Insurance (prudential standard) determination No. 3 of 2006 - Prudential Standard GPS 310 - Audit and Actuarial Reporting and Valuation
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An insurer must arrange to have the ILVR prepared by the Approved Actuary peer reviewed by a Reviewing Actuary, addressed to either the insurer or the insurer’s Approved Auditor.
The FCR is not required to be subject to review by the Reviewing Actuary. However, an insurer may choose to have the FCR subject to peer review if the insurer considers it appropriate to do so.
A Reviewing Actuary must meet the eligibility and fit and proper criteria required to be met by Approved Actuaries.[35] An insurer must provide APRA with the details of the Reviewing Actuary (name, address and telephone number) and a written statement from an authorised officer[36] of the insurer that the Reviewing Actuary meets the eligibility and fit and proper criteria for an Approved Actuary. Where APRA does not consider that the Reviewing Actuary meets these criteria, APRA may, in writing, require that the insurer engage an alternate actuary to conduct the peer review.
A Reviewing Actuary must not be an employee of the insurer. Where an insurer’s Approved Actuary is not an employee of the insurer, the Reviewing Actuary must not be from the same firm[37] or company as the Approved Actuary, or from a related firm or company. A Reviewing Actuary may, however, be from the same firm or company as the insurer’s Approved Auditor or from a related firm or company.
The insurer must take all practical steps to ensure that the Reviewing Actuary is given full access to the insurer’s Approved Actuary and the ILVR, including appendices. Where the Reviewing Actuary believes the provision of further information is necessary, equivalent access must be provided to other items on file supporting the report, relevant source data and staff or relevant contractors. All information must be provided electronically if available in this form. This will include informing the Reviewing Actuary of all prudential requirements applicable to the insurer.
A Reviewing Actuary must prepare a report (the review report) that provides an assessment of the reasonableness of the Approved Actuary’s investigations and report(s) (including the results contained within).
Copies of the review report must be provided to the Approved Actuary, the Approved Auditor, the Board and management of the insurer in the time prescribed by paragraph 28. The review report is not required to be provided to APRA, but must be available to APRA upon request.
In preparing the review report, the Reviewing Actuary must have regard to relevant professional standards issued by the Institute of Actuaries of Australia, to the extent that they are not inconsistent with the requirements of this Prudential Standard.
Part Peer review - Insurance (prudential standard) determination No. 3 of 2006 - Prudential Standard GPS 310 - Audit and Actuarial Reporting and Valuation - Peer review | Zoe
A review report must include:
(a) a description of the scope of the review, including details of the investigations and the reports being reviewed and the processes followed in the review;
(b) a description of the extent to which the Reviewing Actuary had access to relevant data, information, reports and staff (and contractors) of the insurer, and to the Approved Actuary;
(c) an assessment of the appropriateness to the ILVR of the data, information and reports to which the Reviewing Actuary had access; and
(d) an assessment of the reasonableness of the Approved Actuary’s investigations and report(s) (including the results contained within).
Attachment A
Insurance Liability Valuation
Where an insurer is required to have an Approved Actuary, it is the role of the Approved Actuary to provide advice to the insurer in respect of the value of the insurer’s insurance liabilities. This advice must be contained in an ILVR.
This Attachment sets out requirements relating to the measurement and reporting of insurance liabilities that must be considered by insurers and Approved Actuaries in determining or providing advice in respect of an insurer’s insurance liabilities. In relation to data, materiality and uncertainty paragraphs 4 to 13 of this Attachment must be complied with by Approved Actuaries when preparing an ILVR. The remainder of this Attachment must be complied with by:
(a) all insurers in relation to the valuation of their insurance liabilities (whether or not the insurer is required to have an Approved Actuary); and
(b) all Approved Actuaries when preparing an ILVR.
Where an Approved Actuary has provided the insurer with any other actuarial report in relation to liability valuation during the preceding 12 months, this must be noted in the ILVR and attached where relevant. An Approved Actuary should exercise judgement in the amount of detail included in the ILVR in respect of advice already given.
Data
An insurer must make the arrangements that are necessary to enable its Approved Actuary to prepare an ILVR.[38] The Approved Actuary must therefore advise the insurer of the data, information and reports that the Approved Actuary will need, and staff and relevant contractors of the insurer with whom the Approved Actuary will need to consult, in order to prepare the ILVR. Where the insurer does not provide adequate and timely access to data, information, reports and staff as required, the Approved Actuary may omit from the ILVR analysis that is dependent on that information, but must provide details as to why it has been omitted and explain any consequent limitations of the ILVR.
The Approved Actuary must take reasonable steps to verify the consistency, completeness and accuracy of the data provided by the insurer with reference to the insurer’s financial and other records. Any discrepancies that cannot be resolved with the insurer must be outlined in the ILVR together with any consequent limitations of the ILVR.
