Section 1 - Insurance (prudential standard) determination No. 3 of 2008 - Prudential Standard GPS 112 Capital Adequacy - Measurement of Capital - Insurance (prudential standard) determination No. 3 of 2008 - Prudential Standard GPS 112 Capital Adequacy - Measurement of Capital | Zoe
Insurance (prudential standard) determination No. 3 of 2008 - Prudential Standard GPS 112 Capital Adequacy - Measurement of Capital
1Insurance (prudential standard) determination No. 3 of 2008 - Prudential Standard GPS 112 Capital Adequacy - Measurement of Capital
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Insurance (prudential standard) determination No. 3 of 2008
Prudential Standard GPS 112 Capital Adequacy: Measurement of Capital
Insurance Act 1973
I, John Roy Trowbridge, Member of APRA, delegate of APRA, under subsection 32(1) of the Insurance Act 1973 (the Act), DETERMINE Prudential Standard GPS 112 Capital Adequacy: Measurement of Capital in the form set out in the Schedule, which applies to all general insurers.
This determination takes effect on 1 July 2008.
Dated 23 June 2008
[Signed]
John Trowbridge
Member
Interpretation
In this instrument:
APRA means the Australian Prudential Regulation Authority.
general insurer has the meaning given in section 11 of the Act.
Schedule
Prudential Standard GPS 112 Capital Adequacy: Measurement of Capital comprises the 37 pages attached.
Prudential Standard GPS 112
Capital Adequacy: Measurement of Capital
Objective and key requirements of this Prudential StandardFor capital adequacy purposes, general insurers must hold a minimum amount of Tier 1 capital and capital base. In addition, they may include an amount of Tier 2 capital as part of their required capital holdings, up to the limits specified in this Prudential Standard.This Prudential Standard sets out the essential characteristics that an instrument must have to qualify as Tier 1 or Tier 2 capital for inclusion in the capital base for assessing capital adequacy.Tier 1 capital comprises the highest quality capital components. Tier 2 capital includes other components which, to varying degrees, fall short of the quality of Tier 1 capital but nonetheless contribute to the overall strength of an institution as a going concern.For capital adequacy purposes, the capital base is defined as the sum of Tier 1 and Tier 2 capital after all specified deductions and adjustments, subject to the various limits that apply.The key requirements of this Prudential Standard are that a general insurer must:
include only eligible capital as a component of capital for regulatory capital purposes;
make certain deductions from capital; and
meet certain limitations with respect to Tier 1 capital and Tier 2 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.
This Prudential Standard is made under section 32 of the Insurance Act 1973 (the Act).
Application
Subject to paragraph 3, this Prudential Standard applies to insurers authorised under the ActF[1]F
Category C insurers are not subject to this Prudential Standard. As outlined in Prudential Standard GPS 110 Capital Adequacy (GPS 110), a different measure of capital adequacy applies to Category C insurers. This reflects the nature of a Category C insurer’s Australian balance sheet, which does not generally include separately identifiable capital instruments.
Subject to any specific transition rules, this Prudential Standard applies to insurers from 1 July 2008 (effective date).
This Prudential Standard sets out the range of capital instruments that are eligible for inclusion in the capital base of an insurer and required deductions from an insurer’s capital base.
Interpretation
Unless otherwise defined in this Prudential Standard, expressions in bold are defined in Prudential Standard GPS 001 Definitions.
For the purposes of this Prudential Standard:
a component of capital is any form of capital defined in this Prudential Standard as eligible for inclusion in Tier 1 capital or Tier 2 capital;
a category of capital refers to a group of components of capital, namely: Fundamental Tier 1 capital, Residual Tier 1 capital (both Non-innovative Residual Tier 1 capital and Innovative Tier 1 capital), Upper Tier 2 capital and Lower Tier 2 capital, as appropriate;
associates is a reference to associates as defined in the Australian Accounting Standards and is to be read as also applying to joint ventures unless otherwise indicated;
cash flow hedges is a reference to cash flow hedges as defined in the Australian Accounting Standards; and
the earnings or retained earnings of an insurer 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 Financial Sector (Collection of Data) Act 2001 (Collection of Data Act) rather than in accordance with Australian Accounting Standards as required for statutory financial reporting under the Corporations Act 2001 (Corporations Act).
Capital base
Capital, for supervisory purposes, is considered in two tiers. Tier 1, or core capital, comprises the highest quality components of capital that fully meet all the essential characteristics of capital described in paragraph 15. Tier 2, or supplementary capital, includes other instruments that, to varying degrees, fall short of the quality of Tier 1 capital but nonetheless contribute to the overall financial strength of an insurer.
An insurer must, for capital adequacy purposes, hold the minimum levels of capital required by GPS 110. As part of these requirements, an insurer must hold Tier 1 capital as defined in, and to the extent required by, this Prudential Standard. In addition, an insurer may include Tier 2 capital, as defined in this Prudential Standard, as part of its required capital holdings up to the limits specified in this Prudential Standard. For capital adequacy purposes, a locally incorporated insurer’s capital base is the sum of Tier 1 and Tier 2 capital, net of all specified deductions and amortisation, subject to the various limits that apply under this Prudential Standard. An insurer must ensure that its capital base exceeds its MCR at all times.
An insurer must ensure that any component of capital included in the insurer’s capital base satisfies, in both form and substance, all applicable requirements of this Prudential Standard for the particular category of capital in which it is included. An insurer must not incorporate a component of capital as part of its capital base where that component does not meet, or is inconsistent with, the requirements of this Prudential Standard.
An insurer must not include a component of capital in a particular category of its capital base if that component, when considered in conjunction with other related transactions that affect its overall economic substance, could be reasonably considered not to satisfy fully the requirements of this Prudential Standard for components of that category of capital.
An insurer must not assign a capital instrument to a particular category of capital, other than capital instruments covered by Attachment C, based on a future event, such as the future sale or issuance of a higher quality capital instrument, until such time as:
the future event occurs;
the future sale or conversion has irrevocably taken place; and
the proceeds have been irrevocably received by the insurer.
An insurer must:
provide APRA, as soon as practicable, with copies of documentation associated with the issue of all Tier 1 and Tier 2 capital instruments; and
where the terms of the instrument depart from established precedent:
1. consult with APRA on the eligibility of the instrument for inclusion in the insurer’s capital base in advance of the issuance of the capital instrument; and
2. provide APRA with all information it requires to assess the eligibility of the capital instrument.
APRA may, in writing, require an insurer to:
exclude from its capital base any component of capital that APRA has reasonable grounds to believe does not represent a genuine contribution to the financial strength of the insurer; or
reallocate to a lower category of capital a component of capital where APRA has reasonable grounds to believe that it does not fully satisfy the requirements of this Prudential Standard for the category to which it was allocated by the insurer.
Tier 1 capital
Tier 1 capital comprises the highest quality components of capital that fully satisfy all of the following essential characteristics:
provide a permanent and unrestricted commitment of funds;
are freely available to absorb losses;
do not impose any unavoidable servicing charge against earnings; and
rank behind the claims of policyholders and creditors in the event of winding-up.
For the purposes of calculating an insurer’s capital base, Tier 1 capital is divided into the following:
Fundamental Tier 1 capital, which is the highest form of capital, consists of:
current year’s earnings net of expected dividends and tax expenses; and
technical provisions in excess of those required by Prudential Standard GPS 310 Audit and Actuarial Reporting and Valuation (GPS 310).[3]
Residual Tier 1 capital, which consists of all other components of capital qualifying for Tier 1 status, is divided into:
Non-innovative Residual Tier 1 capital – comprising perpetualF[4]F non-cumulative preference shares that satisfy the relevant criteria set out in Attachment A; and
Innovative Tier 1 capital – comprising all other Residual Tier 1 capital instruments that satisfy the relevant criteria set out in Attachment A and Attachment C.
