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Prudential Standard GPS 110

Capital Adequacy

Authority

1. This Prudential Standard is made under section 32 of the Insurance Act 1973 (the Act).

Application

2. This Prudential Standard applies to insurers authorised under the Act.[1]

3. Further details of the requirements outlined below are specified in other capital standards.

4. Subject to any specific transition rules, this Prudential Standard applies to insurers from 1 July 2008 (effective date).

5. As a consequence of the key role played by capital in the financial health of an insurer, every insurer must maintain sufficient capital to enable its insurance obligations to be met under a wide range of circumstances. This required level of capital for regulatory purposes is referred to as the Minimum Capital Requirement (MCR).

Interpretation

6. Unless otherwise defined in this Prudential Standard, expressions in bold are defined in Prudential Standard GPS 001 Definitions.

Definition of capital base

7. In assessing the adequacy of an insurer’s capital base, attention must be paid not only to the types of events or problems that it might encounter, but also to the quality of the support provided by various types of capital instruments. The following matters are relevant to whether a capital instrument is adequate for supervisory purposes, namely the extent to which each instrument:

(a) provides a permanent and unrestricted commitment of funds;

(b) is freely available to absorb losses;

(c) does not impose any unavoidable servicing charges against earnings; and

(d) ranks behind the claims of policyholders and creditors in the event of the winding-up of the insurer.

8. Not all types of capital instruments meet these criteria equally. Due to the need to ensure that the capital base of an insurer provides adequate support, APRA imposes some restrictions on the composition of capital eligible to meet the MCR. The capital instruments deemed eligible for inclusion in an insurer’s capital base, and the conditions as to their inclusion, are specified in Prudential Standard GPS 112 Capital Adequacy: Measurement of Capital (GPS 112). GPS 112 defines the different categories and components of eligible capital and the limits applicable to each category of eligible capital.

9. An insurer’s balance sheet may contain certain assets (such as deferred tax assets, goodwill and other intangibles) that are acceptable from an accounting perspective. However, for supervisory purposes, such assets are either generally not available, or of questionable value, should the insurer encounter difficulties. Insurers are therefore required to deduct from their capital base any holdings in these types of assets. Details of these deductions are provided in GPS 112.

10. An insurer must, at all times, maintain a capital base sufficient to enable its insurance obligations to be met under a range of circumstances. An insurer must, at all times, hold eligible capital[2] (after deductions) in excess of its MCR.[3] Where an insurer proposes any reduction in its capital base, it must obtain APRA’s prior written consent.[4]

Category C insurers

11. By the nature of its Australian balance sheet, a Category C insurer will not typically have capital instruments of the type specified in GPS 112. Category C insurers are nevertheless required to meet a variant of the MCR. Specifically, Category C insurers are required to maintain assets in AustraliaF[5] that exceed their liabilities in Australia (less technical provisions in excess of those required by Prudential Standard GPS 310 Audit and Actuarial Reporting and Valuation (GPS 310)) by an amount that is greater than the MCR determined by this Prudential Standard.

12. References to the capital base of an insurer elsewhere in this Prudential Standard are, where they are being applied to a Category C insurer, to be read as referring to ‘net assets in Australia’[6] of that insurer.

13. For further detail regarding the treatment of Category C insurers, refer to Prudential Standard GPS 120 Assets in Australia.

Minimum Capital Requirement (MCR)

14. An insurer’s capital base must be adequate for the scale, nature and complexity of its business and its risk profile. To this end, this Prudential Standard establishes a risk-based approach to the measurement of capital adequacy of an insurer. The MCR is intended to be commensurate with the full range of risks to which an insurer is exposed (including risks relating to insurance claims, investments, counterparty default, asset-liability mismatches, catastrophic events, and operational errors and problems).

15. The MCR may be determined by an insurer using:

(a) an internal model developed by the insurer to reflect the circumstances of its business  the Internal Model Based (IMB) Method;[7] or

(b) the standardised framework detailed in this Prudential Standard – the Prescribed Method; or

(c) a combination of the methods specified in paragraphs (a) and (b).

16. Regardless of the outcome of the method used for determining the MCR, an insurer’s MCR cannot be:

(a) in the case of an insurer other than a Category D insurer or Category E insurer, less than $5 million; and

(b) in the case of a Category D insurer or Category E insurer, less than $2 million.

17. APRA recognises that any measure of the adequacy of an insurer’s capital base involves judgement and estimation, and requires the quantification of risks that may be difficult to quantify. As a result, APRA may, in writing, adjust an insurer’s MCR where it believes that the amount determined by the insurer does not adequately reflect the risk profile of the insurer.[8] In exercise of this discretion to adjust an insurer’s MCR, APRA will have regard to the following:

(a) the length of time the insurer has been operating;

(b) whether the insurer is in or appears likely to be in financial or operational difficulty;

(c) whether the insurer is deemed by APRA to have a disproportionate exposure to a particular type of risk;

(d) whether particular risks faced by an insurer are adequately dealt with by the prudential standards; and

(e) any other relevant matters.

