Prudential Standard GPS 114 sets out the standardized method by which a general insurer or a Level 2 insurance group must calculate an Asset Risk Charge as a component of the prescribed capital amount under the Insurance Act 1973. The instrument is made under section 32 of the Act (Authority, para 1), revokes the earlier determination (opening instrument) and commences on 1 July 2023 (Application and commencement, para 3). It applies to each general insurer authorised under the Act and to Level 2 insurance groups, with requirements imposed on the parent entity where the latter are concerned (Application and commencement, para 2). Certain subsidiaries are captured where they are parent entities of Level 2 groups (preamble).

Mechanically, the Standard requires a regulated institution that uses the Standard Method for prescribed capital to:

perform seven specified stress tests on the value of on-balance sheet and relevant off-balance sheet assets and liabilities (para 10);
translate the effects of those stresses into seven non‑negative “risk charge components” (paras 9-11);
aggregate those components using a prescribed correlation-based formula (paras 78-80) to produce an “aggregated risk charge component”; and
deduct eligible tax benefits from that aggregated amount, subject to constraints reflecting the availability of deferred tax liabilities (paras 12-14).

The stress tests cover real interest rates, expected inflation, currency, equity, property, credit spreads and default (paras 31-77). Some stresses (real interest rates, expected inflation, currency) must be run in both directions and both directional impacts are included in the aggregation (paras 34-36, 39-40, 42-43, 80). Off-balance sheet exposures are included via an “effective exposure” principle (paras 15, 21 and Attachment A). Collateral and guarantees can reduce the impact of stresses where they meet eligibility rules (para 22 and Attachment B). Special treatments exist for hybrid instruments, trust/controlled investment entities, repurchase arrangements, term deposits from ADIs, derivatives and Extended Licence Entities (paras 23-30; Attachments A and C). Level 2 insurance groups face specific modifications and procedural requirements (Attachment D).

meta-content-style-type: text/css meta-content-type: application/xhtml+xml; charset=utf-8 meta-generator: Aspose.Words for .NET 22.10.0 meta-keywords: "[SEC=UNOFFICIAL]" title: Prudential Standard GPS 114

Commonwealth Coat of Arms

Insurance (prudential standard) determination

No. 4 of 2023

Prudential Standard GPS 114 Capital Adequacy: Asset Risk Charge

Insurance Act 1973

I, Helen Rowell, a delegate of APRA:

(a) under subsection 32(4) of the Insurance Act 1973 (the Act), revoke Insurance (prudential standard) determination No. 2 of 2022, including Prudential Standard GPS 114 Capital Adequacy: Asset Risk Charge, made under that Determination; and

(b) under subsection 32(1) of the Act determine Prudential Standard GPS 114 Capital Adequacy: Asset Risk Charge, in the form set out in the Schedule, which applies to:

(i) all general insurers and authorised NOHCs; and

(ii) a subsidiary of a general insurer or authorised NOHC, where that subsidiary is a parent entity of a Level 2 insurance group.

This instrument commences on 1 July 2023.

Dated: 24 May 2023

[Signed]

Helen Rowell

Deputy Chair

Interpretation

In this instrument:

APRA means the Australian Prudential Regulation Authority.

authorised NOHC has the meaning given in section 3 of the Act.

general insurer has the meaning given in section 11 of the Act.

Level 2 insurance group has the meaning given in Prudential Standard GPS 001 Definitions.

parent entity has the meaning given in Prudential Standard GPS 001 Definitions.

subsidiary has the meaning given in Prudential Standard GPS 001 Definitions.

Schedule

Prudential Standard GPS 114 Capital Adequacy: Asset Risk Charge, comprises the document commencing on the following page.

Commonwealth Coat of Arms

Prudential Standard GPS 114

Capital Adequacy: Asset Risk Charge

Objectives and key requirements of this Prudential Standard<br>This Prudential Standard requires a general insurer or Level 2 insurance group to maintain adequate capital against the asset risks associated with its activities.<br>The ultimate responsibility for the prudent management of capital of a general insurer or Level 2 insurance group rests with its Board of directors. The Board must ensure the general insurer or Level 2 insurance group maintains an adequate level and quality of capital commensurate with the scale, nature and complexity of its business and risk profile, such that it is able to meet its obligations under a wide range of circumstances.<br>The Asset Risk Charge is the minimum amount of capital required to be held against asset risks. The Asset Risk Charge relates to the risk of adverse movements in the value of a general insurer’s or Level 2 insurance group’s on-balance sheet and off-balance sheet exposures. Asset risk can be derived from a number of sources, including market risk and credit risk.<br>This Prudential Standard sets out the method for calculating the Asset Risk Charge. This charge is one of the components of the Standard Method for calculating the prescribed capital amount for general insurers and Level 2 insurance groups.

Table of Contents

Authority

Application and commencement

Level 2 insurance groups

Interpretation

Asset Risk Charge

Asset Risk Charge calculation

Assets and liabilities to be stressed

Real interest rate stress

Expected inflation stress

Currency stress

Equity stress

Property stress

Credit spreads stress

Default stress

Aggregation formula

Adjustments and exclusions

Previous exercise of discretion

Attachment A – Off-balance sheet exposures

Attachment B – Treatment of collateral and guarantees as risk mitigants

Attachment C – Extended Licensed Entity

Attachment D – Level 2 insurance groups

Authority

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

Application and commencement

2. This Prudential Standard applies to each:

(a) general insurer authorised under the Act (insurer); and

(b) Level 2 insurance group as defined in Prudential Standard GPS 001 Definitions (GPS 001).

Where a requirement is made in respect of a Level 2 insurance group, the requirement is imposed on the parent entity of the Level 2 insurance group.

3. This Prudential Standard applies to insurers and Level 2 insurance groups (regulated institutions) from 1 July 2023.

Level 2 insurance groups

4. Certain adjustments to the methodologies and calculations in this Prudential Standard apply to Level 2 insurance groups. These adjustments are set out in Attachment D.

Interpretation

5. Terms that are defined in GPS 001 appear in bold the first time they are used in this Prudential Standard.

Asset Risk Charge

6. This Prudential Standard sets out the method for calculating the Asset Risk Charge for a regulated institution using the Standard Method to determine its prescribed capital amount.

7. The Asset Risk Charge relates to the risk of an adverse movement in a regulated institution’s capital base due to credit or market risks. Both assets and liabilities may be affected. Off-balance sheet exposures may also be affected.

Asset Risk Charge calculation

8. The Asset Risk Charge is calculated as:

(a) the ‘aggregated risk charge component’ determined in accordance with paragraph 9; less

(b) any ‘tax benefits’ determined in accordance with paragraphs 12 to 14.

Aggregated risk charge component

9. A regulated institution must calculate the ‘risk charge components’, as defined in paragraph 10, by considering the impact on the capital base of the regulated institution of a range of stresses. These risk charge components are then aggregated using the formula set out in paragraphs 78 to 80, which allows for the likelihood of the scenarios modelled by the stress tests occurring simultaneously. The result of applying the formula is defined as the ‘aggregated risk charge component’.

Risk charge components

10. The risk charge components are calculated by determining the fall in the capital base of the regulated institution in seven stress tests:

(a) ‘real interest rates’ determined in accordance with paragraphs 31 to 36;

(b) ‘expected inflation’ determined in accordance with paragraphs 37 to 40;

(d) ‘equity’ determined in accordance with paragraphs 44 to 47;

(e) ‘property’ determined in accordance with paragraphs 48 to 52;

(f) ‘credit spreads’ determined in accordance with paragraphs 53 to 64; and

(g) ‘default’ determined in accordance with paragraphs 65 to 77.

These stresses are applied either directly to asset values or by way of changes to economic variables that in turn affect the value of both assets and liabilities. Some assets and liabilities may be impacted by more than one of the seven stress tests and will need to be considered in each relevant stress test. For the stresses in (a), (b) and (c), the impact on the capital base will be two separate amounts and these need to be included in the aggregation formula.