Reserves are created after tax and include, but are not limited to:
reserves from equity-settled share-based payments (shares or share options) granted to employees as part of their remuneration package provided that:
the shares or share options granted relate only to the ordinary shares of the insurer itself; and
there are no circumstances in which such remuneration can be converted into another form (e.g. cash).
Any other reserves associated with share-based payments must be excluded from capital; and
cumulative unrealised gains or losses on cash flow hedges offsetting gains or losses included in Tier 1 capital (e.g. movements in the currency value of foreign currency denominated hedging instruments which offset movements in foreign currency denominated items recognised in the foreign currency translation reserve).
Tier 2 capital
Tier 2 capital includes other components of capital that, to varying degrees, fall short of the quality of Tier 1 capital stated in Hparagraph H15 but nonetheless contribute to the overall strength of an insurer as a going concern, and is divided into:
Upper Tier 2 capital – comprising components of capital that are essentially permanent in nature, including some forms of hybrid capital instruments; and
Lower Tier 2 capital – comprising components of capital that are not permanent i.e. dated or limited life instruments.
Upper Tier 2 capital
Upper Tier 2 capital consists of the following components that satisfy the relevant criteria set out in Attachment B and Attachment C:
perpetual cumulative preference shares;
perpetual cumulative mandatory convertible notes;
perpetual cumulative subordinated debt;
any capital amounts otherwise meeting APRA’s requirements for Tier 1 capital instruments (refer to Attachment A) that are ineligible for inclusion as Tier 1 capital as a result of the limits in this Prudential Standard;
any other hybrid capital instruments of a permanent nature approved, in writing, by APRA;
45 per cent of pre-tax revaluation reserves of each of the following (subject to satisfying the conditions specified in Attachment B relevant to each reserve):[5]
property not held at fair value; and
investments in subsidiaries not held at fair value, other than subsidiaries that APRA deems part of an Extended Licensed Entity (ELE) (refer to Prudential Standard GPS 114 Capital Adequacy: Investment Risk Capital Charge (GPS 114))F[6]
The amount recognised must be net of any fair value gains and losses and any gains or losses on hedges offsetting revaluations included in reserves; and
45 per cent of the post-acquisition reserves of associates as defined in the Australian Accounting Standards. This includes, under equity accounting, the insurer’s share of undistributed profits, plus any share of asset revaluations in associates or any other revaluation of investments in associates. The amount recognised must be net of fair value gains and losses and any gains or losses on hedges offsetting revaluations of investments in associates included in reserves.
Where an insurer is aware that a particular asset is impaired and a loss arises, such a loss must be reflected in Tier 1 capital. However, where a particular asset belongs to a class of assets for which asset revaluation reserves are included in Upper Tier 2 capital and the asset has been identified as impaired and losses arise, the losses may be offset against any existing revaluations of the asset or class of revalued assets.
If an asset revaluation reserve included in Upper Tier 2 capital is negative after adjustment for revaluations of assets included in the reserve, for losses due to impairment of assets covered by the reserve and for any gains or losses on hedges offsetting revaluations of assets included in the reserve, the amount of deficit in the reserve must be reported as a deduction from Tier 1 capital.
Lower Tier 2 capital
Lower Tier 2 capital consists of the following components that satisfy the relevant criteria set out in Attachment B and Attachment C:
term subordinated debt;
limited life redeemable preference shares; and
any other similar limited life capital instruments approved, in writing, by APRA.
Dividend and interest payments on Tier 1 and Upper Tier 2 capital instruments
Unless otherwise approved, in writing, by APRA:[7]
the aggregate amount of dividend payments on ordinary shares must not exceed an insurer’s after-tax earnings after taking into account any payments on more senior capital instruments, in the financial year to which they relate; and
the aggregate amount of dividend or interest payments, whether whole or partial, paid on Upper Tier 2, Innovative Tier 1 and Non-innovative Residual Tier 1 capital instruments must not exceed an insurer’s after-tax earnings after taking into account any payments made on more senior capital instruments, calculated before any such payments are applied in the financial year to which they relate.
For these purposes, ‘financial year’ refers to the last four quarters for which the insurer was required to submit quarterly returns[8]F to APRA preceding the date of the proposed payment of interest or dividend.
Holding of shares in insurer by special purpose vehicle (SPV)
Direct investments in shares of an insurer by an SPV (e.g. trust) established under a share-based employee remuneration scheme, may only be included in the insurer’s Tier 1 capital where:
the shares issued to the SPV represent ordinary shares of the insurer;
the amount included in Tier 1 capital is matched by an equivalent charge to profit or loss of the insurer for expensing the issue or funding the acquisition of ordinary shares by the SPV; and
the ordinary shares issued cannot be converted to payment in another form (e.g. cash).
Deductions from an insurer’s capital base
Deductions from Tier 1 capital
The amount of Tier 1 capital to be included in an insurer’s capital base will be net of the following deductions:
goodwill and any other intangible assets, net of adjustments to profit or loss, reflecting any changes arising from impairment of goodwill;[9]
deferred tax assets net of deferred tax liabilities;[10]
any portion of current year earnings or retained earnings that represents any amount deriving from the insurer’s share of undistributed profit or loss in an associate, under equity accounting. This amount must be included in Upper Tier 2 capital;
any surplus, net of deferred tax liabilities, in any defined benefit superannuation fund of which the insurer is an employer-sponsor, unless otherwise approved, in writing, by APRA. Any excluded surplus must reverse any associated deferred tax liability from Tier 1 capital;
any deficit in a defined benefit superannuation fund of which the insurer is an employer-sponsor and that is not already reflected in Tier 1 capital;
all holdings of own Tier 1 capital instruments;
any deficit after taking into account adjustments in the amount available in the respective revaluation reserves for the following items, to the extent not already accounted for in current year earnings or retained earnings:
property not held at fair value;
investments in subsidiaries not held at fair value; or
investments in associates, including any excess of the share of losses in associates under equity accounting;
any identified impairment of an asset where the impairment has not already been taken into account in profit or loss or the impairment has been incorporated in fair value changes captured in an asset revaluation reserve included in Upper Tier 2 capital (refer to Attachment B). This will include the value of any deficit in asset revaluation reserves included in Upper Tier 2 capital after taking into account all adjustments;
unrealised fair value gains (or, where applicable, adding back unrealised fair value losses) arising from changes in an insurer’s own creditworthiness;
any amounts included in revaluation reserves in Upper Tier 2 capital that would otherwise have been included in Tier 1 capital;
cumulative unrealised fair value gains and losses on effective cash flow hedges reflected in retained earnings or reserves included in Tier 1 capital that do not offset gains or losses on revaluations in reserves included in Tier 1 capital;F[11]
during the first and second transition periods,[12] all reinsurance assetsF[13] receivable under each reinsurance arrangement where the insurer has not reached the threshold levels of reinsurance documentation specified in paragraph 35;
after the second transition period,[14] all reinsurance assets receivable under each reinsurance arrangement that does not meet the reinsurance documentation test in paragraph 36;
all reinsurance assets receivable under each reinsurance contract entered into by the insurer incepting on or after 31 December 2008 that do not meet the requirements of paragraph 31 of Prudential Standard GPS 230 Reinsurance Management; and
for inwards reinsurance business, the premium receivables deduction on any portfolio of proportional reinsurance treaties calculated in accordance with paragraph 26.
For each portfolio of proportional reinsurance treaties underwritten by an insurer carrying on inwards reinsurance business where underlying risks have not yet been accepted by the direct insurer, the following equation applies in determining the deduction under paragraph 25(o):
An insurer may apply to APRA for a capital buffer factor to be used in the determination of its premium receivables deduction. APRA will consider the application and may determine an appropriate capital buffer factor in writing.