18. In the normal course of business, an insurer must have in place capital management processes. These must be set out in the insurer’s Business Plan[9] in accordance with Prudential Standard GPS 220 Risk Management.

Internal Model Based Method

19. An insurer may use an in-house capital measurement model to calculate the MCR. Use of the IMB Method is conditional on APRA’s approval.[10] APRA requires insurers to satisfy a range of criteria, as set out in Prudential Standard GPS 113 Minimum Capital Requirement: Internal Model-Based Method (GPS 113).[11] In particular, APRA must be satisfied that the model is well designed, the analysis and assumptions used are sound, and that the results of applying the model are reasonable from a prudential viewpoint. Insurers which do not use an internal model that meets the criteria specified in GPS 113 must use the Prescribed Method described below.

Prescribed Method

20. For insurers using the Prescribed Method, the MCR is determined as the sum of the capital charges for:

(a) insurance risk;

(b) investment risk; and

(c) concentration risk.

Insurance risk

21. The Insurance Risk Capital Charge relates to the risk that the actual value of net insurance liabilities is greater than the value determined in accordance with GPS 310. The method for determining the Insurance Risk Capital Charge is set out in Prudential Standard GPS 115 Insurance Risk Capital Charge.

22. This capital charge has two components:

(a) a charge in respect of outstanding claims risk (Outstanding Claims Capital Charge); and

(b) a charge in respect of premiums liability risk (Premiums Liability Capital Charge).

The Outstanding Claims Capital Charge relates to the risk that the value of the net outstanding claims liabilities is greater than the value determined in accordance with GPS 310. The Premiums Liability Capital Charge relates to the risk that premiums relating to post calculation date exposures, including premiums written before but incepting after the calculation date, are insufficient to fund the liabilities arising from that business.

23. The Outstanding Claims Capital Charge is determined as the sum, over all classes of business of the insurer, of the value of the net outstanding claims liabilities for each class (determined in accordance with GPS 310), multiplied by the appropriate Outstanding Claims Capital Factor for that class.

24. The Premiums Liability Capital Charge is determined as the sum, over all classes of business of the insurer, of the net premiums liabilities for each class (determined in accordance with GPS 310), multiplied by the appropriate Premiums Liability Capital Factor for that class.

25. If an insurer securitises insurance liabilities, the net insurance liabilities may reduce. The insurer must consult APRA prior to entering into the securitisation transaction in order to be able to reduce the Insurance Risk Capital Charge and the Concentration Risk Capital Charge.

Investment risk

26. The Investment Risk Capital Charge relates to the risk of adverse movements in the value of an insurer’s assets or off-balance sheet exposures or both. Investment risk can be derived from a number of sources, including market risk and credit risk.

27. Subject to paragraphs 28 to 31, the Investment Risk Capital Charge is determined as the value of each investment multiplied by the relevant Investment Capital Factor for that investment, summed across all assets and certain off-balance sheet exposures.. For the purposes of this Prudential Standard, assets and exposures must be valued in accordance with the relevant reporting standards made under the Financial Sector (Collection of Data) Act 2001 (Collection of Data Act).[12] The method for determining the Investment Risk Capital Charge is set out in Prudential Standard GPS 114 Investment Risk Capital Charge (GPS 114).

28. The Investment Risk Capital Charge may reduce through the reduction in investment risk arising from the availability of risk mitigants (e.g. collateral security or guarantees), subject to the criteria specified in GPS 114.

29. An insurer must hold additional capital, in the form of an Investment Concentration Charge, if its exposure to a particular asset or counterparty exceeds the thresholds set out in GPS 114.

30. In certain circumstances, an insurer may choose to hold assets in a special purpose vehicle (SPV), rather than on its own balance sheet. Where APRA has approved the inclusion of a SPV as part of the insurer’s Extended Licensed Entity (ELE),[13]F the insurer is able to ‘look through’ the legal structures involved, to determine its Investment Risk Capital Charge (and any Investment Concentration Charge) based on the individual assets of the SPV, rather than simply on its direct exposure to the entity.

31. If an insurer securitises assets, the insurer must consult APRA prior to entering into the securitisation transaction in order to be able to reduce the Investment Risk Capital Charge.

Concentration risk

32. At a minimum, the Concentration Risk Capital Charge relates to the risk associated with an accumulation of exposures to a single catastrophic event at a single site. However, APRA will require a whole of portfolio approach to be implemented by an insurer if APRA assesses that the single event approach is inadequate in evaluating that insurer’s reinsurance needs. If this is required of an insurer and it does not comply with the requirement, the insurer’s MCR may be increased in accordance with paragraph 17. The method for determining the Concentration Risk Capital Charge is set out in Prudential Standard GPS 116 Concentration Risk Capital Charge (GPS 116). For lenders mortgage insurers, additional requirements for calculating the Concentration Risk Capital Charge are also set out in GPS 116.