11. For the purposes of paragraph 10, no risk charge component may be negative and, therefore, if there is no fall in the capital base of the regulated institution due to the application of the stresses, the risk charge component is assumed to be zero.

Tax benefits

12. The risk charge component for each stress test must be calculated so that no value is attributed to any tax benefits that may result from the stress test. However, tax benefits may be deducted from the aggregated risk charge component.

13. The tax benefits deducted from the aggregated risk charge component are the tax benefits resulting from scenarios modelled by the stress tests, reduced to allow for the reduction in Asset Risk Charge due to the aggregation formula. The tax benefits are therefore calculated as:

Tax benefits times aggregated risk charge component divided by sum of risk charge component

14. The tax benefits from paragraph 13 must be recognised as a deduction from the Asset Risk Charge only if tax legislation allows them to be absorbed by the existing deferred tax liabilities. For this purpose, the deferred tax liabilities are those liabilities (if any) that remain after netting off the deferred tax assets and liabilities in the calculation of the deductions from Common Equity Tier 1 Capital in Prudential Standard GPS 112 Capital Adequacy: Measurement of Capital (GPS 112).

Assets and liabilities to be stressed

15. In determining each risk charge component, a regulated institution must include the effective exposure[1] of the regulated institution’s assets and liabilities to each of the risks if the exposure is impacted by the stress test. Some assets and liabilities may have effective exposures to multiple risks.

16. Investment income receivables must be included with the asset that generated the income and then subject to the appropriate stress tests.

17. The following assets and liabilities must not be stressed:

(a) assets whose value must be deducted from the capital base (e.g. goodwill in subsidiaries) in GPS 112; and

(b) any part of assets in excess of the asset concentration limits specified in Prudential Standard GPS 117 Capital Adequacy: Asset Concentration Risk Charge.

18. In addition to paragraph 17, a regulated institution that is an employer-sponsor of a defined benefit superannuation fund does not need to reassess any deficit in the fund as a result of the seven stress tests, unless the regulated institution has provided a guarantee in relation to the benefits.

19. The stress tests must be applied to the fair value of each of the regulated institution’s assets. A regulated institution may measure its non-financial assets, short term receivables and intercompany receivables and payables using the requirements in Australian Accounting Standards rather than fair value.[2]

20. For Category C insurers, the Asset Risk Charge must be applied to the assets in Australia only of the Category C insurer, consistent with reporting standards made under the Financial Sector (Collection of Data) Act 2001.

Off-balance sheet exposures

21. A regulated institution may be exposed to various asset risks through transactions or dealings other than those reflected on its balance sheet. Each of the stress tests must include any changes to the regulated institution’s on-balance sheet assets and liabilities that would result from application of the stresses to the regulated institution’s off-balance sheet exposures. A regulated institution must use effective exposure for any off-balance sheet exposures of the regulated institution. Detailed information on the treatment of off-balance sheet exposures is set out in Attachment A.

Collateral and guarantees

22. The impact of applying the asset risk stresses may be reduced where the regulated institution holds certain types of collateral against an asset, or where the asset has been guaranteed. Detailed information on the eligibility of collateral and guarantees is set out in Attachment B.

Treatment of specific asset classes

23. Hybrid assets such as convertible notes must be split into their interest-bearing and equity/option exposures. A regulated institution must consider the changes in value of the two exposures separately for each of the asset risk stresses.

24. For assets of a regulated institution held under a trust or in a controlled investment entity,[3] the regulated institution may calculate the Asset Risk Charge by looking-through to the assets and liabilities of the trust. Alternatively, the investment may be treated as an equity asset (a listed equity asset if the investment is listed, or an unlisted equity asset if the investment is unlisted). Look-through must be used if the trust or controlled investment entity is both unlisted and geared.[4]

25. A security that is the subject of a repurchase or securities lending agreement must be treated as if it were still owned by the lender of the security. Any counterparty risk that arises from the transaction must be recognised in the default stress.

26. Term deposits issued by an authorised deposit-taking institution (ADI) must be treated in the same way as a corporate bond issued by the ADI. If the ADI guarantees a minimum amount on early redemption, the minimum amount may be recognised as a floor to the stressed value of the asset in each of the real interest rates and expected inflation stresses. In the credit spreads stress, the minimum amount may be recognised as a floor to the stressed value, but it must be reduced by multiplying it by (1 – default factor).

Derivatives

27. Derivatives include forwards, futures, swaps, options and other similar contracts. Derivatives expose a regulated institution to the full range of investment risks, even though in many cases there may be no, or only a very small, initial outlay.

28. Changes to the capital base that would arise from changes in the value of derivatives must be included in the risk charges arising from each of the asset risk stresses.

29. A risk charge must be applied to the fair value of over-the-counter derivatives in the default stress to allow for the risk of counterparty default. This is in addition to any charges that would arise from other asset risk stresses.

Extended Licence Entity

30. In certain circumstances, a regulated institution may choose to hold assets in a Special Purpose Vehicle (SPV) or other related entity, rather than on its own balance sheet. Detailed information on the treatment of an ‘Extended Licence Entity’ (ELE) is set out in Attachment C.

Real interest rate stress

31. This stress measures the impact on the capital base of a regulated institution from changes in real interest rates.

32. Real interest rates are the portion of the nominal risk-free interest rates that remain after deducting expected CPI inflation.

33. All assets and liabilities whose values are dependent on real or nominal interest rates must be revalued using the stressed real or nominal rates.

34. The stress adjustments to real interest rates are determined by multiplying the greater of three per cent or the nominal risk-free interest rates by 0.25 (upward stress) or by -0.20 (downward stress). The stress adjustments must be added to the nominal risk-free interest rates. The stress adjustments must also be added to real yields if these are used explicitly in the valuation of an asset or liability (e.g. inflation-indexed bonds). Post-stress real yields may be negative.

35. The maximum stress adjustment is 200 basis points in either direction. The minimum upward stress is 75 basis points and the minimum downward stress is 60 basis points. Nominal risk-free interest rates and real yields may be negative after applying the downward stress adjustment.

36. The regulated institution must calculate the impact on the capital base of an upward movement and a downward movement in real interest rates. The impact of each calculation must not be less than zero. Both impact calculations must be used for the purposes of the aggregation formula in paragraph 78.

Expected inflation stress

37. This stress measures the impact on the capital base of changes to expected Consumer Price Index (CPI) inflation rates. The expected inflation stress also affects nominal interest rates. The expected inflation stress does not apply to assets that are affected by the property or equity stresses.

38. In each scenario, assets and liabilities whose values are dependent on expected inflation or nominal interest rates must be revalued using the stressed expected inflation or nominal interest rates.

39. The stress adjustments to expected inflation rates are an increase of 125 basis points and a decrease of between 50 and 100 basis points. A downward stress of 50 basis points applies when the nominal risk-free interest rate is negative. A downward stress of 100 basis points applies when the nominal risk-free interest rate exceeds one per cent per annum. If the nominal risk-free interest rate is between zero and one per cent per annum the downward stress is determined as the sum of 50 basis points and half of the nominal risk-free interest rate. The stress adjustments must be added to the nominal risk-free interest rates. The stress adjustments must also be added to any expected inflation rates included in the valuation of assets or liabilities. Nominal risk-free interest rates and expected inflation rates may be negative after applying the downwards stress adjustments.

40. The regulated institution must calculate the impact on the capital base of an upward movement and a downward movement in expected inflation or nominal interest rates. The impact of each calculation must not be less than zero. Both impact calculations must be used for the purposes of the aggregation formula in paragraph 78.

Currency stress

41. This stress measures the impact on the capital base of changes in foreign currency exchange rates.

42. The regulated institution must calculate the impact on the capital base of both an increase and a decrease of 25 per cent in the value of the Australian dollar against all foreign currencies.[5] In each of these scenarios, the Australian dollar must be assumed to move in the same direction against all foreign currencies. The impact of each calculation must not be less than zero. Both impact calculations must be used for the purposes of the aggregation formula in paragraph 78.

