the estimated expected reinsurance recoveries relate to the same classes of business that are currently covered by the existing documented reinsurance arrangements; and
(c) it is fully expected that the reinsurance will be replaced on similar terms when current arrangements expire.
Estimation undertaken on the combined claims experience of several classes of business
44. The estimation of the value of reinsurance recoverables and expected reinsurance recoveries would normally be undertaken on the basis of each class of business written by the insurer. However, there are certain forms of reinsurance where reinsurance recoveries and expected reinsurance recoveries receivable depend on the combined claims experience of several or all classes of business underwritten by the insurer. In such instances, the estimation will be required to factor in all the individual results by class of business covered by the reinsurance arrangements.
Non-reinsurance recoveries
45. Non-reinsurance recoveries are amounts that may be recovered under arrangements other than reinsurance arrangements, such as salvage, subrogation and sharing agreements. The treatment of non-reinsurance recoveries must be consistent with that required by reporting standards made under the Collection of Data Act.
Adjustments and exclusions
46. APRA may, by notice in writing to an insurer, adjust or exclude a specific requirement in this Prudential Standard in relation to that insurer.
Previous exercise of discretion
47. A regulated institution must contact APRA if it seeks to place reliance, for the purposes of complying with this Prudential Standard, on a previous exemption or other exercise of discretion made by APRA under a previous version of this Prudential Standard.
Attachment A – Level 2 insurance groups
Valuation of insurance liabilities
A Level 2 insurance group may consist of Australian business only (insurers authorised by APRA) or may comprise both Australian and international business.
2. Subject to paragraph 5 of this Attachment, a Level 2 insurance group must determine the value of its insurance liabilities in a manner consistent with that set out in this Attachment. The valuation must then be used for the purpose of:
(a) calculating the Level 2 insurance group’s prescribed capital amount in accordance with the capital standards; and
(b) completing the Level 2 insurance group’s accounts in accordance with reporting standards made under the Collection of Data Act.
Australian business
3. In respect of Australian business, the insurance liability valuation for a Level 2 insurance group should be consistent with that for an insurer under this Prudential Standard subject to identified consolidated adjustments such as intra-group transactions and diversification. In the case of a Level 2 insurance group with only Australian business, the valuation of group insurance liabilities must be based on the valuation of each insurer in the group and must be compiled as follows:
(a) the sum of the insurance liabilities for each insurer in the group; plus or minus
(b) consolidation adjustments for intra-group transactions (which are likely to be eliminations); plus or minus
(c) consolidation adjustments for diversification benefits in risk margins (if any); plus or minus
(d) any other adjustments the Group Actuary considers necessary to comply with this Prudential Standard.
4. On the application of the parent entity of a Level 2 insurance group, APRA may determine in writing that the Group Actuary of the Level 2 insurance group can apply the method set out in paragraphs 5 to 8 of this Attachment in relation to its Australian business. APRA may specify that the determination is subject to conditions.
International business
5. In the case of a Level 2 insurance group with international business, the Group Actuary must also determine appropriate values in respect of outstanding claims and premiums liabilities for the international controlled entities before applying the steps described in paragraph 3 of this Attachment.
6. The consolidated accounts of the group prepared in accordance with Australian Accounting Standards will include consolidated insurance assets and liabilities (and corresponding reinsurance assets and liabilities).
7. In respect of international business, the Group Actuary may adopt derived valuations for outstanding claims liabilities and premiums liabilities based on accounting records for the group subject to:
(a) assessment by the Group Actuary that the derived valuations are appropriate and exceed (are more conservative than) the requirements of this Prudential Standard; and
(b) making any other adjustments required as a consequence of this assessment.
The requirements specified in paragraphs 7(a) and 7(b) will not apply to international consolidated entities which APRA deems to be immaterial. The parent entity of a Level 2 insurance group will need to consult with APRA prior to excluding any international consolidated entities from the requirements in paragraphs 7(a) and 7(b). Consolidation adjustments referred to in paragraph 3 of this Attachment may also be required.
8. The business segments used should not combine Australian and international businesses in the same segments for the purposes of determining the outstanding claims liabilities and premiums liabilities of a Level 2 insurance group because the Australian business already has outstanding claims liability and premiums liability estimates from its AVR that is used as a component of the group results.
9. The determination of the capital base of a Level 2 insurance group where premiums liabilities are reported on the basis of paragraphs 7 and 8 of this Attachment will, in some circumstances, differ to that prescribed under GPS 112. Any amount of premiums liabilities determined using accounting entries which is higher than the premiums liabilities defined by this standard at a 75 per cent level of sufficiency (i.e. a surplus) cannot be included in the capital base of the Level 2 insurance group as a surplus technical provision. Any amount of premiums liabilities determined using accounting entries which is lower than the premiums liabilities defined by this prudential standard at a 75 per cent level of sufficiency (i.e. a deficit) must be included in the capital base of the Level 2 insurance group as a deficit technical provision.
[1] Material net written premium, for exposure not already included in the calculation of the premiums liabilities is to be treated in line with the requirements of Prudential Standard GPS 115 Capital Adequacy: Insurance Risk Charge.
[2] Such reporting is required in both an AVR and in statutory reporting (refer to reporting standards made under the Collection of Data Act).
[3] This is also required to comply with reporting standards made under the Collection of Data Act.
[4] For further detail in respect of documentation of reinsurance arrangements, refer to Prudential Standard GPS 230 Reinsurance Management.
[5] Refer to reporting standards made under the Collection of Data Act for recognition of the reinsurance recoverables and expected reinsurance recoveries. Refer to Prudential Standard GPS 112 Capital Adequacy: Measurement of Capital (GPS 112) and Prudential Standard GPS 110 Capital Adequacy for detail in respect of capital requirements in relation to these risks.
[6] If an insurer is exempt from the requirement to appoint an actuary, the insurer must make the assessment and comment as required by this paragraph.