33. The Concentration Risk Capital Charge is set equal to the insurer’s Maximum Event Retention (MER), plus the cost of one reinstatement of the catastrophe reinsurance cover in cases where the reinstatement reinsurance cover has not been pre-paid by the insurer. APRA will monitor an insurer’s calculation of its MER and may, where it is not satisfied with the methods or assumptions used, allow or require adjustments to be made to the calculation.[14]

34. In calculating the MER, an insurer may take into account potential reinsurance assets receivable from a reinsurance arrangement only if the reinsurance arrangement:

(a) complies with the two month rule and six month rule imposed under Prudential Standard GPS 230 Reinsurance Management (GPS 230); or

(b) fails to comply with those rules as at the date of the relevant deadline but:

(i) subsequent to the deadline specified under the two month rule, the reinsurance arrangement is documented in accordance with the other requirements of the two month rule (in which case the reinsurance assets from the reinsurance arrangement may be taken into account for the purposes of calculating the MER until the reinsurance arrangement fails to comply with the six month rule); or

(ii) subsequent to the deadline specified under the six month rule, the reinsurance arrangement is documented in accordance with the other requirements of the six month rule; or

(c) has been treated by APRA, under GPS 230, as complying with the two month rule and six month rule.

Disclosure

35. To improve policyholder and market understanding of its capital adequacy position, an insurer must publish annually the following items:

(a) the amount of eligible Tier 1 capital, with separate disclosure of each of the components of capital specified in GPS 112;

(b) the aggregate amount of any deductions from Tier 1 capital;

(c) the amount of eligible Tier 2 capital, with separate disclosure of each of the components of capital specified in GPS 112;

(d) the aggregate amount of any deductions from Tier 2 capital;

(e) the total capital base of the insurer derived from the items (a) to (d);

(f) the MCR of the insurer; and

(g) the capital adequacy multiple of the insurer (item (e) divided by item (f)).[15]

Reductions in capital

36. An insurer must obtain APRA’s written consent prior to making any planned reduction in its capital. APRA’s consent may be subject to conditions.

37. A reduction in an insurer’s capital includes, but is not limited to:

(a) a share buyback;

(b) the redemption, repurchase or early repayment of any qualifying Tier 1 and Tier 2 capital instruments issued by the insurer or an SPV;

(c) trading in the insurer’s own shares or capital instruments outside of any arrangement agreed upon with APRA in accordance with GPS 112;

(d) payment of dividends on ordinary shares that exceeds an insurer’s after-tax earnings, after including any payments on more senior capital instruments, in the financial year[16] to which they relate; and

(e) dividend or interest payments (whether whole or partial) on Upper Tier 2, Innovative Tier 1 and Non-innovative Residual Tier 1 capital that exceed an insurer’s after-tax earnings, including any payments made on more senior capital instruments, calculated before any such payments are applied in the financial year[17] to which they relate.

38. An insurer proposing a capital reduction must provide APRA with a forecast showing the projected future capital position after the proposed capital reduction. The forecast must extend for at least three years. The insurer must satisfy APRA that its capital, after the proposed reduction, will remain adequate for its future needs.

39. Any reference to the earnings or retained earnings of an insurer in paragraph 37 is a reference to the earnings or retained earnings of the insurer determined in a manner consistent with the insurer’s prudential reporting to APRA under the Collection of Data Act rather than in accordance with Australian Accounting Standards as required for statutory financial reporting under the Corporations Act 2001.

Reductions in capital for run-off insurers

40. This paragraph applies to a run-off insurer. The insurer must submit to APRA:

(a) documents clearly setting out and evidencing its current financial position; and

(b) a forecast required under paragraph 38 with insurance liabilities valued in accordance with the methodology set out in GPS 310, except that the valuation must demonstrate that the tangible assets of the insurer, after the proposed capital reduction, are sufficient to cover its insurance liabilities to a 99.5 per cent level of sufficiency, plus any other liabilities, as calculated by its Appointed Actuary.[18]

Category C insurers

41. Any repatriation of assets in Australia, whether direct or indirect, by a Category C insurer that will result in a reduction in its net assets in Australia must be subject to APRA’s prior consent consistent with the requirements of paragraphs 36 to 38.[19]

42. Paragraph 41 does not apply to any repatriation of assets in Australia out of the current year profits of a Category C insurer where the assets being repatriated to the head office of the Category C insurer or any other branch or related entity[20] of the Category C insurer do not exceed the Category C insurer’s after-tax earnings in the year to which they relate (i.e. a repatriation of assets not wholly or partly funded from retained earnings).

Transition for internal model

43. For the purposes of paragraph 19, the criteria that must be met for an internal model to be approved are those specified:

(a) at Attachment B to Prudential Standard GPS 110 Capital Adequacy made on 25 September 2006 until commencement of GPS 113; and

(b) in GPS 113 with effect from commencement of GPS 113.

Determinations made under previous GPS 110

44. An approval, determination, direction or requirement made by APRA under a provision specified in Column 1 of the following table that is in operation immediately prior to the commencement of this Prudential Standard is taken, on and from the effective date, to have been made under the provision of this Prudential Standard specified in the same row of Column 2 of the table.