43. An increase in the capital base arising from a movement of the Australian dollar against one foreign currency must not be used as an offset to reductions in the capital base arising from the movement of the Australian dollar against other foreign currencies.

Equity stress

44. This stress measures the impact on the capital base of a fall in equity and other asset values. This stress applies to both listed and unlisted equity assets and to any other assets that are not considered in any of the other asset risk stresses. This stress also includes an increase to equity volatility. The volatility stress will affect an asset whose value is affected by movements in equity volatility (e.g. equity derivatives).

45. For listed equities, the fall in value is to be determined by increasing the dividend yield on the ASX 200 index at the reporting date by 2.5 per cent. The same proportionate fall in value must be applied to both Australian and overseas listed equities.

46. For unlisted equities and other assets, the fall in value is to be determined by increasing the dividend yield on the ASX 200 index at the reporting date by 3 per cent. The same proportionate fall in value must be applied to all unlisted equities and other assets. The ASX 200 dividend yield must be determined using dividends for the 12 months prior to the reporting date and asset values at the reporting date.

47. For assets whose value is affected by movements in equity volatility, an addition of 15 per cent must be made to the forward-looking equity volatility parameter for all durations.

Property stress

48. This stress measures the impact on the capital base of changes in property and infrastructure asset values.

49. The fall in value of the assets must be determined by increasing the rental yield for property assets or earnings yield for infrastructure assets by 2.75 per cent.

50. For property assets, the rental yields are to be based on the most recent leases in force and are determined net of expenses.

51. For infrastructure assets, the yields to be used are the earnings yields before tax.

52. The rental yields and fall in value may be determined separately for each asset, or on a portfolio basis.

Credit spreads stress

53. This stress measures the impact on the capital base of an increase in credit spreads and the risk of default.

54. This stress applies to interest-bearing assets, including cash deposits and floating rate assets. Credit derivatives and zero-coupon instruments such as bank bills must also be included.

55. The stressed value of an asset must be determined by adding the spread specified in Table 1 to the current yield on the asset and then multiplying the reduced value of the asset by (1 – default factor). The credit spreads and default factors depend on the counterparty grade and the nature of the asset:

Table 1: Credit spreads and default factors

Counterparty grade	Default (%)	Bonds[6] spread (%)	Structured/ securitised spread (%)	Re-securitised spread (%)
1 (government)	0.0	0.0	0.0	0.0
1 (other)	0.2	0.6	1.0	1.8
2	0.6	0.8	1.4	2.4
3	1.2	1.2	2.0	3.2
4	3.0	1.6	2.5	4.0
5	6.0	2.0	3.0	5.0
6	10.0	2.5	3.5	6.0
7	16.0	3.0	4.5	7.5

56. A ‘securitised/structured asset’ is an asset that provides an exposure to a pool or portfolio of assets or risks. This is typically in the form of a tranched exposure and includes credit-related securitisation exposures and insurance linked securities. Examples of these include Residential Mortgage-Backed Securities, Asset-backed Securities and catastrophe bonds. A covered bond issued by an ADI must not be treated as a securitised/structured asset.

57. An investment that provides exposure to an untranched pool of multiple reference entities, assets or risks must be treated:

(a) on a ‘look-through’ basis;

(b) as an equity asset (applying the equity stress instead of the credit spreads stress); or

58. Credit wrapped bonds must be treated as a securitised asset if the external rating of the bond makes some allowance for the structural protection offered by the credit wrap. Otherwise the bond must be treated as a bond with no credit wrap.

59. A re-securitisation exposure is a securitisation exposure in which the risk associated with an underlying pool of exposures is tranched and at least one of the underlying exposures is a securitisation exposure. In addition, an exposure to one or more re-securitisation exposures is a re-securitisation exposure.

60. For floating rate assets, the increase in yield must be assumed to apply for the period until a regulated institution has the contractual right to redeem the asset at face value. For at-call floating rate assets, only the default factor must be applied. For floating rate assets that are not immediately redeemable, both the credit spread and default factors must be applied.

61. For fixed rate assets where the regulated institution has a contractual right to early redemption of the asset, the stressed value of the asset is subject to a minimum of the guaranteed redemption value multiplied by (1 – default factor).

62. Unsecured loans that have a 100 per cent charge applied in the default stress in accordance with paragraph 72 must be assumed to be unaffected by the credit spreads stress.

63. The ‘government’ category applies to:

(a) assets guaranteed by the Commonwealth Government; and

(b) assets guaranteed by foreign governments that have a counterparty grade of 1 and are denominated in the official or national currency of the guarantor.

64. Assets guaranteed by an Australian state or territory government may be rated up one grade. For example, assets with counterparty grade 1 must be treated as grade 1 (government) and assets with counterparty grade 2 must be treated as grade 1 (other).

Default stress

65. This stress applies to reinsurance assets, over-the-counter derivatives, unpaid premiums and all other credit or counterparty exposures that have not been affected by the credit spreads stress.

66. This stress includes the risk of counterparty default. A regulated institution must determine risk charges for the default stress for the risk of counterparty default on exposures that include (but are not limited to) reinsurance assets, unpaid premiums, futures and options, swaps, hedges, warrants, forward rate and repurchase agreements.

67. Where a regulated institution has unpaid premium, unclosed business, and non-reinsurance recoveries in respect of business ceded under a whole of account quota share arrangement, this stress may be applied to the net (rather than gross) of the quota share position.

68. The default factors are specified in Table 2. These factors apply to all assets affected by this stress, with the exception of certain types of assets specified in paragraphs 70 to 76.

Table 2: Default factors by counterparty grade

Counterparty grade	Default factor (%)
1 (government)	0
1 (other)	2
2	2
3	4
4	6
5	8
6	12
7	20

69. For the purpose of the default stress, reinsurance assets are to be the central estimate of reinsurance assets as measured in accordance with Prudential Standard GPS 340 Insurance Liability Valuation (GPS 340). For other assets, the default factor must be applied to the amount of loss that would be incurred if the counterparty defaulted and no recovery was made.

70. For unpaid premiums the factors are four per cent for premiums due less than six months previously and eight per cent for other premiums due.

71. For unclosed business a four per cent factor applies.

72. The following types of unsecured loans have a 100 per cent default factor applied[7]:

(a) loans to directors of the regulated institution, or their spouses;

(b) loans to directors of related bodies corporate, or their spouses;

(d) loans to employees exceeding $1,100.

73. Assets guaranteed by an Australian state or territory government must be rated up one grade. For example, assets with counterparty grade 1 must be treated as grade 1 (government) and assets with counterparty grade 2 must be treated as grade 1 (other).

Reinsurance assets due from non-APRA authorised reinsurers

74. Reinsurance assets due from non-APRA-authorised reinsurers are subject to the default stress factors that are higher than would otherwise apply under paragraph 68. These are set out in Table 3 below.

Table 3: Default factors by counterparty grade for non-APRA-authorised reinsurance assets

Counterparty grade	Default factor (%)
1 (government)	2
1 (other)	2
2	4
3	6
4	8
5	12
6	20
7	20

75. The default factors for reinsurance recoverables from non-APRA-authorised reinsurers arising under reinsurance contracts incepting on or after 31 December 2008 are as specified in Table 4 below (in replacement of those specified in Table 2 in paragraph 68) to each reinsurance recoverable on and from the second annual balance date after the event giving rise to the reinsurance recoverable occurred.[8] This treatment applies only to the extent that the reinsurance recoverables are not supported by collateral, a guarantee or a letter of credit as specified in Attachment B.[9]

Table 4: Default factors for reinsurance recoveries from non-APRA authorised reinsurers on and from the second balance date

Counterparty grade	Default factor (%)
1	20
2	40
3	60
4	100
5	100
6	100
7	100

76. A default factor of 100 per cent applies to a reinsurance recoverable due from a non-APRA-authorised reinsurer if:

a) the recoverable has become a receivable (i.e. it is due and payable);

b) the receivable is overdue for more than six months since a request for payment has been made to the reinsurer; and

c) there is no formal dispute between the insurer and reinsurer in relation to that receivable.[10]

77. For the purposes of determining the amount of a reinsurance recoverable, if there is an offsetting arrangement between the regulated institution and the reinsurer that results in premium being withheld by the insurer in lieu of claim payments, the withholding of that premium is taken to be payment to the extent any claims payments are overdue. However, if there is a requirement for offsets to be approved by the reinsurer, the date of the offset request is taken to be the date that approval is given.