Each item in this equation relates only to the relevant fraction[18]F of the portfolio of proportional reinsurance treaties for which underlying risks have not yet been accepted by the direct insurer. A negative premium receivables deduction is not to be taken into account for the purposes of paragraph 25(o). Any deferred tax liability generated in relation to the relevant fraction of the portfolio of proportional reinsurance treaties may not be used to reduce the deferred tax asset deduction required under paragraph 25(b).
For the purposes of paragraph 25(e), an insurer may make representations to APRA to include a surplus as an asset (and hence include the surplus in Tier 1 capital) where the insurer that is the employer-sponsor is able to demonstrate unequivocal and unrestricted access to a fund surplus in a timely manner. Where APRA is satisfied regarding such access, an insurer may include the surplus in its assets subject to an Investment Capital Factor of 20 per cent (refer to GPS 114). This surplus will no longer be required to be deducted from Tier 1 capital.
Deductions from Upper or Lower Tier 2 capital
The amount of Upper and Lower Tier 2 capital to be included in an insurer’s capital base will be net of all holdings of own Upper and Lower Tier 2 capital instruments respectively.
Own instrument purchases
An insurer may not, without obtaining APRA’s prior written approval, enter into an arrangement where it may purchase, or provide financial assistance with a dominant purpose of facilitating the purchase by another party of, its own Tier 1 or Tier 2 capital instruments. Any such purchases will be subject to a limit agreed with APRA. APRA will require an amount of capital equal to that limit to be deducted from Tier 1 or Tier 2 capital as appropriate (depending on whether the prospective purchases relate to Tier 1 or Tier 2 capital instruments).
General rule for deduction
An insurer that does not hold sufficient capital to absorb required deductions from Tier 2 capital must deduct an amount equivalent to the shortfall in its Tier 2 capital from its Tier 1 capital.
Limitations
All required deductions from capital must be undertaken prior to calculating any limits applied in paragraph 32.
The amounts of Tier 1 and Tier 2 capital included in an insurer’s capital base is subject to the following limits:
Tier 1 capital
Fundamental Tier 1 capital must constitute at least 75 per cent of net Tier 1 capital (the sum of Fundamental Tier 1 and Residual Tier 1 capital less Tier 1 deductions). This requirement does not apply to mutually-owned insurers in their formative years of operation, where approved, in writing, by APRA;
Residual Tier 1 capital is limited to 25 per cent of net Tier 1 capital. Any excess amount is counted as Upper Tier 2 capital;
Innovative Tier 1 capital is limited to 15 per cent of net Tier 1 capital, except for insurers that are subject to APRA-approved transition arrangements. Any excess amount is counted as Upper Tier 2 capital;
Net Tier 1 capital must constitute at least 50 per cent of an insurer’s required capital base. This requirement does not apply to mutually-owned insurers in their formative years of operation, where approved, in writing, by APRA;
Tier 2 capital
Total Tier 2 capital (net of all specified deductions and amortisation) is limited to a maximum of 100 per cent of an insurer’s net Tier 1 capital. This requirement does not apply to mutually-owned insurers in their formative years of operation, where approved by APRA; and
Total Lower Tier 2 capital (net of all specified deductions and amortisation) is limited to a maximum of 50 per cent of an insurer’s net Tier 1 capital. This requirement does not apply to mutually-owned insurers in their formative years of operation, where approved by APRA.
According to paragraph 32(d), an insurer’s net Tier 1 capital must constitute at least 50 per cent of its required capital base. APRA may, in writing, require an insurer to hold:
more than 50 per cent of its required capital base in the form of Tier 1 capital; or
a greater proportion of its Tier 1 capital in the form of Fundamental Tier 1 capital than the proportion required by this Prudential Standard.
IFRS transition arrangements
Any transitional relief relating to IFRS granted under paragraph 7 of Attachment H to Prudential Standard GPS 110 Capital Adequacy made on 25 September 2006 continues in effect until the date of expiry specified by APRA when granting the relief, or such other date as APRA may specify in writing.[19]
Transition rules relating to deductions from Tier 1 capital
For the purposes of paragraphs 25(l) and 25(m) of this Prudential Standard:
the key dates in the transition periods, in relation to an insurer, are as follows:
Balance Dates
30 June
30 September
30 November
1 December
31 December
31 March
First day of first transition period
30 June 2007
30 September 2007
30 November 2007
1 December 2007
31 December 2007
31 March 2008
Last day of first transition period
29 June 2008
29 September 2008
29 November 2008
30 November 2008
30 December 2008
30 March 2009
First day of second transition period
30 June 2008
30 September 2008
30 November 2008
1 December 2008
31 December 2008
31 March 2009
Last day of second transition period
29 June 2009
29 September 2009
29 November 2009
30 November 2009
30 December 2009
30 March 2010
the threshold levels of reinsurance documentation are as follows:
Threshold level of reinsurance documentation
Application period
60 per cent of reinsurance assets receivable by value must be derived from reinsurance arrangements that meet the reinsurance documentation test (see paragraph 36)
First transition period
80 per cent of the reinsurance assets receivable by value must be derived from reinsurance arrangements that meet the reinsurance documentation test (see paragraph 36)
Second transition period
For the purposes of paragraphs 25(l), 25(m) and 35(b), a reinsurance arrangement meets the reinsurance documentation test if the arrangement:
complies with the two month rule and six month rule under GPS 230; or
fails to comply with those rules as at the date of the relevant deadline but:
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 arrangement is treated as meeting the reinsurance documentation test until the reinsurance arrangements fail the six month rule); or
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
1. is otherwise treated by APRA under GPS 230 as complying with the two month rule and six month rule.
Other transition arrangements
An insurer may continue to include in its capital base any instrument that was, before 1 July 2008, eligible for inclusion but that does not meet the requirements at Attachments A and B of this Prudential Standard, until such time as the instrument is repaid, redeemed or converted as applicable. This transitional relief does not extend to new issues of capital instruments or issues under existing capital raisings that occurred on or after 2 July 2007 unless otherwise approved as eligible capital by APRA.[20]
Determinations made under previous GPS 110
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.
Column 1: Provision of Prudential Standard GPS 110 Capital Adequacy made on 25 September 2006
Column 2: Provision of this Prudential Standard
Attachment A, Paragraph 10(b)(ii): approve redemption or call option in relation to Residual Tier 1 capital.
Attachment A, Paragraph 1(b)(ii)
Attachment A, Paragraph 10(c)(ii): approve special or dividend payments on a Residual Tier 1 instrument outside of normal scheduled payments.
Attachment A, Paragraph 1(c)(ii)
Attachment A, paragraph 16(a): approve ‘step-up’ in dividends or interest in relation to innovative Tier 1 capital.
Attachment A, Paragraph 7(a)
Attachment A, paragraph 26(b)(ii): approve redemption or call option in relation to Upper Tier 2 capital.
Attachment B, Paragraph 5(b)(ii)
Attachment A, paragraph 26(h): approve ‘step-up’ in dividends or interest in relation to Upper Tier 2 capital.
Attachment B, Paragraph 5(i)
Attachment A, paragraph 26(k): treat a hybrid capital instrument as falling into a lower level of capital.
Attachment B, Paragraph 5(m)
Attachment A, paragraph 31(g): approve ‘step-up’ in dividends or interest in relation to Lower Tier 2 capital.
Attachment B, Paragraph 10(g)
Attachment A, paragraph 35(g): approve an exception for ‘step ups’ to be undetaken on multiple occasions (and/or for variable amounts) in relation to Tier 1 & Upper Tier 2 instruments.
Attachment B, Paragraph 14(g)
Attachment A, paragraph 36(g): approve an exception for ‘step ups’ to be undetaken on multiple occasions (and/or for variable amounts) in relation to Lower Tier 2 instruments.
Attachment B, Paragraph 15(g)
Attachment A, paragraph 39(e): approve a non-deduction of the surplus of an insurer employee-sponsored defined benefits superannuation fund from Tier 1 capital.