Capital Adequacy

Authority

1. This Prudential Standard is made under section 32 of the Insurance Act 1973 (the Act).

Application

2. This Prudential Standard applies to insurers authorised under the Act.[1]

3. Further details of the requirements outlined below are specified in other capital standards.

4. Subject to any specific transition rules, this Prudential Standard applies to insurers from 1 July 2008 (effective date).

5. As a consequence of the key role played by capital in the financial health of an insurer, every insurer must maintain sufficient capital to enable its insurance obligations to be met under a wide range of circumstances. This required level of capital for regulatory purposes is referred to as the Minimum Capital Requirement (MCR).

Interpretation

6. Unless otherwise defined in this Prudential Standard, expressions in bold are defined in Prudential Standard GPS 001 Definitions.

Definition of capital base

7. In assessing the adequacy of an insurer’s capital base, attention must be paid not only to the types of events or problems that it might encounter, but also to the quality of the support provided by various types of capital instruments. The following matters are relevant to whether a capital instrument is adequate for supervisory purposes, namely the extent to which each instrument:

(a) provides a permanent and unrestricted commitment of funds;

(b) is freely available to absorb losses;

(c) does not impose any unavoidable servicing charges against earnings; and

(d) ranks behind the claims of policyholders and creditors in the event of the winding-up of the insurer.

8. Not all types of capital instruments meet these criteria equally. Due to the need to ensure that the capital base of an insurer provides adequate support, APRA imposes some restrictions on the composition of capital eligible to meet the MCR. The capital instruments deemed eligible for inclusion in an insurer’s capital base, and the conditions as to their inclusion, are specified in Prudential Standard GPS 112 Capital Adequacy: Measurement of Capital (GPS 112). GPS 112 defines the different categories and components of eligible capital and the limits applicable to each category of eligible capital.

9. An insurer’s balance sheet may contain certain assets (such as deferred tax assets, goodwill and other intangibles) that are acceptable from an accounting perspective. However, for supervisory purposes, such assets are either generally not available, or of questionable value, should the insurer encounter difficulties. Insurers are therefore required to deduct from their capital base any holdings in these types of assets. Details of these deductions are provided in GPS 112.

10. An insurer must, at all times, maintain a capital base sufficient to enable its insurance obligations to be met under a range of circumstances. An insurer must, at all times, hold eligible capital[2] (after deductions) in excess of its MCR.[3] Where an insurer proposes any reduction in its capital base, it must obtain APRA’s prior written consent.[4]

Category C insurers

11. By the nature of its Australian balance sheet, a Category C insurer will not typically have capital instruments of the type specified in GPS 112. Category C insurers are nevertheless required to meet a variant of the MCR. Specifically, Category C insurers are required to maintain assets in AustraliaF[5] that exceed their liabilities in Australia (less technical provisions in excess of those required by Prudential Standard GPS 310 Audit and Actuarial Reporting and Valuation (GPS 310)) by an amount that is greater than the MCR determined by this Prudential Standard.

12. References to the capital base of an insurer elsewhere in this Prudential Standard are, where they are being applied to a Category C insurer, to be read as referring to ‘net assets in Australia’[6] of that insurer.

13. For further detail regarding the treatment of Category C insurers, refer to Prudential Standard GPS 120 Assets in Australia.

Minimum Capital Requirement (MCR)

14. An insurer’s capital base must be adequate for the scale, nature and complexity of its business and its risk profile. To this end, this Prudential Standard establishes a risk-based approach to the measurement of capital adequacy of an insurer. The MCR is intended to be commensurate with the full range of risks to which an insurer is exposed (including risks relating to insurance claims, investments, counterparty default, asset-liability mismatches, catastrophic events, and operational errors and problems).

15. The MCR may be determined by an insurer using:

(a) an internal model developed by the insurer to reflect the circumstances of its business  the Internal Model Based (IMB) Method;[7] or

(b) the standardised framework detailed in this Prudential Standard – the Prescribed Method; or

(c) a combination of the methods specified in paragraphs (a) and (b).

16. Regardless of the outcome of the method used for determining the MCR, an insurer’s MCR cannot be:

(a) in the case of an insurer other than a Category D insurer or Category E insurer, less than $5 million; and

(b) in the case of a Category D insurer or Category E insurer, less than $2 million.

17. APRA recognises that any measure of the adequacy of an insurer’s capital base involves judgement and estimation, and requires the quantification of risks that may be difficult to quantify. As a result, APRA may, in writing, adjust an insurer’s MCR where it believes that the amount determined by the insurer does not adequately reflect the risk profile of the insurer.[8] In exercise of this discretion to adjust an insurer’s MCR, APRA will have regard to the following:

(a) the length of time the insurer has been operating;

(b) whether the insurer is in or appears likely to be in financial or operational difficulty;

(c) whether the insurer is deemed by APRA to have a disproportionate exposure to a particular type of risk;

(d) whether particular risks faced by an insurer are adequately dealt with by the prudential standards; and

(e) any other relevant matters.