Aggregation formula

78. The aggregated risk charge component is calculated as:

Risk charge of default plus the root sum of the maximum of the correlation between x and y, multiplied by risk charges for those components and the sign of x and y

where

(a) Ax is the risk charge component for asset risk stress x;

(b) Ay is the risk charge component for asset risk stress y;

(d) Corrx,y is the correlation between asset risk stresses x and y;

(e) sign (x) is 1 for the equity, property and credit spreads stresses. For the real interest rates and expected inflation stresses, sign (x) is 1 if the stress is a decrease in rates, otherwise it is -1. For the currency stress, sign (x) is 1 if the stress is a depreciation of the Australian dollar against foreign currencies, otherwise it is -1; and

(f) sign (y) is defined in the same way as sign (x).

79. The correlation matrix is:

Table 5: Asset Risk Charge correlation matrix

	RIR	INF	CUR	EQY	PROP	CSP
RIR	1	0.2	0.2	0.2	0.2	0.2
INF	0.2	1	0.2	0.4	0.4	0.2
CUR	0.2	0.2	1	0.6	0.2	0.4
EQY	0.2	0.4	0.6	1	0.4	0.8
PROP	0.2	0.4	0.2	0.4	1	0.4
CSP	0.2	0.2	0.4	0.8	0.4	1

80. The real interest rates, expected inflation and currency stresses apply in two directions. The aggregation needs to be performed twice for each of these stresses if both stresses produce a non-zero risk charge component, with the larger of the aggregates chosen. If two of the bidirectional stresses have a non-zero risk charge component for stresses in both directions, the aggregation will need to be performed four times — once for each combination of stresses. If all three of the bidirectional stresses have a non-zero risk charge component for stresses in both directions, the aggregation will need to be performed eight times.

Adjustments and exclusions

81. APRA may, by notice in writing to a regulated institution, adjust or exclude a specific requirement in this Prudential Standard in relation to that regulated institution.

Previous exercise of discretion

82. A regulated institution must contact APRA if it seeks to place reliance, for the purposes of complying with this Prudential Standard, on a previous exemption or other exercise of discretion made by APRA under a previous version of this Prudential Standard.

Attachment A – Off-balance sheet exposures

A regulated institution may be exposed to various asset risks through transactions or dealings other than those reflected on its balance sheet.
The principle of considering the effective exposure of the regulated institution to asset risks must be applied to any off-balance sheet exposures of the regulated institution. Changes to the capital base arising from off-balance sheet exposures must be recognised in each of the asset risk stresses.
As a general rule, a regulated institution must not be exposed to a counterparty for an unlimited amount and any exposure must be for a finite period. An exception to this rule is where a potential credit exposure results from reinsurance of an insurance contract that is required by law to be unlimited. Before a regulated institution does enter into an arrangement with a counterparty that does not have appropriate limits, it must:

(a) notify APRA;

(b) explain how this arrangement complies with its Risk Management Strategy; and

Such an exposure may cause APRA to apply a supervisory adjustment in accordance with Prudential Standard GPS 110 Capital Adequacy.

Direct credit substitutes

4. To the extent that a regulated institution has issued instruments of the following kind:

(a) guarantees (including written put options serving as guarantees);

(b) letters of credit; or

the regulated institution is exposed to the risk of having to make payment on these instruments should a default event occur that requires the regulated institution to pay an amount under the instrument. The risk of such events occurring must be considered in the default stress. The default factors must be applied to the face value of each exposure. Where the credit substitute is supported by collateral or a guarantee, the provisions of relevant paragraphs from Attachment B may be applied.

Surety bonds

5. A regulated institution that issues a surety bond which meets the definition set out in paragraph 6 of this Attachment may approach APRA for treatment in accordance with the approach set out in paragraph 7 of this Attachment, as an alternative to the treatment outlined in paragraph 4 of this Attachment.

6. For the purposes of paragraph 5 of this Attachment, a surety bond means an undertaking given by a regulated institution at the request of a person (Customer) pursuant to an agreement (Surety Agreement) between the regulated institution and the Customer made in the following circumstances:

(a) the Customer enters into the Surety Agreement in order to enable the Customer to meet a requirement of another agreement (Principal Agreement) between the Customer, or a person associated with the Customer, and a person other than the regulated institution (Principal);

(b) under the surety bond, the regulated institution undertakes to make a payment to, or perform an obligation for the benefit of, the Principal or another person nominated by the Principal (Beneficiary) in the circumstances specified in the surety bond;

(c) the surety bond is issued to the Principal or the Beneficiary in relation to, or in connection with, an obligation owed by the Customer, or a person associated with the Customer, to the Principal under the Principal Agreement being an obligation that:

(i) is a performance obligation or contains an element of performance on the part of the Customer, or a person associated with the Customer; and

(ii) does not relate solely to an obligation on the part of the Customer, or a person associated with the Customer, to pay a stipulated amount to the Principal in the event that a specified event occurs; and

(d) under the Surety Agreement, the Customer is liable to the regulated institution if the regulated institution makes a payment or incurs a liability to the Principal or the Beneficiary under the surety bond.

7. A regulated institution must seek written approval from APRA to treat any surety bonds the regulated institution has issued as if they were an insurance risk (for the purposes of meeting the requirements of the GI Prudential Standards only). This would require the regulated institution to include surety bond exposures within the insurer’s assessment of insurance liabilities, as determined under GPS 340, and to apply the relevant capital factors specified in Prudential Standard GPS 115 Capital Adequacy: Insurance Risk Charge. For the purposes of calculating net outstanding claims liabilities and net premiums liabilities (as determined under GPS 340), the regulated institution may treat any risk mitigation arrangement as if it were reinsurance.

8. A regulated institution seeking APRA’s approval for this approach outlined in paragraph 7 of this Attachment would need to include with its application a written confirmation from the regulated institution’s Appointed Actuary that that person is able to appropriately measure the risk of the surety bond business within the regulated institution’s insurance liabilities.

Attachment B – Treatment of collateral and guarantees as risk mitigants

The impact of applying the asset risk stresses may be reduced where the regulated institution holds certain types of collateral against an asset, or where the asset has been guaranteed, as a means of reducing risk.
For a regulated institution where the assets in question are reinsurance recoverables due from non-APRA-authorised reinsurers, different rules regarding treatment of collateral and guarantees apply (refer to paragraphs 6 to 10 of this Attachment).

Collateral

3. Collateral held against an asset may be considered in place of the asset if this would reduce the Asset Risk Charge. Where the fair value of the collateral does not cover the full value of the asset, the collateral must only replace that part of the asset that is covered by the collateral.

4. Collateral may be recognised in place of an asset only to the extent that it takes the form of a registered charge, registered mortgage or other legally enforceable security interest in, or over, an ‘Eligible Collateral Item’. ‘Eligible Collateral Items’ are cash, government securities, or debt obligations (i.e. loans, deposits, placements, interest rate securities and other receivables) where the counterparty has a counterparty grade of 1, 2 or 3. The Eligible Collateral Item must also be held for a period not less than that for which the asset is held.

Guarantees

5. The stresses applied in the credit spreads and default stresses may be determined using the counterparty grade of a third-party guarantor if the guarantee is explicit, unconditional, irrevocable and legally enforceable for the remaining term to maturity of the related asset. The guarantor must have a counterparty grade (or for governments, a long-term foreign currency credit rating) of 1, 2 or 3. Guarantees provided by the regulated institution’s parent or a related entity are not eligible for this treatment.