Paragraph 25(d)
Attachment A, paragraph 40: determine an appropriate capital buffer factor to be used in the determination of an insurer’s premium receivables deduction.
Paragraph 26
Attachment A, paragraph 43: approve purchase of insurer’s own Tier 1 or Tier 2 capital.
Paragraph 29
Attachment A, paragraph all 44(b)(i): exempt a mutually-owned insurer from requirement that Fundamental Tier 1 capital must constitute 75% of net Tier 1 capital.
Paragraph 32(a)
Attachment A, paragraph 44(c) of previous GPS 110: exempt a mutually-owned insurer from requirement that Tier 1 Capital constitute 50% of capital base.
Paragraph 32(d)
Attachment A, paragraph 44(d): exempt mutually-owned insurer from requirement that total Tier 2 capital must be limited to 100% of net Tier 1 capital.
Paragraph 32(e)
Attachment A, paragraph 44(e): exempt mutually-owned insurer from requirement that total lower Tier 2 capital must limited to 50% of net Tier 1 capital.
Paragraph 32(f)
Attachment A, paragraph 45(d)(i): determine that an insurer’s capital base is less than its MCR in the context of the insurer issuing capital instruments through SPVs.
Attachment C, Paragraph 1(d)(i)
Attachment A
Tier 1 capital
Residual Tier 1 capital
For an instrument to qualify as Residual Tier 1 capital, an insurer must ensure that it satisfies the following criteria:[21]
the instrument is unsecured and paid up:
1. any partly paid issue is eligible only to the extent that it has been paid up. Subject to the conditions specified in paragraph 6 of this Attachment, unpaid perpetual non-cumulative preference shares issued through ‘stapled’ structures are permitted (to the extent that they are paid up); and
2. only the proceeds of the issue that have been received by the issuer are permitted to count as capital;
the instrument is perpetual:
the instrument is not redeemable at the option of the holder and has no provisions which require future redemption by the issuer; and
redemption at the option of the issuer is permitted, provided the redemption or call option is subject to APRA’s written approval at the time of exercise and it does not operate in conjunction with any other feature that creates or signals a de facto tenor of the instrument. If this occurs, APRA will consider the instrument to be a dated instrument and ineligible for inclusion as Tier 1 capital. Issue documentation must give clear and prominent notice to prospective investors that the issuer’s right to exercise any such option to redeem or purchase the instrument is subject to APRA’s prior written approval;
the instrument does not impose fixed servicing costs on the issuer:
dividend or interest payments to the holders of the instrument are at the discretion of the issuer. The issuer is able to waive any dividend or interest payments on the instrument and alter the timing of payments;
any unpaid dividends or interest are non-cumulative (i.e. not required to be made up by the issuer at a later date). The instrument, both in form and substance, does not provide for cumulative dividend or interest payments. For example, the instrument does not provide for payment of a higher dividend or interest rate if dividend or interest payments are not made on time or a reduced dividend or interest rate if such payments are made on time. Any special or optional dividends or interest payments on the instrument outside of normal scheduled payments require APRA’s prior written approval;
the non-payment of a dividend or interest on the instrument does not trigger any restrictions on the issuer other than its ability to pay dividends on ordinary shares, or purchase shares (outside normal trading operations) or retire other shares or pay dividends or interest on more junior capital instruments;
the instrument does not provide for payment of any form of compensation to investors other than by way of a distribution of profits. Any such profit distribution is in the form of a cash dividend or interest payments. Payment in kind is not permitted;
dividend or interest payments on the instrument are not linked to the credit standing of the issuer. However, linking dividend or interest payments on the instrument to movements in general market indices is permitted; and
the rate of dividends or interest on the instrument, or the formulae for calculating dividend or interest payments on the instrument, is predetermined and set out in the issue documentation;
the instrument is able to absorb losses incurred by the issuer on a going concern basis and in the winding-up of the issuer, including satisfying the criteria specified in paragraph 4 of this Attachment;
the instrument is subordinated in right of repayment of principal, interest and dividends to all policyholders and creditors of the issuer, and the issue documentation:
1. clearly indicates the subordinated nature of the instrument to prospective holders;
2. clearly precludes the exercise of any contractual rights of set-off between the instrument and any claims by the issuer on the holders of the instrument;
3. does not contain any clauses that could trigger early repayment of debt (e.g. cross-default clases, negative pledges, restrictive covenants); and
4. states that the only form of default under the instrument is the winding up of the insurer and that the occurrence of such an event does not prejudice the subordination of the instrument;
the instrument, where drawn down in a series of tranches, meets the requirements of this Prudential Standard as if each tranche were a capital issue in its own right;
the instrument does not contain any terms, covenants or restrictions that could inhibit the issuer’s ability to be managed in a sound and prudent manner, particularly in times of financial difficulty, or restrict APRA’s ability to resolve any problems encountered by the issuer (e.g. clauses preventing further senior debt issues are prohibited);
there are no cross-default clauses in the documentation of any debt or other capital instruments of the issuer linking the issuer’s obligations under the instrument to default by the issuer under any of its other obligations, or default by another party, related or otherwise; and
the instrument is marketed in line with its prudential treatment, and does not include any ‘repackaging’ arrangements which have the effect of compromising the permanency of capital raised. If the prospectus or other offering documentation or marketing of the instrument suggests to investors that the instrument has attributes of a lower level of capital than claimed for prudential treatment, APRA will treat the instrument as an instrument falling into that lower level of capital for prudential purposes.
Where an instrument is subject to the laws of a jurisdiction other than a state or territory of Australia, the insurer must also ensure that the instrument complies with and is enforceable under the laws of that jurisdiction. APRA may require the insurer to provide confirmation by way of an independent legal opinion addressed to APRA by a firm or practitioner of APRA’s choice, at the expense of the insurer.
An insurer must inform APRA of any subsequent modification of the terms or conditions of the instrument. An insurer must:
provide APRA with copies of documentation associated with the modification of the instrument; and
where the terms and conditions of the instrument as modified depart from established precedent:
consult with APRA on the eligibility of the instrument as modified for inclusion in the insurer’s capital base in advance of the modification of the instrument; and
provide APRA with all information it requires to assess the eligibility of the instrument as modified.
For the purposes of paragraph 1(d) of this Attachment, the issuer must ensure that:
the instrument (both principal and any unpaid dividends or interest) is treated as a specific class of share capital or members’ interest of the issuer. The contractual rights of the holders of the instrument to receive and enforce any payments under the instrument are consistent with the intention that the instrument functions as if it constituted a specific class of share capital or members’ interest of the issuer;
the issuer does not have any liability to make a dividend or interest payment on the instrument if making the payment would result in the issuer becoming, or being likely to become, insolvent for the purposes of the Corporations Act or, where the issuer is incorporated in a foreign jurisdiction, for the purposes of equivalent corporate insolvency law of that jurisdiction; and
issue documentation makes explicit that:
1. payment of dividends or interest on the instrument is at the discretion of the issuer;
2. failure of the issuer to make a dividend or interest payment on the instrument does not constitute an event of default;
3. holders have no right to apply for the winding-up or administration of the issuer, or cause a receiver, or receiver and manager, to be appointed in respect of the issuer on the grounds that the issuer fails to make, or is or may become unable to make, a dividend or interest payment under the instrument; and
4. holders of the instrument will have no offsetting rights or claims on the issuer in the event that the issuer cancels or suspends dividend or interest payments on the instrument.