18. In the normal course of business, an insurer must have in place capital management processes. These must be set out in the insurer’s Business Plan[9] in accordance with Prudential Standard GPS 220 Risk Management.

Internal Model Based Method

19. An insurer may use an in-house capital measurement model to calculate the MCR. Use of the IMB Method is conditional on APRA’s approval.[10] APRA requires insurers to satisfy a range of criteria, as set out in Prudential Standard GPS 113 Minimum Capital Requirement: Internal Model-Based Method (GPS 113).[11] In particular, APRA must be satisfied that the model is well designed, the analysis and assumptions used are sound, and that the results of applying the model are reasonable from a prudential viewpoint. Insurers which do not use an internal model that meets the criteria specified in GPS 113 must use the Prescribed Method described below.

Prescribed Method

20. For insurers using the Prescribed Method, the MCR is determined as the sum of the capital charges for:

(a) insurance risk;

(b) investment risk; and

(c) concentration risk.

Insurance risk

21. The Insurance Risk Capital Charge relates to the risk that the actual value of net insurance liabilities is greater than the value determined in accordance with GPS 310. The method for determining the Insurance Risk Capital Charge is set out in Prudential Standard GPS 115 Insurance Risk Capital Charge.

22. This capital charge has two components:

(a) a charge in respect of outstanding claims risk (Outstanding Claims Capital Charge); and

(b) a charge in respect of premiums liability risk (Premiums Liability Capital Charge).

The Outstanding Claims Capital Charge relates to the risk that the value of the net outstanding claims liabilities is greater than the value determined in accordance with GPS 310. The Premiums Liability Capital Charge relates to the risk that premiums relating to post calculation date exposures, including premiums written before but incepting after the calculation date, are insufficient to fund the liabilities arising from that business.

23. The Outstanding Claims Capital Charge is determined as the sum, over all classes of business of the insurer, of the value of the net outstanding claims liabilities for each class (determined in accordance with GPS 310), multiplied by the appropriate Outstanding Claims Capital Factor for that class.

24. The Premiums Liability Capital Charge is determined as the sum, over all classes of business of the insurer, of the net premiums liabilities for each class (determined in accordance with GPS 310), multiplied by the appropriate Premiums Liability Capital Factor for that class.

25. If an insurer securitises insurance liabilities, the net insurance liabilities may reduce. The insurer must consult APRA prior to entering into the securitisation transaction in order to be able to reduce the Insurance Risk Capital Charge and the Concentration Risk Capital Charge.

Investment risk

26. The Investment Risk Capital Charge relates to the risk of adverse movements in the value of an insurer’s assets or off-balance sheet exposures or both. Investment risk can be derived from a number of sources, including market risk and credit risk.

27. Subject to paragraphs 28 to 31, the Investment Risk Capital Charge is determined as the value of each investment multiplied by the relevant Investment Capital Factor for that investment, summed across all assets and certain off-balance sheet exposures.. For the purposes of this Prudential Standard, assets and exposures must be valued in accordance with the relevant reporting standards made under the Financial Sector (Collection of Data) Act 2001 (Collection of Data Act).[12] The method for determining the Investment Risk Capital Charge is set out in Prudential Standard GPS 114 Investment Risk Capital Charge (GPS 114).

28. The Investment Risk Capital Charge may reduce through the reduction in investment risk arising from the availability of risk mitigants (e.g. collateral security or guarantees), subject to the criteria specified in GPS 114.

29. An insurer must hold additional capital, in the form of an Investment Concentration Charge, if its exposure to a particular asset or counterparty exceeds the thresholds set out in GPS 114.

30. In certain circumstances, an insurer may choose to hold assets in a special purpose vehicle (SPV), rather than on its own balance sheet. Where APRA has approved the inclusion of a SPV as part of the insurer’s Extended Licensed Entity (ELE),[13]F the insurer is able to ‘look through’ the legal structures involved, to determine its Investment Risk Capital Charge (and any Investment Concentration Charge) based on the individual assets of the SPV, rather than simply on its direct exposure to the entity.

31. If an insurer securitises assets, the insurer must consult APRA prior to entering into the securitisation transaction in order to be able to reduce the Investment Risk Capital Charge.

Concentration risk

32. At a minimum, the Concentration Risk Capital Charge relates to the risk associated with an accumulation of exposures to a single catastrophic event at a single site. However, APRA will require a whole of portfolio approach to be implemented by an insurer if APRA assesses that the single event approach is inadequate in evaluating that insurer’s reinsurance needs. If this is required of an insurer and it does not comply with the requirement, the insurer’s MCR may be increased in accordance with paragraph 17. The method for determining the Concentration Risk Capital Charge is set out in Prudential Standard GPS 116 Concentration Risk Capital Charge (GPS 116). For lenders mortgage insurers, additional requirements for calculating the Concentration Risk Capital Charge are also set out in GPS 116.