Collateral, guarantees and letters of credit in respect of reinsurance recoverables due from non-APRA authorised reinsurers[11]

6. Where a regulated institution possesses recognised collateral in Australia against reinsurance recoverables due from a non-APRA-authorised reinsurer, it may, in the default stress, apply the default factor relevant to the collateral to the value of the reinsurance recoverables (instead of applying the default factor that would otherwise apply to the reinsurance recoverables). For the purposes of this paragraph, collateral is recognised only:

(a) to the extent that it takes the form of:

(i) assets held in Australia that form part of a trust fund maintained by a trustee resident in Australia for the benefit of the insurer;

(ii) deposits held by the insurer in Australia, which are controlled by the insurer in Australia, made by the non-APRA-authorised reinsurer;

(iii) a combination of the two forms of collateral specified in paragraphs (i) and (ii); or

(iv) any other form of collateral as may be approved by APRA in writing in a particular case; and

(b) if it provides effective security against liabilities arising under the reinsurance contract; and

(c) if it is not available for distribution to creditors of the reinsurer other than the insurer in the event of the insolvency of the reinsurer.

7. Where the fair value of the collateral does not cover the full value of the reinsurance recoverables, only that part of the value of the reinsurance recoverables that is covered by collateral may be assigned the default factor applicable to the collateral.

8. Where a regulated institution possesses a guarantee or letter of credit in respect of the reinsurance recoverables due from a non-APRA-authorised reinsurer, the default factor to be used is that applicable to the guarantor or the issuer of the letter of credit, as the case may be. This paragraph applies only if each of the following conditions is satisfied:

(a) the guarantor or issuer of the letter of credit is an ADI or, in the case of a Category E insurer, its parent entity or other related entity, provided the entity has a counterparty grade of 1, 2 or 3;

(b) the guarantee or letter of credit is explicit, unconditional and irrevocable;

(d) the obligation of the guarantor or issuer of the letter of credit to pay the insurer is specifically linked to performance of the reinsurance contract or contracts under which the reinsurance recoverables arise.

9. Except in the case of a Category E insurer, a guarantee or letter of credit provided to an insurer by its parent entity or other related entity is not eligible for the treatment provided for in paragraph 8 of this Attachment.

10. The collateral, guarantee or letter of credit referred to in paragraphs 6 to 8 of this Attachment must be effective for the expected period for payment of claims under the reinsurance contract under which the reinsurance recoverables arise. If this is impractical, the collateral, guarantee or letter of credit must be effective for a period of at least 24 months and must include a termination provision requiring the issuer to give the insurer 12 months written notice of the issuer’s intention to terminate the collateral, guarantee or letter of credit.

Attachment C – Extended Licensed Entity

In certain circumstances, a regulated institution may choose to hold assets in an SPV or other related entity, rather than on its own balance sheet. Where a regulated institution receives approval under paragraph 3 of this Attachment, the regulated institution will be able to determine its Asset Risk Charge based on the individual assets and liabilities of the related entity rather than simply on the regulated institution’s direct exposure to that entity. This treats the activities of the regulated entity and the related entity as comprising an Extended Licensed Entity (ELE).
The extent to which the risk of a regulated institution’s exposure to a related entity is commensurate with the underlying holdings of that entity, depends on the extent to which the regulated institution has control over, or is integrated with the entity, as well as on the existence of material third party liabilities of the entity. The regulated institution must consider any potential complications under a scenario where underlying asset holdings must be liquidated during financial stress.
Subject to the specific requirements set out in paragraph 4 of this Attachment, a regulated institution may apply to APRA to have one or more related entities approved as part of its ELE. Once approved, APRA will allow the regulated institution to ‘look-through’ the legal structures involved, and to ‘consolidate’ the balance sheet of the related entity with its own, for the purpose of determining the Asset Risk Charge. In effect, this allows the regulated institution to treat its own balance sheet and that of the approved related entity as a single entity for the purpose of calculating the Asset Risk Charge.
In deciding whether to approve an entity as part of a regulated institution’s ELE, APRA will have regard to the following criteria in respect of the relationship between the regulated institution and the related entity:

(a) the related entity must be wholly owned and controlled by the regulated institution, with a Board of directors/trustees that is comprised entirely of members of the regulated institution’s Board or senior management;

(b) the regulated institution must demonstrate to APRA that there are no legal or regulatory barriers (e.g. restrictions imposed by law or a regulator in a foreign jurisdiction) to the transfer of the assets back to the regulated institution;

(c) the regulated institution’s risk management systems and controls must apply fully to the operations of the related entity. The senior management of the regulated institution must be in a position to monitor the operations of the related entity to the same extent as the operations of the regulated institution itself. Systems for monitoring and maintaining control over the related entity must be included within the internal and external audit programs of the regulated institution;

(d) the regulated institution must be able to furnish stand-alone accounting records for the related entity and provide APRA with full and unfettered access to this information at any time (including during on-site visits);

(e) where the related entity holds or invests in assets on behalf of the regulated institution, the related entity must have no material third party liabilities, other than exempt tax liabilities and employee entitlements;

(f) where the related entity borrows on behalf of the regulated institution, all funds must be on-lent directly to the regulated institution; and

(g) the related entity must not conduct any business that the regulated institution would otherwise be prevented from conducting under the Act.

Attachment D – Level 2 insurance groups

The following adjustments to the methodologies and calculations in this Prudential Standard must be applied by the Level 2 insurance group:

Tax benefit

(a) Level 2 insurance groups may recognise tax benefits as a deduction from the Asset Risk Charge if tax legislation allows them to be absorbed by the existing deferred tax liabilities within the Level 2 insurance group. However, a Level 2 insurance group must not recognise tax benefits whose value is contingent on the tax benefits being absorbed by deferred tax liabilities of entities outside the Level 2 insurance group;

Currency stress

(b) Level 2 insurance groups must make all consolidation adjustments for intra-group arrangements before applying the currency stress outlined in this Prudential Standard;

Default stress

(c) Level 2 insurance groups must make all consolidation adjustments for intra-group arrangements before applying the stress outlined in this Prudential Standard; and

(d) The modification to the default stress relating to reinsurance recoverables from non-APRA-authorised reinsurers, as set out in paragraphs 74, 75 and 76 of this Prudential Standard, does not apply to the reinsurance recoverables of the international business of the Level 2 insurance group.[12]

2. A Level 2 insurance group must consult with APRA prior to entering into a material securitisation transaction in order to reduce the Asset Risk Charge.

3. A Level 2 insurance group may use a best endeavours basis to determine the identification of asset or counterparty exposures for international business. The best endeavours basis must use information held by entities within the Level 2 insurance group, or otherwise publicly available information, in a manner consistent with the group’s documented credit risk management policies.

[1] The effective exposure of an insurer’s assets and liabilities must also include the regulatory adjustments to Common Equity Tier 1 Capital to allow for the effects of accounts receivable and accounts payable outlined in Attachment B of GPS 112, but gross of any tax effects.

[2] For the purpose of calculating the result of the stress tests other than the default stress, a regulated institution must use the net insurance liabilities calculated in accordance with Prudential Standard GPS 340 Insurance Liability Valuation (GPS 340) instead of the equivalent statutory account values.

[3] For this purpose, an investment entity is an entity where the sole purpose of the entity is investment activities.

[4] For this purpose, a trust or entity may be geared through borrowings or through the use of derivatives.

[5] In the increase scenario, the Australian dollar values of foreign currency assets and liabilities will fall by 20 per cent. In the decrease scenario, the Australian dollar values of foreign currency assets and liabilities will increase by 33.3 per cent.

[6] and other non-securitised assets including covered bonds issued by an ADI.

[7] Unsecured loans that have a 100 per cent default factor applied in accordance with paragraph 72 are not subject to credit spreads stress, real interest rates stress, expected inflation stress and currency stress.

[8] For a claims-made policy, the reference to “event” is to the date a claim notification was made. Novated contracts are regarded as incepting at the time specified in the contract they replaced, except where a later time is specified in the novation deed.