Non-innovative Residual Tier 1 capital
For perpetual non-cumulative preference shares to qualify as Non-innovative Residual Tier 1 capital, an insurer must ensure that they satisfy both the criteria set out in paragraph 1 of this Attachment and the following criteria:
the preference shares have not been issued indirectly through an SPV. An indirect issue is not eligible for inclusion in Non-innovative Residual Tier 1 capital although the preference shares may be included in Innovative Tier 1 capital provided they also satisfy the criteria set out in Attachment C and the relevant criteria in this Attachment;
the preference shares do not provide for any step-up in dividends. A conversion from fixed to floating rate (or vice-versa) or a switch in index basis, where there is no change in the effective margin included in the rate of dividend, is not considered a step-up;
conversion of the preference shares into ordinary shares is permitted, subject to the following criteria:
conversion cannot occur at the option of the holder;
the conversion formula for determining the number of ordinary shares received upon conversion of a preference share is fixed in the issue documentation and includes a cap on the maximum number of ordinary shares that holders will receive upon conversion;
for the purposes of paragraph 5(c)(ii) of this Attachment, the maximum number of ordinary shares received upon conversion of each preference share does not exceed the ratio of the price of the preference share at issue divided by 50 per cent of the price of the ordinary share at time of issue of the preference shares. For these purposes, in calculating the ordinary share price at time of issue, adjustments may be made for subsequent ordinary share splits, bonus issues and similar transactions;
the conversion is not structured in a way that would effectively provide for a return of capital or compensation for unpaid dividends; and
any exercise of the conversion option by the issuer is subject to APRA’s prior written approval. Approval is not required for any mandatory conversions whose terms were agreed to by APRA prior to issuance of the preference shares; and
perpetual non-cumulative preference shares issued through ‘stapled’ structures are permitted, subject to the conditions specified in paragraph 6 of this Attachment.
For the purposes of paragraphs 1(a)(i) and 5(d) of this Attachment:
the preference shares are issued directly by the insurer and are ‘stapled’ to securities (stapled securities) issued directly by an overseas branch of the insurer. The stapled structure must not involve any use of SPVs and must be simple and transparent;
either or both of the preference shares and the stapled securities are paid up. Any partly paid preference shares or stapled securities are eligible only to the extent that they have been paid up;
the preference shares and the stapled securities are not traded separately and are stapled together unless and until an ‘unstapling event’ occurs;
the terms and conditions of the stapled securities mirror substantially those of the preference shares such that the stapled securities operate effectively as if they were the preference shares. Accordingly, the terms and conditions of the stapled securities do not compromise the Tier 1 qualities of the underlying preference shares;
‘unstapling’of the preference shares and the stapled securities at the option of the issuer is permitted. The instrument documentation must clearly stipulate the events that will cause the preference shares to be ‘unstapled’ resulting in the stapled securities being extinguished and the holders of the stapled securities holding the preference shares instead. ‘Unstapling’ must take place where:
proceedings for the liquidation of the insurer commence; or
APRA revokes the authorisation of the insurer pursuant to subsection 15(1) of the Act;
issue documentation requires holders of the stapled securities to hold the underlying preference shares upon the occurrence of an unstapling event. Where necessary, APRA may require an independent legal opinion confirming this result addressed to APRA by a firm or practitioner of APRA’s choice, at the expense of the insurer. To reduce the inherent legal risk associated with unstapling of the structure, the insurer must ensure the clarity, consistency and certainty with which the contractual terms and conditions are specified in the issue documentation, in particular that:
all entities involved in the stapled structure have the capacity and power needed to issue the relevant instruments and perform obligations under them;
the rights and obligations created by the preference shares and the stapled securities are legal, valid, binding and enforceable on all relevant parties in all relevant jurisdictions; and
the ‘unstapling’ mechanism will take effect as contemplated in the issue documentation even if the insurer or other entity has become, or is likely to become insolvent, including where it is in administration, receivership, winding up, or where APRA has revoked the authorisation of the insurer pursuant to subsection 15(1) of the Act; and
adequate internal policies and controls are in place such that the unstapling procedures are correctly followed.
Innovative Tier 1 capital
For an instrument to qualify as Innovative Tier 1 capital, an insurer must ensure that it satisfies the criteria set out in paragraph 1 of this Attachment and the following criteria:
where the instrument provides for a ‘step-up’ in dividends or interest, the terms of the step-up are limited, fixed at the time of issue and subject to APRA’s prior written approval (refer to paragraph 8 of this Attachment for further criteria in relation to step-ups);
a step-up in dividends or interest or an equity conversion is permitted in conjunction with an issuer call option, provided the step-up or equity conversion meets all relevant criteria specified in paragraphs 7(a), 7(c) and 8 of this Attachment, and, where the application of a step-up or equity conversion is optional, the issue cannot mandate the exercise of the call option if the step-up or equity conversion is not applied;
where the instrument provides for a mandatory conversion or an option to the holders or the issuer to convert into another form of eligible Tier 1 capital instrument, the instrument must not contain any conversion feature that effectively provides for a return of capital or compensation for unpaid dividends or interest. The rate of conversion in all circumstances must be fixed (e.g. by way of a formulae) at the time of issue; and
where the instrument is issued indirectly through an SPV, it satisfies the criteria set out in Attachment C.
For the purposes of paragraph 7(a) of this Attachment:
a step-up in dividends or interest includes the following events:
1. a change in margin on a floating rate instrument;
2. a change in rate on a fixed rate instrument;
3. a conversion from fixed to floating rate (or vice versa), with a change in the effective margin included in the rate of dividend or interest of the instrument; or
4. a switch in the index basis (e.g. from a 3-month to 6-month floating rate or from a 3-month LIBOR to a 3-month BBSW) with a change in the effective margin included in the rate of dividend or interest of the instrument;
a moderate step-up in the rate of dividends or interest is permitted, provided the increase in dividends or interest is no greater than either:
100 basis points, less the swap spread between the initial index basis and the stepped-up index basis; or
50 per cent of the initial credit spread, less the swap spread between the initial index basis and the stepped-up index basis;
the issue documentation specifies which of the two measures specified in paragraph 8(b) of this Attachment is to apply to the instrument;
switching between the two measures specified in paragraph 8(b) of this Attachment is not allowed;
where the step-up involves a conversion from fixed to floating rate (or vice versa), as set out in paragraph 8(a)(i) of this Attachment or a switch in index basis, the swap spread must be fixed as at the pricing date and reflect the differential in pricing on that date between the initial reference rate and the stepped-up reference rate;
any step-up in dividends or interest must not be operative within the first 10 years from drawdown; and
in principle, only one step-up in dividends or interest is permitted over the life of the instrument. Exceptions for step-ups to be undertaken on multiple occasions (and/or for variable amounts) may be approved by APRA, in writing, at the time of issuing the instrument.
Attachment B
Tier 2 Capital
Upper Tier 2 capital
Asset revaluation reserves
For the purposes of this Prudential Standard, only revaluation reserves arising from the revaluation of property and investments in subsidiaries not held at fair value, other than subsidiaries that APRA deems part of an ELE and associates referred to in paragraphs 2 to 4 of this Attachment, can be included in the capital of an insurer.
An insurer may only include reserves arising from the revaluation of property in Upper Tier 2 capital subject to the following conditions:
the property is owned by the insurer;
the property represents only land and buildings;
the reserves are shown as a component of equity in the published audited financial accounts of the insurer;
the revaluations are prudent, in accordance with Australian Accounting Standards and subject to audit or review consistent with Auditing and Assurance Standards; and
the amount of reserves incorporates the full effect of any fair value gains and losses and any gains or losses on hedges offsetting revaluations of property not held at fair value included in the reserves.
An insurer may only include reserves, including any share of undistributed profits in subsidiaries otherwise included in earnings, arising from the revaluation of investments in subsidiaries not held at fair value (other than subsidiaries that APRA deems to be part of an ELE) in Upper Tier 2 capital subject to the following conditions:
an insurer is able, if required by APRA, to demonstrate that a reliable fair value can be credibly inferred to the subsidiary. This could include demonstrating recent prices received for the sale of entities with similar business profiles, or reliable estimates of the fair value of assets and liabilities of a subsidiary or values derived from other sound valuation practices;
the amounts included in the reserves are shown as a component of equity in any published audited financial accounts of the insurer;
the revaluations are prudent, in accordance with Australian Accounting Standards, and subject to audit or review consistent with Auditing and Assurance Standards; and
the amount of reserves incorporates the full effect of any fair value gains and losses and any gains or losses on any hedges offsetting revaluations of the investments in subsidiaries not held at fair value.