The Approved Actuary must be familiar with the administration and accounting procedures for policies and claims for the insurer and with the characteristics of the insurance policies and claim processes that may materially impact upon the estimation of insurance liabilities.
The Approved Actuary must be familiar with, or obtain advice on, the economic, technological, medical, legal and social trends within the broader community that may impact upon the value of insurance liabilities.
The degree to which the Approved Actuary relies on data, information or reports provided by the insurer, or upon testing of the data or other information by the insurer’s internal auditor, Approved Auditor or other external auditor, must be explained in the ILVR together with any consequent limitations of the ILVR.
Where the Approved Actuary is relying on work undertaken by other actuaries, the Approved Actuary must be satisfied as to the suitability of assumptions and methods used by the other actuaries, and where the Approved Actuary is not satisfied, alternative methods must be used and explained in the ILVR.
Materiality
The Approved Actuary must take into account materiality when preparing an ILVR. Where information, if misstated or omitted, would cause the results or opinions of the Approved Actuary to be misleading to users of the ILVR, that information would be considered material (‘materiality’ for this purpose is independent of materiality within the meaning of Australian accounting standards). Whether something is material or not will always be a matter for an Approved Actuary’s judgement.
Uncertainty
The Approved Actuary must describe, qualitatively, the key drivers of uncertainty for each class of business or portfolio being valued. Material changes in these key drivers, or uncertainty generally, since the previous valuation, must be explained and, if appropriate, quantified in the ILVR.
Any material changes or significant emerging experience since the previous evaluation in the insurance liability outcomes by class of business must be explained in the ILVR.
The Approved Actuary must explain the practical consequences of the uncertainty of the estimates included in the ILVR. In many cases, the range of reasonable values of the liabilities will be very large. The conclusions that may be drawn from a value at one end of this range may be very different from the conclusions drawn by a value at the other end.
Valuation of insurance liabilities
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 (after taking advice from its Approved Actuary, where the insurer is required to have one).
In determining the value for outstanding claims liabilities and premiums liabilities, a value for the central estimate and associated risk margin must be determined by class of business (subject to considerations of materiality and the professional judgement of the Approved Actuary, where the insurer is required to have one). Central estimates and risk margins for outstanding claims liabilities and premiums liabilities must therefore be calculated and reported separately, and by class of business, to APRA.[39] 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.
The principles of this Prudential Standard must be applied to the calculation of both gross and net insurance liabilities.
The central estimate
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.
Where experience is highly volatile, model parameters estimated from the experience can also be volatile. The central estimate should 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.
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 and policy management expenses; and
(d) claims run-off.
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.
The assumptions used should 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
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 one class of risk for example those associated with the underlying assets, such as asset-liability mismatch risk.
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.
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.
The risk margins must be determined having regard to the uncertainty of the gross insurance liabilities and to any uncertainty related to the estimate of reinsurance and non-reinsurance recoveries that are deducted from the estimate of gross insurance liabilities.
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.
The risk margin plays a role in achieving an appropriate pattern of profit emergence for a class of business. However, the risk margin must not be used as a tool for smoothing the effect of changes in assumptions or valuation methods.
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, the insurer’s risk profile or volume of business, or external factors (for example, legislative requirements). Any material changes must be documented.
Allowance for diversification and/or reinsurance can be made in determining the risk margin. The justification for and method of determining such diversification allowance (which must be assessed on a holistic basis for the insurer) and reinsurance recoveries must be clearly documented.
Discount rates
The value of an insurer’s insurance liabilities is typically independent of the value of the insurer’s underlying assets. A discount rate that is based on current observable, market-based and objective rates that directly relate to the nature, structure and term of the future obligations must therefore be used.
The rates to be used in discounting the expected future claims payments for a class of business are derived from the gross redemption yields, as at the calculation date, of a portfolio of sovereign risk securities in the currency of, and with a similar expected payment profile to, the insurance liabilities for that class (for example, Commonwealth Government securities for Australian liabilities). It is acceptable to use either the average rate or a series of discount rates taken from the relevant yield curve.
Where the expected payment profile of the insurance liabilities cannot be matched (for example, because the duration is too long), a discount rate regarded as consistent with the intention of paragraphs 31 and 32 of this Attachment must be used.
Methods for valuing insurance liabilities
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.
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. Approximate methods may, for example, be justified for short-tail classes of business where the effect of not discounting future expected claims is not material.
The onus for justification of the appropriateness of any valuation method rests with the Board of the insurer and, where the insurer is required to have one, the Approved Actuary. Where an Approved Actuary has been involved in the valuation of the insurance liabilities, the Approved Actuary must explain in the ILVR the reasons for any valuation methods used.