[9] For the avoidance of doubt, the default factors specified in Table 4 apply to the amount of relevant reinsurance recoverables that exceeds the amount of available collateral, guarantee or letter of credit.

[10] Any dispute between the insurer and reinsurer in relation to a receivable arising from a reinsurance recoverable would have been taken into account in the valuation processes provided for under GPS 340

[11] For the purpose of application of paragraphs 6 to 10 of this Attachment to a Level 2 insurance group, ‘insurer’ must be read to mean a Level 1 insurer (as defined in GPS 001).

[12] For clarity, this means that the reinsurance recoverables from non-APRA-authorised reinsurers of entities within the Level 2 insurance group that are not insurers are not subject to the default factors in Table 3, subject to the default factors in Table 4 or the default factor as determined by paragraph 76 for the default stress test.

meta-content-style-type: text/css meta-content-type: application/xhtml+xml; charset=utf-8 meta-generator: Aspose.Words for .NET 22.10.0 meta-keywords: "[SEC=UNOFFICIAL]" title: Prudential Standard GPS 114

Insurance (prudential standard) determination

No. 4 of 2023

Prudential Standard GPS 114 Capital Adequacy: Asset Risk Charge

Insurance Act 1973

I, Helen Rowell, a delegate of APRA:

(b) under subsection 32(1) of the Act determine Prudential Standard GPS 114 Capital Adequacy: Asset Risk Charge, in the form set out in the Schedule, which applies to:

(i) all general insurers and authorised NOHCs; and

(ii) a subsidiary of a general insurer or authorised NOHC, where that subsidiary is a parent entity of a Level 2 insurance group.

This instrument commences on 1 July 2023.

Dated: 24 May 2023

[Signed]

Helen Rowell

Deputy Chair

Interpretation

In this instrument:

APRA means the Australian Prudential Regulation Authority.

authorised NOHC has the meaning given in section 3 of the Act.

general insurer has the meaning given in section 11 of the Act.

Level 2 insurance group has the meaning given in Prudential Standard GPS 001 Definitions.

parent entity has the meaning given in Prudential Standard GPS 001 Definitions.

subsidiary has the meaning given in Prudential Standard GPS 001 Definitions.

Schedule

Prudential Standard GPS 114 Capital Adequacy: Asset Risk Charge, comprises the document commencing on the following page.

Prudential Standard GPS 114

Capital Adequacy: Asset Risk Charge

Core concepts in GPS 114 are defined operationally within the Standard rather than by novel legal definitions in the instrument. Key concepts and their operational effects in the Standard are:

Asset Risk Charge: the minimum capital required against asset risks. It is calculated as the aggregated risk charge component less permitted tax benefits (paras 6-9, 8). The Asset Risk Charge is a component of the Standard Method for prescribed capital (para 6).
Risk charge components: the fall in a regulated institution’s capital base caused by each of seven stress tests (paras 9-11). Each component is floored at zero (para 11).
Aggregated risk charge component: the result of combining the individual risk charge components using the prescribed aggregation formula that accounts for correlations between stresses (paras 9, 78-80). The formula treats default separately and aggregates other stresses with correlation factors set in Table 5 (para 79).
Effective exposure: the metric for off‑balance sheet exposures and instruments where notional amounts do not reflect true exposure. Regulated institutions must use effective exposure when including off‑balance sheet items in stresses (paras 15, 21; Attachment A). Footnote 1 adds that effective exposure must include regulatory adjustments to Common Equity Tier 1 capital related to receivables/payables per GPS 112 Attachment B, gross of tax effects.
Stress scenarios: seven distinct stresses (real interest rates, expected inflation, currency, equity, property, credit spreads, default) applied to assets and liabilities as relevant, sometimes in two directions (paras 10, 31-77). Some stresses operate via changes to economic variables (e.g. yields), others by direct percentage changes to valuation metrics (e.g. equity dividend yield increases) (paras 34-36, 44-47, 48-52, 53-64).
Tax benefits: tax effects modelled by stresses are excluded at the individual risk charge component level but may be deducted from the aggregated risk charge component if they are practically available to be absorbed by existing deferred tax liabilities (paras 12-14). The Standard prescribes a formula for determining the allowable tax benefit deduction (para 13) and links recognition to the GPS 112 calculation of deferred tax liabilities (para 14).
Look‑through / treatment options for pooled vehicles: assets held through trusts or controlled investment entities can be either looked through to underlying holdings or treated as (listed or unlisted) equity; look‑through is mandatory if the vehicle is both unlisted and geared (para 24).
Extended Licence Entity (ELE): APRA may approve a related entity (for example, an SPV) to be treated as part of the regulated institution for Asset Risk Charge purposes where specific integration and control criteria are met (Attachment C paras 1-4). Approval allows look‑through and consolidation for the Asset Risk Charge calculation.
Level 2 insurance group adjustments: Attachment D specifies consolidation requirements (currency and default stresses) and limits on tax benefit recognition and certain reinsurance recoverable treatments for Level 2 groups (Attachment D paras 1-1(d)). Material securitisation transactions by Level 2 groups require prior consultation with APRA (Attachment D para 2).

These concepts combine into a mechanics-led stress aggregation regime intended to quantify exposure of capital to market and credit risks. The Standard repeatedly emphasises valuation assumptions (fair value in most cases) and the interaction with other prudential standards (GPS 112 for capital measurement, GPS 340 for insurance liabilities, GPS 117 for concentration limits and GPS 110 for supervisory adjustments) (paras 17, 19; footnotes; Attachment A para 3).

GPS 114 applies to a defined set of regulated institutions and, within those, to particular entities and business lines as set out in the Standard:

Primary coverage: each general insurer authorised under the Insurance Act 1973 and Level 2 insurance groups (Application and commencement, para 2). Where a requirement is made in respect of a Level 2 group, the requirement is imposed on the parent entity of that group (para 2). The opening instrument also extended application to authorised NOHCs and to subsidiaries of general insurers or authorised NOHCs where that subsidiary is a parent of a Level 2 group.
Board and senior management: the Standard places ultimate responsibility for capital adequacy on the Board of directors (Objectives and key requirements box). Boards must therefore ensure the processes, valuations and controls required by the Standard are in place.
Entities holding particular assets: regulated institutions that hold assets via trusts, controlled investment entities, SPVs or related entities are affected by look‑through and ELE rules (paras 24, Attachment C). In particular, if a trust/investment entity is unlisted and geared, look‑through is required (para 24).
Reinsurance counterparties and non‑APRA authorised reinsurers: insureds with reinsurance recoverables from non‑APRA authorised reinsurers face higher default factors and different collateral/guarantee recognition rules (paras 74-76; Attachment B paras 6-10). Level 2 groups have a specific carve‑out for international business reinsurance recoverables (Attachment D 1(d)).
Counterparties in credit or trade relationships: the Standard categorises counterparties into counterparty grades (used to set credit spread and default factors , Tables 1 and 2 in paras 55 and 68). Assets guaranteed by Commonwealth/foreign governments or Australian states/territories receive special grading treatment (paras 63-64 and 73).
Category C insurers and reporting constraints: Category C insurers must apply the Asset Risk Charge only to assets in Australia (para 20), which will affect offshore investment allocation calculations and reporting under the Financial Sector (Collection of Data) Act 2001, as referenced.
Entities using derivatives, secured funding or securities lending: derivatives must be included in each stress (paras 27-29); repo and securities lending must treat lent securities as still owned by the lender and recognise counterparty risk in default stress (para 25). Term deposits of ADIs are treated as corporate bonds for credit spread/default purposes (para 26).
Insurers issuing surety bonds: surety bonds can only be treated as insurance risks (and included within GPS 340 liabilities and GPS 115 capital factors) with APRA’s written approval, and require an Appointed Actuary confirmation (Attachment A paras 5-8).
Level 2 insurance groups specifically: they must consolidate intra-group arrangements prior to applying currency and default stresses (Attachment D paras 1(b) and 1(c)), may only recognise tax benefits within the group (Attachment D 1(a)), must consult APRA before material securitisations (Attachment D para 2), and may use a “best endeavours” basis for identifying international exposures (Attachment D para 3).