An insurer may only include reserves representing an insurer’s share of profits in associates or revaluation of assets in associates under equity accounting plus any reserves otherwise arising from the revaluation of investments in associates in Upper Tier 2 capital subject to the following conditions:
where reserves simply reflect investments in associates and are revalued, an insurer is able, if required by APRA, to demonstrate that a reliable fair value can be credibly inferred to the investment in the associate. This could include demonstrating recent prices received for the sale of an equity interest in the associate or by way of sale of entities with similar business profiles, or reliable estimates of the fair value of assets and liabilities of the associate or values derived from other sound valuation practices;
the amounts included in the reserves are shown as a component of equity in any published audited financial accounts of the insurer;
any revaluations are prudent, in accordance with Australian Accounting Standards, and the amounts reported in the reserves are subject to audit or review consistent with Auditing and Assurance Standards; and
the amount of reserves incorporates the full effect of any fair value gains and losses and any gains or losses on any hedges offsetting revaluations of the investments in associates.
Hybrid capital instruments
For an instrument to qualify as Upper Tier 2 capital, an insurer must ensure that it satisfies the following criteria:[22]F
the instrument is unsecured and paid up, and in particular:
any partly paid issue is eligible only to the extent that it has been paid up; and
only the proceeds of the issue that have been received by the issuer are permitted to count as capital;
the instrument is perpetual and:
1. the instrument is not redeemable at the option of the holder and has no other provisions which require future redemption by the issuer; and
2. redemption at the option of the issuer is permitted, provided the redemption or call option is subject to APRA’s prior written approval at the time of its exercise and it does not operate in conjunction with any other feature that creates or signals a de facto tenor of the instrument. If this occurs, APRA will treat the instrument as a dated instrument and ineligible for inclusion as Upper Tier 2 capital. Issue documentation must give clear and prominent notice to prospective investors that the issuer’s right to exercise any such option to redeem or purchase the instrument is subject to APRA’s prior written approval;
the instrument where drawn down in a series of tranches meets the requirements of this Prudential Standard as if each tranche were a separate capital issue in its own right;
cumulative dividend or interest payments on the instrument are permitted subject to paragraph 8 of this Attachment;
the instrument is able to absorb losses incurred by the issuer on a going concern basis and in the winding-up of the issuer, and in particular, satisfying the criteria specified in paragraph 9 of this Attachment;
the instrument is subordinated in right of repayment of principal, interest and dividends to all policyholders and creditors of the issuer, except those creditors (not policyholders) expressed to rank equally with or behind the holders of the instrument and the issue documentation and, in particular, the instrument:
clearly indicates the subordinated nature of the instrument to prospective holders;
precludes the exercise of any contractual rights of set-off between the instrument and any claims by the issuer on the holders of the instrument;
does not contain any clauses that could trigger early repayment of debt (e.g. cross default clauses, negative pledges, restrictive covenants);
states that the only form of default under the instrument is the winding up of the insurer, provided such an event does not prejudice the subordination of the instrument; and
states that the only remedies for an event of default are to prove for an unpaid amount contractually due in the event of liquidation or administration of the issuer;
the instrument does not provide for any accelerated repayment of principal, except in the event of liquidation or winding-up of the issuer. The winding-up must be irrevocable i.e. either by way of a court order or an effective resolution by shareholders or members. The making of an application to wind-up, or the appointment of a receiver, administrator or official with similar powers, including the exercise of APRA’s powers under subsection 15(1) of the Act, are not sufficient to accelerate repayment of the instrument;
where the instrument provides for a mandatory conversion or an option to the holders or the issuer to convert into share capital of the issuer, the instrument does not contain any conversion feature that effectively provides for a return of capital or compensation for unpaid dividends or interest. The rate of conversion is fixed (e.g. by way of a formula) at the time of issue;
where the instrument provides for a ‘step-up’ in dividends or interest, the terms of the step-up are limited, fixed at the time of issue and subject to APRA’s prior written approval (refer to paragraph 14 of this Attachment for further criteria in relation to step-ups);
a step-up in dividends or interest or an equity conversion is permitted in conjunction with an issuer call option, provided the step-up or equity conversion meets all relevant criteria specified in paragraphs 5(h), 5(i) and 14 of this Attachment and, where the application of a step-up or equity conversion is optional, the issue cannot mandate the exercise of the call option if the step-up or equity conversion is not applied;
the instrument does not contain any terms, covenants or restrictions that could inhibit the issuer’s ability to be managed in a sound and prudent manner, particularly in times of financial difficulty, or restrict APRA’s ability to resolve any problems encountered by the issuer (e.g. clauses preventing further senior debt issues);
there are no cross-default clauses in the documentation of any debt or other capital instruments of the issuer linking the issuer’s obligations under the instrument to default by the issuer under any of its other obligations, or default by another party, related or otherwise;
the instrument is marketed in line with its prudential treatment, and does not include any ‘repackaging’ arrangements that have the effect of compromising the permanency of capital raised. If the prospectus or other offering documentation or marketing of the instrument suggests to investors that the instrument has attributes of a lower level of capital than claimed for prudential treatment, APRA will treat the instrument as an instrument falling into that lower level of capital for prudential purposes;
the insurer must have satisfied itself (where appropriate by taking into account written opinion from relevant legal advisers), on reasonable ground, that at time of issue of the instrument, the right to defer dividend or interest payments as provided for in paragraph 9(c)(i) of this Attachment is binding on holders of the instrument. An insurer must, if required by APRA, be able to demonstrate grounds on which it satisfied itself in this regard; and
where the instrument is issued indirectly through an SPV, it also satisfies the criteria set out in Attachment C.
Where the instrument is subject to the laws of a jurisdiction other than a state or territory of Australia, an insurer must also ensure that the instrument complies with and is enforceable under the laws of that jurisdiction. APRA may require the insurer to provide confirmation by way of an independent legal opinion addressed to APRA by a firm or practitioner of APRA’s choice, at the expense of the insurer.
An insurer must inform APRA of any subsequent modification of the terms or conditions of the instrument. An insurer must:
provide APRA with copies of documentation associated with the modification of the instrument; and
where the terms and conditions of the instrument as modified depart from established precedent:
consult with APRA on the eligibility of the instrument as modified for inclusion in the insurer’s capital base in advance of the modification of the instrument; and
provide APRA with all information it requires to assess the eligibility of the instrument as modified.
For the purposes of paragraph 5(d) of this Attachment:
the instrument must allow the issuer an option to defer dividend or interest payments where profitability does not justify a dividend or interest payment;[23]
where an instrument does not provide the issuer with the option to defer or reduce dividends or interest when profitability does not justify payment, such an instrument must be assessed as a Lower Tier 2 capital instrument;
while unpaid dividends or interest to the holders of the instrument can be accumulated, they must not be compounded. For example, the instrument must not provide for payment of a higher dividend or interest rate if dividend or interest payments are not made on time, nor a reduced dividend or interest rate if such payments are made on time;
the non-payment of a dividend or interest on the instrument must not trigger any restrictions on the issuer other than its ability to pay dividends on ordinary shares, or purchase shares (outside normal trading operations) or retire other shares, or pay dividends or interest on more junior capital instruments;
the instrument must not provide for payment of any form of compensation to investors other than by way of a distribution of profits. Any such profit distribution must be in the form of a cash dividend or interest payments. Payment in kind is not permitted;
dividend or interest payments on the instrument must not be linked to the credit standing of the issuer. However, linking dividend or interest payments on the instrument to movements in general market indices is permitted; and
the rate of dividends or interest on the instrument, or the formulae for calculating dividend or interest payments on the instrument, are predetermined and set out in the issue documentation.