33. The Concentration Risk Capital Charge is set equal to the insurer’s Maximum Event Retention (MER), plus the cost of one reinstatement of the catastrophe reinsurance cover in cases where the reinstatement reinsurance cover has not been pre-paid by the insurer. APRA will monitor an insurer’s calculation of its MER and may, where it is not satisfied with the methods or assumptions used, allow or require adjustments to be made to the calculation.[14]

34. In calculating the MER, an insurer may take into account potential reinsurance assets receivable from a reinsurance arrangement only if the reinsurance arrangement:

(a) complies with the two month rule and six month rule imposed under Prudential Standard GPS 230 Reinsurance Management (GPS 230); or

(b) fails to comply with those rules as at the date of the relevant deadline but:

(i) subsequent to the deadline specified under the two month rule, the reinsurance arrangement is documented in accordance with the other requirements of the two month rule (in which case the reinsurance assets from the reinsurance arrangement may be taken into account for the purposes of calculating the MER until the reinsurance arrangement fails to comply with the six month rule); or

(ii) subsequent to the deadline specified under the six month rule, the reinsurance arrangement is documented in accordance with the other requirements of the six month rule; or

(c) has been treated by APRA, under GPS 230, as complying with the two month rule and six month rule.

Disclosure

35. To improve policyholder and market understanding of its capital adequacy position, an insurer must publish annually the following items:

(a) the amount of eligible Tier 1 capital, with separate disclosure of each of the components of capital specified in GPS 112;

(b) the aggregate amount of any deductions from Tier 1 capital;

(c) the amount of eligible Tier 2 capital, with separate disclosure of each of the components of capital specified in GPS 112;

(d) the aggregate amount of any deductions from Tier 2 capital;

(e) the total capital base of the insurer derived from the items (a) to (d);

(f) the MCR of the insurer; and

(g) the capital adequacy multiple of the insurer (item (e) divided by item (f)).[15]

Reductions in capital

36. An insurer must obtain APRA’s written consent prior to making any planned reduction in its capital. APRA’s consent may be subject to conditions.

37. A reduction in an insurer’s capital includes, but is not limited to:

(a) a share buyback;

(b) the redemption, repurchase or early repayment of any qualifying Tier 1 and Tier 2 capital instruments issued by the insurer or an SPV;

(c) trading in the insurer’s own shares or capital instruments outside of any arrangement agreed upon with APRA in accordance with GPS 112;

(d) payment of dividends on ordinary shares that exceeds an insurer’s after-tax earnings, after including any payments on more senior capital instruments, in the financial year[16] to which they relate; and

(e) dividend or interest payments (whether whole or partial) on Upper Tier 2, Innovative Tier 1 and Non-innovative Residual Tier 1 capital that exceed an insurer’s after-tax earnings, including any payments made on more senior capital instruments, calculated before any such payments are applied in the financial year[17] to which they relate.

38. An insurer proposing a capital reduction must provide APRA with a forecast showing the projected future capital position after the proposed capital reduction. The forecast must extend for at least three years. The insurer must satisfy APRA that its capital, after the proposed reduction, will remain adequate for its future needs.

39. Any reference to the earnings or retained earnings of an insurer in paragraph 37 is a reference to the earnings or retained earnings of the insurer determined in a manner consistent with the insurer’s prudential reporting to APRA under the Collection of Data Act rather than in accordance with Australian Accounting Standards as required for statutory financial reporting under the Corporations Act 2001.

Reductions in capital for run-off insurers

40. This paragraph applies to a run-off insurer. The insurer must submit to APRA:

(a) documents clearly setting out and evidencing its current financial position; and

(b) a forecast required under paragraph 38 with insurance liabilities valued in accordance with the methodology set out in GPS 310, except that the valuation must demonstrate that the tangible assets of the insurer, after the proposed capital reduction, are sufficient to cover its insurance liabilities to a 99.5 per cent level of sufficiency, plus any other liabilities, as calculated by its Appointed Actuary.[18]

Category C insurers

41. Any repatriation of assets in Australia, whether direct or indirect, by a Category C insurer that will result in a reduction in its net assets in Australia must be subject to APRA’s prior consent consistent with the requirements of paragraphs 36 to 38.[19]

42. Paragraph 41 does not apply to any repatriation of assets in Australia out of the current year profits of a Category C insurer where the assets being repatriated to the head office of the Category C insurer or any other branch or related entity[20] of the Category C insurer do not exceed the Category C insurer’s after-tax earnings in the year to which they relate (i.e. a repatriation of assets not wholly or partly funded from retained earnings).

Transition for internal model

43. For the purposes of paragraph 19, the criteria that must be met for an internal model to be approved are those specified:

(a) at Attachment B to Prudential Standard GPS 110 Capital Adequacy made on 25 September 2006 until commencement of GPS 113; and

(b) in GPS 113 with effect from commencement of GPS 113.

Determinations made under previous GPS 110

44. An approval, determination, direction or requirement made by APRA under a provision specified in Column 1 of the following table that is in operation immediately prior to the commencement of this Prudential Standard is taken, on and from the effective date, to have been made under the provision of this Prudential Standard specified in the same row of Column 2 of the table.