Claims escalation
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), and appropriate allowance must be made for this. Claims payments include third party costs incurred in settling those claims, for example, investigation, medical and legal fees.
Estimation of reinsurance recoveries
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 recoveries.[40]
For the purpose of calculating an insurer’s insurance liabilities, it should 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 recoveries will be made in full.[41]
Where reinsurance arrangements are not fully documented or are not fully placed, or there is a risk that recoveries will not be received from a reinsurer, the insurer will either not be able to recognise the reinsurance recoveries as assets or will be required to hold capital against these risks.[42]
Aggregate reinsurance recoveries must be separated into appropriate subsets to 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 Approved Actuary must consider the materiality of reinsurance recoveries. If they are material, the Approved Actuary must assess the potential range of amounts not recoverable from reinsurers, based on the uncertainty of individual and aggregate gross losses.
The estimation of 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 reinsurance. This assumption must only be made when existing reinsurance arrangements are documented and when the estimated reinsurance recoveries relate to the same classes of business that are currently covered by the existing documented reinsurance arrangements, and it is fully expected that the reinsurance will be replaced on similar terms when current arrangements expire.
The estimation of the value of 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 recoveries 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
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.
Attachment B
Transition Rules
Expiry date of this attachment
This Attachment will no longer have effect after 31 December 2007.
Specific transition rules
Exemptions from the requirement to have an Approved Actuary under the old Prudential Standards will not automatically continue after 1 October 2006 (effective date). An insurer must reassess its status of continued exemption in accordance with the revised criteria for exemption under subparagraphs 14 (a) to (e) of the new Prudential Standard and ensure that:
(a) if the insurer no longer qualifies for exemption under the revised criteria, arrangements are made for the appointment of an Approved Actuary from the effective date; or
(b) appropriate arrangements are in place prior to the effective date to meet the revised criteria for exemption.
Regardless of when an insurer’s financial year ends, peer review of the insurer’s ILVR (under paragraph 64) is required when the insurer is required to submit its ILVR to APRA after the effective date.
For an insurer with a financial year ending before the effective date which is required to report by a date after the effective date, both the audit report and audit certificate must be prepared according to the requirements under paragraphs 38 to 42. In preparing the audit report, an Approved Auditor must comment against each of the criteria based on the requirements under the old Prudential Standards. Where the Approved Auditor is of the opinion that one or more of the criteria could not be assured if tested against all Prudential Standards coming into force on the effective date, the Approved Auditor must highlight this in the audit report.
For an insurer subject to the requirement to submit an FCR in accordance with paragraphs 43 to 48:
(a) the insurer must complete and submit the FCR to APRA by the time specified in paragraph 11 of this Prudential Standard if the end of the insurer’s financial year falls on or after the effective date; or
(b) the insurer must complete and submit an initial FCR to APRA if the end of the insurer’s financial year falls before the effective date and the submission date specified in paragraph 11 falls after the effective date. The insurer should prepare the initial FCR on a best endeavours basis in accordance with paragraphs 43 to 48 and the relevant professional standard issued by the Institute of Actuaries of Australia. If, for practical reasons, an insurer is not able to comply with particular requirements of paragraphs 43 to 48, the insurer must provide those reasons in the initial FCR.[43] Notwithstanding the requirements of paragraph 11, the initial FCR is due six months after the end of the insurer’s financial year.
Application for a later date to comply with particular requirements
APRA has the ability to determine a later date, but no later than 31 December 2007, to comply with particular requirements of this Prudential Standard (compliance date). APRA cannot exercise this discretion where the failure of the insurer to be able to comply by the effective date is due to the inaction of the Board and management in making adequate preparations to comply with this Prudential Standard.
In relation to an application for a compliance date later than the effective date, the criteria that APRA will consider in assessing the application are:
(a) the insurer has submitted the application to APRA 20 business days before the effective date;
(b) the insurer can demonstrate that since the determination date of this Prudential Standard, it has been taking reasonable actions to ensure that it will be in a position to comply with this Prudential Standard by the effective date; and
(c) the insurer can demonstrate that since the determination date of this Prudential Standard, one of the following issues has given rise to the inability of the insurer to comply with this Prudential Standard by the effective date:
(i) an event has occurred, outside the insurer’s control that has led to it being in a position where it cannot comply with this Prudential Standard (e.g. loss of a key person);
(ii) the insurer has not been able to retain human resources of sufficient skill and experience after a genuine market search within a period that would enable it to put in place the necessary policies, systems and procedures to ensure compliance with this Prudential Standard by the effective date; or
(iii) for a foreign insurer, it cannot comply with this Prudential Standard by the effective date due to delays caused by home country regulatory issues relating to a significant demonstrable inconsistency between this Prudential Standard and legal requirements imposed by its home country regulator.