For the purposes of paragraph 5(e) of this Attachment, the issuer must ensure that:
the instrument (both principal and any unpaid dividends or interest) is treated as a specific class of share capital or members’ interest of the issuer in the event that the issuer’s retained earnings become negative. The contractual rights of the holders of the instrument to receive and enforce any payments under the instrument must be consistent with the intention that the instrument functions as if it constituted a specific class of share capital or members’ interest of the issuer in this situation;
the issuer does not have any liability to make a scheduled dividend or interest payment on the instrument if making the payment would result in the issuer becoming, or being likely to become, insolvent for the purposes of the Corporations Act or, where the issuer is incorporated in a foreign jurisdiction, for the purposes of equivalent corporate insolvency law of that jurisdiction; and
issue documentation makes explicit that:
the issuer has the right to defer dividend or interest payments on the instrument in accordance with paragraphs 8(e) and/or 9(b) of this Attachment;
failure of the issuer to make a scheduled dividend or interest payment on the instrument does not constitute an event of default; and
holders have no right to apply for the winding-up or administration of the issuer, or cause a receiver, or receiver and manager, to be appointed in respect of the issuer on the grounds that the issuer fails to make, or is or may become unable to make, a scheduled dividend or interest payment under the instrument. However, in the event of liquidation, holders may claim previously deferred dividend and interest payments that remain unpaid.
Lower Tier 2 capital
For an instrument to qualify as Lower Tier 2 capital, an insurer must ensure that it satisfies the following criteria:
the instrument is unsecured and paid up:
1. any partly paid issue is eligible only to the extent that it has been paid up; and
2. only the proceeds of the issue that have been received by the issuer are permitted to count as capital;
the instrument has a minimum term of five years and satisfies the criteria specified in paragraph 13 of this Attachment;
issue documentation makes explicit that all scheduled dividend or interest payments on the instrument are conditional upon the issuer being solvent at the time of payment and no payment may be made unless the issuer is solvent immediately afterwards. Failure of the issuer to make any scheduled dividend or interest payments in this case does not constitute an event of default. An instrument may continue to accrue interest on any unpaid amounts. This can include interest on deferred interest payments;
the instrument does not provide for payment of a higher dividend or interest rate if dividend or interest payments are not made on time, nor a reduced dividend or interest rate if such payments are made on time;
dividend or interest payments on the instrument are not linked to the credit standing of the issuer. However, linking dividend or interest payments on the instrument to movements in general market indices is permitted;
the rate of dividends or interest on the instrument, or the formulae for calculating dividend or interest payments on the instrument, are predetermined and set out in the issue documentation;
where the instrument provides for a step-up in dividends or interest, the terms of the step-up are limited, fixed at the time of issue and subject to APRA’s prior written approval. Paragraph 15 of this Attachment provides further criteria in relation to step-ups;
a step-up in dividends or interest is permitted in conjunction with an issuer call option, provided the step-up meets all relevant criteria set out in paragraphs 10(g) and 15 of this Attachment and, where the application of a step-up is optional, the issue cannot mandate the exercise of the call option if the step-up is not applied. Otherwise, the instrument is deemed to mature on the date on which the step-up provisions take effect;
the instrument is subordinated in right of repayment of principal, interest and dividends to all policyholders and creditors of the issuer, except those creditors (not policyholders) expressed to rank equally with or behind the holders of the instrument, including that issue documentation clearly:
indicates the subordinated nature of the instrument to prospective holders, and
precludes the exercise of any contractual rights of set-off between the instrument and any claims by the issuer on the holders of the instrument;
in the event that the issuer defaults under the terms of the instrument, remedies available to the holders are limited to actions for specific performance, recovery of amounts currently outstanding or the winding-up of the issuer. The amounts which may be claimed in the event that the issuer defaults can include any accrued unpaid dividends and interest, including market interest on these unpaid amounts. All such unpaid dividends and interest must be subordinated to the claims of policyholders and creditors of the issuer;
the instrument does not provide for any accelerated repayment of principal, except in the event of liquidation or winding-up of the issuer. The winding-up must be irrevocable i.e. either by way of a court order or an effective resolution by shareholders or members. The making of an application to wind-up, or the appointment of a receiver, administrator, or official with similar powers, including the exercise of APRA’s powers under section 15(1) of the Act, are not sufficient to accelerate repayment of the instrument;
the instrument does not contain any terms, covenants or restrictions that could inhibit the issuer’s ability to be managed in a sound and prudent manner, particularly in times of financial difficulty, or restrict APRA’s ability to resolve any problems encountered by the issuer (e.g. clauses preventing further senior debt issues);
there are no cross-default clauses in the documentation of any debt or other capital instruments of the issuer linking the issuer’s obligations under the instrument to default by the issuer under any of its other obligations or default by another party, related or otherwise; and
where the instrument is issued indirectly through an SPV, it also satisfies the criteria set out in Attachment C.
Where the instrument is subject to the laws of a jurisdiction other than a state or territory of Australia, an insurer must also ensure that the instrument complies with and is enforceable under the laws of that jurisdiction. APRA may require the insurer to provide confirmation by way of an independent legal opinion addressed to APRA by a firm or practitioner of APRA’s choice, at the expense of the insurer.
An insurer must inform APRA of any subsequent modification of the terms or conditions of the instrument. An insurer must:
provide APRA with copies of documentation associated with the modification of the instrument; and
where the terms and conditions of the instrument as modified depart from established precedent:
consult with APRA on the eligibility of the instrument as modified for inclusion in the insurer’s capital base in advance of the modification of the instrument; and
provide APRA with all information it requires to assess the eligibility of the instrument as modified.
For the purposes of paragraph 10(b) of this Attachment:
where the instrument is drawn down in a series of tranches, it meets the requirements of this Prudential Standard as if each tranche were a separate capital issue in its own right and the minimum original maturity of each tranche is five years from the date of drawdown;
where the instrument provides holders with the right or option to demand repayment prior to maturity, the first possible repayment date is regarded as the effective maturity date of the instrument;
where the instrument offers the issuer a redemption or call option prior to maturity, issue documentation gives clear and prominent notice to prospective investors that the issuer’s right to exercise any such option to repay, purchase, or otherwise redeem the instrument is subject to APRA’s prior written approval; and
the amount of the instrument eligible for inclusion in Lower Tier 2 capital is to be amortised on a straight line basis at a rate of 20 per cent per annum over the last four years to maturity as follows:
Years to Maturity
Amount Eligible for Inclusion in Lower Tier 2 Capital
More than 4
100 per cent
Less than and including 4 but more than 3
80 per cent
Less than and including 3 but more than 2
60 per cent
Less than and including 2 but more than 1
40 per cent
Less than and including 1
20 per cent
Step-ups in dividends or interest
Upper Tier 2 instruments
For the purposes of paragraphs 5(i) of this Attachment:
a step-up in dividends or interest includes the following events:
a change in margin on a floating rate instrument;
a change in rate on a fixed rate instrument;
a conversion from fixed to floating rate (or vice versa), with a change in the effective margin included in the rate of dividend or interest of the instrument; or
a switch in the index basis (e.g. from a 3-month to 6-month floating rate or from a 3-month LIBOR to a 3-month BBSW) with a change in the effective margin included in the rate of dividend or interest of the instrument;
moderate step-up in the rate of dividends or interest is permitted, provided the increase in dividends or interest is no greater than either:
100 basis points, less the swap spread between the initial index basis and the stepped-up index basis; or
50 per cent of the initial credit spread, less the swap spread between the initial index basis and the stepped-up index basis;
the issue documentation specifies which of the two measures specified in paragraph 14(b)(ii) of this Attachment is to apply to the instrument;
switching between the two measures specified in paragraph 14(b)(ii) of this Attachment is not allowed;
where the step-up involves a conversion from fixed to floating rate (or vice versa), as set out in paragraph 14(a) of this Attachment, or a switch in index basis, the swap spread must be fixed as at the pricing date and reflect the differential in pricing on that date between the initial reference rate and the stepped-up reference rate;
any step-up in dividends or interest must not be operative within the first 10 years from drawdown; and
in principle, only one step-up in dividends or interest is permitted over the life of the instrument. Exceptions for step-ups to be undertaken on multiple occasions (and/or for variable amounts) may be approved by APRA, in writing, at the time of issuing the instrument.