Objective and key requirements of this Prudential Standard

This Prudential Standard aims to ensure that general insurers maintain adequate capital to act as a buffer against the risks associated with their activities.

This Prudential Standard outlines the overall framework adopted by APRA for assessing the capital adequacy of a general insurer.

The key requirements of this Prudential Standard are that a general insurer must:

• maintain minimum levels of capital determined according to the Internal Model Based Method or the Prescribed Method;
• determine its Minimum Capital Requirement having regard to a range of risk factors that may threaten its ability to meet policyholder obligations. Under the Prescribed Method, these are insurance risk, investment risk and concentration risk. A general insurer using the Internal Model Based Method will be expected to include at least these risks, but also all other relevant risk factors, within its method of calculation;
• make certain public disclosures about its capital adequacy position; and
• seek APRA’s consent for reductions in capital.

This Prudential Standard forms part of a comprehensive set of prudential standards that deal with the measurement of a general insurer’s capital adequacy.

Insurance risk

21. The Insurance Risk Capital Charge relates to the risk that the actual value of net insurance liabilities is greater than the value determined in accordance with GPS 310. The method for determining the Insurance Risk Capital Charge is set out in Prudential Standard GPS 115 Insurance Risk Capital Charge.

22. This capital charge has two components:

(a) a charge in respect of outstanding claims risk (Outstanding Claims Capital Charge); and

(b) a charge in respect of premiums liability risk (Premiums Liability Capital Charge).

The Outstanding Claims Capital Charge relates to the risk that the value of the net outstanding claims liabilities is greater than the value determined in accordance with GPS 310. The Premiums Liability Capital Charge relates to the risk that premiums relating to post calculation date exposures, including premiums written before but incepting after the calculation date, are insufficient to fund the liabilities arising from that business.

23. The Outstanding Claims Capital Charge is determined as the sum, over all classes of business of the insurer, of the value of the net outstanding claims liabilities for each class (determined in accordance with GPS 310), multiplied by the appropriate Outstanding Claims Capital Factor for that class.

24. The Premiums Liability Capital Charge is determined as the sum, over all classes of business of the insurer, of the net premiums liabilities for each class (determined in accordance with GPS 310), multiplied by the appropriate Premiums Liability Capital Factor for that class.

25. If an insurer securitises insurance liabilities, the net insurance liabilities may reduce. The insurer must consult APRA prior to entering into the securitisation transaction in order to be able to reduce the Insurance Risk Capital Charge and the Concentration Risk Capital Charge.

Investment risk

26. The Investment Risk Capital Charge relates to the risk of adverse movements in the value of an insurer’s assets or off-balance sheet exposures or both. Investment risk can be derived from a number of sources, including market risk and credit risk.

27. Subject to paragraphs 28 to 31, the Investment Risk Capital Charge is determined as the value of each investment multiplied by the relevant Investment Capital Factor for that investment, summed across all assets and certain off-balance sheet exposures.. For the purposes of this Prudential Standard, assets and exposures must be valued in accordance with the relevant reporting standards made under the Financial Sector (Collection of Data) Act 2001 (Collection of Data Act).[12] The method for determining the Investment Risk Capital Charge is set out in Prudential Standard GPS 114 Investment Risk Capital Charge (GPS 114).

28. The Investment Risk Capital Charge may reduce through the reduction in investment risk arising from the availability of risk mitigants (e.g. collateral security or guarantees), subject to the criteria specified in GPS 114.

29. An insurer must hold additional capital, in the form of an Investment Concentration Charge, if its exposure to a particular asset or counterparty exceeds the thresholds set out in GPS 114.

30. In certain circumstances, an insurer may choose to hold assets in a special purpose vehicle (SPV), rather than on its own balance sheet. Where APRA has approved the inclusion of a SPV as part of the insurer’s Extended Licensed Entity (ELE),[13]F the insurer is able to ‘look through’ the legal structures involved, to determine its Investment Risk Capital Charge (and any Investment Concentration Charge) based on the individual assets of the SPV, rather than simply on its direct exposure to the entity.

31. If an insurer securitises assets, the insurer must consult APRA prior to entering into the securitisation transaction in order to be able to reduce the Investment Risk Capital Charge.

Concentration risk

32. At a minimum, the Concentration Risk Capital Charge relates to the risk associated with an accumulation of exposures to a single catastrophic event at a single site. However, APRA will require a whole of portfolio approach to be implemented by an insurer if APRA assesses that the single event approach is inadequate in evaluating that insurer’s reinsurance needs. If this is required of an insurer and it does not comply with the requirement, the insurer’s MCR may be increased in accordance with paragraph 17. The method for determining the Concentration Risk Capital Charge is set out in Prudential Standard GPS 116 Concentration Risk Capital Charge (GPS 116). For lenders mortgage insurers, additional requirements for calculating the Concentration Risk Capital Charge are also set out in GPS 116.