Lower Tier 2 instruments
For the purposes of paragraph 10(g) of this Attachment:
a step-up in dividends or interest includes the following events:
a change in margin on a floating rate instrument;
a change in rate on a fixed rate instrument;
a conversion from fixed to floating rate (or vice versa), with a change in the effective margin included in the rate of dividend or interest of the instrument; or
a switch in the index basis (e.g. from a 3-month to 6-month floating rate or from a 3-month LIBOR to a 3-month BBSW) with a change in the effective margin included in the rate of dividend or interest of the instrument;
moderate step-up in the rate of dividends or interest is permitted, provided the increase in dividends or interest is no greater than:
50 basis points, less the swap spread between the initial index basis and the stepped-up index basis, for an issue with a maturity up to 10 years;
100 basis points, less the swap spread between the initial index basis and the stepped-up index basis, for an issue with a maturity of more than 10 years; or
50 per cent of the initial credit spread, less the swap spread between the initial index basis and the stepped-up index basis;
the issue documentation specifies which of the three measures specified in paragraph 15(b) is to apply to the instrument;
switching among the three measures specified in paragraph 15(b) is not allowed;
where the step-up involves a conversion from fixed to floating rate (or vice versa), as set out in paragraph 15(a), or a switch in index basis, the swap spread must be fixed as at the pricing date and reflect the differential in pricing on that date between the initial reference rate and the stepped-up reference rate;
any step-up in dividends or interest must not be operative within the first five years from drawdown; and
in principle, only one step-up in dividends or interest is permitted over the life of the instrument. Exceptions for step-ups to be undertaken on multiple occasions (and/or for variable amounts) may be approved by APRA, in writing, at the time of issuing the instrument.
Attachment C
Criteria for capital issues involving use of SPVs
For a capital instrument issued through an SPV, an insurer must ensure that it satisfies the following criteria:
the SPV issuing the instrument is a single purpose non-operating entity established for the sole purpose of raising capital for the insurer. The SPV has no liabilities outside the capital instrument it issues, and its assets do not exceed materially the amount of the capital instrument issued. The SPV is not able to operate independently of the insurer;
the proceeds of the instrument issued by the SPV are fully invested in the capital instrument issued by the insurer. The proceeds flow immediately into the insurer;
the terms and conditions of the instrument issued by the insurer mirror substantially those included in the instrument issued by the SPV. Essentially, both instruments are unsecured, fully paid up (any partly paid issue is eligible only to the extent that it has been paid up) and subordinated to all policyholders and creditors of the insurer. They have the same maturity;
to satisfy the essential characteristic of loss absorption for Tier 1 and Upper Tier 2 capital instruments and to activate this loss absorption ability well before any serious deterioration in the insurer’s financial position, the instrument issued by the SPV permits the absorption of losses in the event of any of the following:
APRA determines, in writing, that the insurer’s capital base is less than its MCR;
APRA issues a written direction to the insurer under section 36 of the Act for the insurer to increase its capital;
APRA revokes the authorisation of the insurer pursuant to subsection 15(1) of the Act or proceedings have been commenced for the winding-up of the insurer; or
the retained earnings of the insurer have become negative;
unless otherwise agreed, in writing, with APRA, the mechanism used to satisfy the loss absorption requirement in Hparagraph 1(d)H of this Attachment is mandatory conversion into ordinary shares or non-cumulative irredeemable preference shares of the insurer as appropriate. The rate of conversion is fixed (e.g. by way of a formula) at the time of subscription to the instrument. The insurer maintains a sufficient margin of authorised but unissued share capital to enable such conversion to take place at any time;
the instrument issued by the SPV is not covered by a guarantee of the issuer of related entity or any other arrangement that legally or economically enhances the seniority of the holders vis-à-vis policyholders, creditors and subordinated debt holders of the insurer;
the main features of the instrument issued by the SPV and the structure of the issue are transparent and easily understood by investors. An issue is not eligible for inclusion in an insurer’s capital base where the complexity of its structure raises doubt over the legal and regulatory risk associated with it; and
the key features of Tier 1, Upper or Lower Tier 2 capital instrument issued by the SPV are disclosed in the insurer’s published annual accounts. This includes disclosing:
the name of the entity issuing the instrument and the name of the entity receiving the ultimate proceeds of the issue;
the amount and currency denomination of the instrument;
the jurisdiction in which the instrument was issued and other jurisdictions whose laws might apply;
the dividend or interest rate payable on the instrument, including any provisions for step-up or supplementary dividends. Where the instrument pays a participating dividend based on dividends paid on ordinary shares, the formulae for calculating payments are set out;
any provisions for the exercise of call options or triggering conversion of the instrument; and
the triggers and mechanisms used to achieve loss absorption.
[3] Where technical provisions in excess of those required by GPS 310 are included as Tier 1 capital, they must be net of expected reinsurance recoveries and reinsurance recoverables. They must then be reduced to take account of tax effects.
[4] For the purposes of this Prudential Standard, an instrument is perpetual where it does not have a maturity date.
[5] This amount includes cumulative unrealised gains or losses on effective cash flow hedges. Where a revaluation is calculated net of hedges, the amount of hedges concerned must be excluded from reported Tier 1 capital; i.e. the gains or losses on hedges must be deducted from or added back to Tier 1 capital.
[6] This amount excludes any reserve recognised from the revaluation of the goodwill component of investments in subsidiaries not held at fair value.
[7] Refer to GPS 110 for the approval requirement.
[8] In accordance with reporting standards made under the Collection of Data Act.
[9] This includes that component of investments in controlled entities which represents goodwill and any other intangible assets (i.e. current value less value of identifiable net tangible assets).
10 Where the amount of deferred tax liabilities exceeds the amount of deferred tax assets, the excess cannot be added to Tier 1 capital (i.e. the net deduction is zero). This item also excludes any amounts associated with surpluses in any insurer employer-sponsored superannuation funds.
[11] Any gains on hedges are to be deducted and any losses on hedges are to be added back.
[12] Refer to paragraph 35 for transition period dates.
[13] For the purposes of this Prudential Standard, ‘reinsurance assets’ refers to reinsurance assets net of doubtful debts.
[14] Refer to paragraph 35 for transition period dates.
[15] For the purposes of this equation, ‘net premium receivables’ is the premium receivables net of doubtful debts, premiums paid or payable for retrocession and exchange commissions.
[16] For the purposes of this equation, ‘net premiums liabilities’ is the premiums liabilities net of expected recoveries.
[17] The tax rate is the corporate taxation rate applying to the proportional reinsurance contract (in Australia or a foreign country).
[18] The relevant fraction is: (expected direct premium under the treaty until the next review date less direct premium written under the treaty) divided by expected direct premium under the treaty until the next review date. The relevant fraction cannot be less than zero.
[20] This is the date that APRA released details of proposed changes to capital requirements for insurers.
[21] Capital instruments approved by APRA for Tier 1 status prior to 1 July 2006 are deemed to comply with the criteria set out in paragraph 1 of this Attachment.
[22] Capital instruments approved by APRA for Upper Tier 2 status prior to 1 July 2006 are deemed to comply with the criteria set out in paragraph 5 of this Attachment.
[23] Refer to paragraph 23 of this Prudential Standard.