33. The Concentration Risk Capital Charge is set equal to the insurer’s Maximum Event Retention (MER), plus the cost of one reinstatement of the catastrophe reinsurance cover in cases where the reinstatement reinsurance cover has not been pre-paid by the insurer. APRA will monitor an insurer’s calculation of its MER and may, where it is not satisfied with the methods or assumptions used, allow or require adjustments to be made to the calculation.[14]

34. In calculating the MER, an insurer may take into account potential reinsurance assets receivable from a reinsurance arrangement only if the reinsurance arrangement:

(a) complies with the two month rule and six month rule imposed under Prudential Standard GPS 230 Reinsurance Management (GPS 230); or

(b) fails to comply with those rules as at the date of the relevant deadline but:

(i) subsequent to the deadline specified under the two month rule, the reinsurance arrangement is documented in accordance with the other requirements of the two month rule (in which case the reinsurance assets from the reinsurance arrangement may be taken into account for the purposes of calculating the MER until the reinsurance arrangement fails to comply with the six month rule); or

(ii) subsequent to the deadline specified under the six month rule, the reinsurance arrangement is documented in accordance with the other requirements of the six month rule; or

(c) has been treated by APRA, under GPS 230, as complying with the two month rule and six month rule.

Disclosure

35. To improve policyholder and market understanding of its capital adequacy position, an insurer must publish annually the following items:

(a) the amount of eligible Tier 1 capital, with separate disclosure of each of the components of capital specified in GPS 112;

(b) the aggregate amount of any deductions from Tier 1 capital;

(c) the amount of eligible Tier 2 capital, with separate disclosure of each of the components of capital specified in GPS 112;

(d) the aggregate amount of any deductions from Tier 2 capital;

(e) the total capital base of the insurer derived from the items (a) to (d);

(f) the MCR of the insurer; and

(g) the capital adequacy multiple of the insurer (item (e) divided by item (f)).[15]

Reductions in capital

36. An insurer must obtain APRA’s written consent prior to making any planned reduction in its capital. APRA’s consent may be subject to conditions.

37. A reduction in an insurer’s capital includes, but is not limited to:

(a) a share buyback;

(b) the redemption, repurchase or early repayment of any qualifying Tier 1 and Tier 2 capital instruments issued by the insurer or an SPV;

(c) trading in the insurer’s own shares or capital instruments outside of any arrangement agreed upon with APRA in accordance with GPS 112;

(d) payment of dividends on ordinary shares that exceeds an insurer’s after-tax earnings, after including any payments on more senior capital instruments, in the financial year[16] to which they relate; and

(e) dividend or interest payments (whether whole or partial) on Upper Tier 2, Innovative Tier 1 and Non-innovative Residual Tier 1 capital that exceed an insurer’s after-tax earnings, including any payments made on more senior capital instruments, calculated before any such payments are applied in the financial year[17] to which they relate.

38. An insurer proposing a capital reduction must provide APRA with a forecast showing the projected future capital position after the proposed capital reduction. The forecast must extend for at least three years. The insurer must satisfy APRA that its capital, after the proposed reduction, will remain adequate for its future needs.

39. Any reference to the earnings or retained earnings of an insurer in paragraph 37 is a reference to the earnings or retained earnings of the insurer determined in a manner consistent with the insurer’s prudential reporting to APRA under the Collection of Data Act rather than in accordance with Australian Accounting Standards as required for statutory financial reporting under the Corporations Act 2001.

Reductions in capital for run-off insurers

40. This paragraph applies to a run-off insurer. The insurer must submit to APRA:

(a) documents clearly setting out and evidencing its current financial position; and

(b) a forecast required under paragraph 38 with insurance liabilities valued in accordance with the methodology set out in GPS 310, except that the valuation must demonstrate that the tangible assets of the insurer, after the proposed capital reduction, are sufficient to cover its insurance liabilities to a 99.5 per cent level of sufficiency, plus any other liabilities, as calculated by its Appointed Actuary.[18]

Category C insurers

41. Any repatriation of assets in Australia, whether direct or indirect, by a Category C insurer that will result in a reduction in its net assets in Australia must be subject to APRA’s prior consent consistent with the requirements of paragraphs 36 to 38.[19]

42. Paragraph 41 does not apply to any repatriation of assets in Australia out of the current year profits of a Category C insurer where the assets being repatriated to the head office of the Category C insurer or any other branch or related entity[20] of the Category C insurer do not exceed the Category C insurer’s after-tax earnings in the year to which they relate (i.e. a repatriation of assets not wholly or partly funded from retained earnings).

Transition for internal model

43. For the purposes of paragraph 19, the criteria that must be met for an internal model to be approved are those specified:

(a) at Attachment B to Prudential Standard GPS 110 Capital Adequacy made on 25 September 2006 until commencement of GPS 113; and

(b) in GPS 113 with effect from commencement of GPS 113.

Determinations made under previous GPS 110

44. An approval, determination, direction or requirement made by APRA under a provision specified in Column 1 of the following table that is in operation immediately prior to the commencement of this Prudential Standard is taken, on and from the effective date, to have been made under the provision of this Prudential Standard specified in the same row of Column 2 of the table.