Who pays: ultimately the regulated institution bears the capital cost , the Asset Risk Charge increases the prescribed capital amount that the insurer or group must hold. This creates an economic cost borne by the entity’s capital providers and, indirectly, policyholders/owners through capital allocation decisions and pricing. Who decides: APRA sets the matrix, calibrations and has discretion to adjust or exclude requirements for specific institutions (para 81). Boards and senior management decide internal valuation, documentation, and whether to seek APRA approvals (Attachment C para 3, Attachment A para 7).

Duties imposed by GPS 114 derive from both calculation mechanics and procedural obligations. Rights are mostly procedural (to seek APRA approvals or rely on past discretions). Key duties and rights include:

Duties

Calculation duty: regulated institutions using the Standard Method must calculate the Asset Risk Charge following the detailed procedure: measure exposures, apply seven stresses obtaining non‑negative risk charge components, aggregate them using the formula in paras 78-80 and deduct eligible tax benefits (paras 8-14, 78-80).
Inclusive measurement duty: the stresses must be applied to the fair value of assets (except where the Standard allows use of Australian Accounting Standards for non‑financial assets, short-term receivables and intercompany items) and must include effective exposures for off‑balance sheet items (paras 19-21; footnote 2; Attachment A).
Off‑balance and collateral duties: regulated institutions must include the effect of off‑balance sheet exposures as effective exposures (para 21; Attachment A). Collateral is recognised only if it is an eligible collateral item (registered charge/mortgage/security interest over cash/government securities/debt obligations of counterparty grade 1-3) and held for at least the asset holding period (Attachment B paras 3-4). Guarantees are eligible only if explicit, unconditional, irrevocable, enforceable and by a guarantor of grade 1-3 (Attachment B para 5).
Specific treatment duties: hybrid securities must be split into debt and equity components (para 23); look‑through is mandatory for unlisted and geared investment vehicles (para 24); repos and securities lending are treated as ownership by the lender (para 25); term deposits of ADIs are treated as ADI bonds with possible floors if early redemption guarantee exists (para 26); derivatives must be included in each stress and OTC derivatives carry an additional default counterparty charge (paras 27-29).
Disclosure to APRA and approvals: institutions must notify APRA before entering into arrangements that create unlimited exposures (Attachment A para 3), must seek APRA approval to treat surety bonds as insurance (Attachment A paras 5-8), may apply for ELE treatment and must meet strict criteria (Attachment C paras 1-4), and Level 2 groups must consult APRA before material securitisation transactions (Attachment D para 2).
Treatment of tax benefits: calculate risk components without attributing tax benefits (para 12), but compute tax benefits separately for possible deduction at the aggregated level using the formula in para 13 and subject to the requirement that deferred tax liabilities can absorb them (para 14).

Rights / procedural entitlements

Right to seek adjustment/exclusion: APRA may, by written notice, adjust or exclude a specific requirement for a regulated institution (para 81). This is a right in the sense that institutions may apply for such relief (though the Standard does not prescribe the application process).
Right to rely on previous discretions only with APRA contact: institutions that wish to rely on prior APRA exercises of discretion must contact APRA (para 82).
Right to apply for ELE or surety bond treatment: regulated institutions may apply to APRA for ELE approval (Attachment C para 3) or for surety bond treatment as insurance (Attachment A para 7), provided the Standard’s criteria are met.
Right for Level 2 groups to use best endeavours internationally: permitted to identify exposures for international business on a best endeavours basis, using internal or public information consistent with documented credit risk policies (Attachment D para 3).

Operational obligations often require supporting documentation, such as an Appointed Actuary’s written confirmation when seeking surety bond treatment (Attachment A para 8), and ready access to related entity accounting records for ELE approval (Attachment C para 4(d)). The Board has the duty to ensure that the entity holds adequate capital commensurate with scale, nature and complexity of the business (Objectives and key requirements box). APRA’s supervisory tools and its discretion to adjust requirements give it a decision role, but the Standard sets the calculation mechanics and prescribes which assets, offsets and mitigants are eligible.

GPS 114 itself sets the technical requirements but does not create stand‑alone criminal or civil penalties. It is a prudential standard made under section 32 of the Insurance Act 1973 (Authority, para 1) and therefore operates as a binding regulatory instrument within APRA’s prudential framework. Enforcement arises through APRA’s supervisory powers under the Act and related prudential standards rather than through sanctions spelled out in GPS 114. The Standard contains the following enforcement-relevant mechanisms and references:

APRA discretion and notices: APRA may adjust or exclude any specific requirement in the Standard in relation to a regulated institution by written notice (para 81). This is a supervisory tool that implies APRA oversight and tailored treatment, and is the primary mechanism within the Standard for regulatory intervention or relief.
Interaction with GPS 110: Attachment A para 3 expressly contemplates that an exposure arrangement without appropriate limits may cause APRA to apply a supervisory adjustment under Prudential Standard GPS 110 Capital Adequacy. GPS 110 contains supervisory adjustment powers; GPS 114 references this as a possible enforcement action for unbounded exposures.
Consultation requirements and approvals: several provisions require prior or subsequent APRA contact as a precondition for alternative treatments, notably ELE approval (Attachment C para 3), surety bond treatment (Attachment A para 7), consultation prior to material securitisation for Level 2 groups (Attachment D para 2), and notification for unlimited counterparty exposure arrangements (Attachment A para 3). Non‑compliance with such process obligations could lead to APRA exercising supervisory powers.
Capital measurement linkage: GPS 114 is a component of the Standard Method for prescribed capital. Failing to calculate or hold the required capital will manifest in contravention of prudential capital adequacy obligations under the Insurance Act. The Act and other prudential standards contain APRA’s enforcement powers, including directions and other corrective measures (note: those statutory powers are not reproduced in GPS 114 itself; para 1 indicates the Standard is made under the Act).
Documentation and traceability: the Standard expects valuation methods, look‑through analyses, collateral documentation and Appointed Actuary confirmations for alternative treatments (paras 19, 24, Attachment B, Attachment A para 8, Attachment C para 4). Shortcomings in recordkeeping or failure to obtain approvals create supervisory risk.

The Standard therefore sets out compliance prescriptions and APRA supervisory levers rather than standalone penal provisions. The explicit statutory basis (para 1) and references to supervisory adjustments (Attachment A para 3) indicate that enforcement and sanctions would be exercised using APRA’s statutory powers under the Insurance Act and related prudential standards, rather than through GPS 114 alone. Regulated institutions should therefore assume enforcement is through APRA supervision, including tailored notices, adjustments, and broader powers available under the Insurance Act and other prudential standards.

GPS 114 is expressly cross‑referenced to several other prudential standards and statutory instruments, creating a networked compliance landscape:

Insurance Act 1973: GPS 114 is made under section 32 of the Act (Authority, para 1). The Act provides APRA with the statutory power to make prudential standards, and GPS 114 operates as part of that statutory framework.
GPS 112 Capital Adequacy: Measurement of Capital: GPS 114 relies on GPS 112 for the definition and calculation of deductions from Common Equity Tier 1 capital, and specifically for determining whether deferred tax liabilities exist to absorb tax benefits before those can be deducted from the Asset Risk Charge (paras 12-14; footnote 1). Footnote 1 requires inclusion of regulatory adjustments to CET1 related to receivables and payables as set out in GPS 112 Attachment B.
GPS 340 Insurance Liability Valuation: For purposes of stress test calculations other than the default stress, regulated institutions must use the net insurance liabilities calculated in accordance with GPS 340 instead of equivalent statutory account values (footnote 2). For the default stress, reinsurance assets are to be the central estimate of reinsurance assets as measured under GPS 340 (para 69).
GPS 117 Asset Concentration Risk Charge: Assets in excess of the asset concentration limits specified in GPS 117 must not be included in the stresses (para 17(b)). This cross-reference effectively prioritises GPS 117 limits when determining the scope of assets subject to GPS 114.
GPS 110 Capital Adequacy (supervisory adjustments): Attachment A para 3 notes that APRA may apply a supervisory adjustment under GPS 110 where a regulated institution enters arrangements creating unlimited counterparty exposure or other exposures without appropriate limits. This links GPS 114’s off‑balance sheet treatment to GPS 110 supervisory tools.
The Financial Sector (Collection of Data) Act 2001: Category C insurers must apply the Asset Risk Charge to Australian assets only, consistent with reporting standards made under that Act (para 20). This places GPS 114 within the data‑reporting framework administered under that statute.
Domestic and foreign law constraints: Attachment C requires that the regulated institution demonstrate there are no legal or regulatory barriers in foreign jurisdictions to transferring assets back to the regulated institution (Attachment C para 4(b)). This requirement imposes an interaction with foreign legal regimes when applying for ELE approval.
Tax law: The recognition of tax benefits depends on whether tax legislation allows those benefits to be absorbed by existing deferred tax liabilities (para 14). GPS 114 therefore intersects with tax law and the tax position of the entity or group, and it references the GPS 112 treatment of deferred tax assets/liabilities.
Prudential definitions: GPS 114 relies on definitions in GPS 001 for Level 2 insurance group, parent entity and subsidiary (Interpretation, para 5). Those definitional linkages mean that entities should consult GPS 001 to understand scope and group classification implications.

These cross‑references mean GPS 114 must be read in conjunction with GPS 112, GPS 340, GPS 117, GPS 110, GPS 001 and relevant statutory reporting requirements. Practical compliance requires reconciliation of valuation bases across standards (e.g. fair value for assets under GPS 114 versus accounting measurement), consistent application of intra‑group consolidation for Level 2 purposes (Attachment D), and alignment of tax recognition with GPS 112 and applicable tax legislation (paras 12-14). APRA’s discretion to adjust or exclude requirements (para 81) and the requirement to consult APRA on certain matters (Attachments) mean the Standard operates within a broader supervisory dialogue.

The formal instrument text records the immediate amendment history relevant to GPS 114:

This Prudential Standard is Insurance (prudential standard) determination No. 4 of 2023, determined by Helen Rowell, Deputy Chair and APRA delegate, dated 24 May 2023 (preamble). The instrument revokes Insurance (prudential standard) determination No. 2 of 2022, including the previous Prudential Standard GPS 114, and determines the new GPS 114 in the form provided (preamble).
The instrument takes effect from 1 July 2023 (Application and commencement, para 3). The revocation of the 2022 determination and replacement by the 2023 instrument is stated explicitly in the instrument preamble.
Attachment D contains a procedural note that Level 2 insurance groups must consult with APRA prior to entering material securitisation transactions in order to reduce the Asset Risk Charge (Attachment D para 2). That provision imposes an ongoing procedural requirement rather than an amendment per se, but it is a change in administrative practice relative to a regime without consultation obligations.
Paragraph 82 addresses transitional or legacy discretions: a regulated institution must contact APRA if it seeks to rely, for compliance with the current Prudential Standard, on a previous exemption or other exercise of discretion made by APRA under a previous version of the Standard (para 82). This clause preserves continuity but requires APRA contact for reliance on earlier discretion.

The Standard also contains several footnotes and attachments that reference prior dates or treatments (for example, Table 4 in para 75 replacing default factors for reinsurance recoverables from non-APRA-authorised reinsurers for contracts incepting on or after 31 December 2008). These are permanent parts of the current Standard and indicate selective historical treatment changes embedded in the instrument.

No other amendment chronology, legislative history, or prior versions are contained in the text provided beyond the explicit revocation of the 2022 determination and the 2023 commencement. Regulated institutions with legacy approvals or exemptions must consult APRA per para 82.

The text of GPS 114 supplied contains no references to litigation, court decisions, administrative appeals or case law. The Standard names no judicial authorities and does not cite any litigation outcomes. It contains references to other prudential standards and statutory provisions (e.g. Insurance Act 1973, GPS 112, GPS 340, GPS 117, GPS 110 and GPS 001) but it does not record any legal challenges to the Standard, or to prior APRA determinations, within the instrument itself.

Consequently, there is no litigation history recorded in the instrument to summarise. If an institution needs to assess precedential or contested interpretations of GPS 114’s detail (for example the scope of APRA discretion under para 81, the availability of tax benefit deductions under paras 12-14, or the application of look‑through rules), it will need to look to external case law, internal APRA guidance, or supervisory determinations outside the text provided. GPS 114 itself does not document any such cases, and therefore no source‑grounded litigation history can be supplied from this instrument.

GPS 114 contains several technical details and procedural traps that can materially affect an insurer’s capital calculation if not handled precisely. The following are specific provisions that warrant close attention:

Bidirectional stresses require multiple aggregations: real interest rate, expected inflation and currency stresses are applied both up and down (paras 34-36, 39-40, 42-43). The aggregation (para 80) must therefore be run multiple times (up to eight combinations if all three bidirectional stresses produce non‑zero components) and the largest aggregate chosen. Failure to test both directions or to follow the aggregation protocol will misstate the aggregated risk charge.
Tax benefit recognition is conditional and formulaic: individual risk components must be calculated without attributing tax benefits (para 12). Tax benefits may be deducted from the aggregated risk charge only where such benefits can be absorbed by existing deferred tax liabilities measured under GPS 112 (para 14). The Standard prescribes a formula for the deduction (para 13) that scales tax benefits by the ratio of aggregated to summed risk charges; incorrect application or incorrect deferred tax accounting under GPS 112 will distort the allowed deduction.
Effective exposure and accounting bases: off‑balance sheet items must use effective exposure (para 21; Attachment A), and for stress tests other than default, the net insurance liabilities from GPS 340 must be used instead of statutory account values (footnote 2). Inconsistent bases between actuarial valuation and market valuation can lead to mismatches unless reconciled.
Look‑through mandatory for certain vehicles: where the regulated institution’s investment vehicle is both unlisted and geared, look‑through to underlying assets is required (para 24). Treating such assets as unlisted equity instead of looking through will be non‑compliant.
Collateral and guarantee thresholds are narrow: eligible collateral must be in a specific legal form (registered charge/mortgage/security interest) and over Eligible Collateral Items (cash, government securities, or certain debt obligations) and must be held for the asset holding period (Attachment B paras 3-4). Guarantees must be explicit, unconditional, irrevocable, enforceable and by guarantors of grade 1-3, and guarantees by parent or related entities are ineligible except for specified cases (Attachment B paras 5, 9). Misclassifying or failing to document collateral/guarantees will deny risk mitigant recognition.
Reinsurance from non‑APRA authorised reinsurers: default factors for non‑APRA authorised reinsurers are materially higher (Table 3, para 74) and Table 4 provides replaced higher default factors for reinsurance recoverables incepting on or after 31 December 2008 subject to collateral and guarantee exceptions (para 75). Additionally, a 100 per cent default factor may apply where a recoverable is overdue by over six months and not disputed (para 76). Treating such recoverables as low risk without collateral/guarantee evidence will understate capital needs.
Term deposits and ADI guarantees: term deposits from an ADI are treated like corporate bonds (para 26). If an ADI guarantees a minimum on early redemption, that minimum can be used as a floor in interest rate and inflation stresses and adjusted in credit spreads stress by (1 - default factor). Missing this optional floor can overstate stressed losses.
Derivatives and OTC counterparty risk: derivatives must be included in each stress (paras 27-28) and an additional default stress charge applies to OTC derivatives for counterparty default (para 29). Overlooking the default overlay on OTC derivatives will understate the default stress.
ELE approval requires tight control and documentation: Attachment C sets strict criteria for approval , wholly owned and controlled, boards constituted of the regulated institution’s board or senior management, no legal or regulatory transfer barriers, full risk management integration, standalone accounting records with unfettered APRA access and no material third party liabilities (Attachment C para 4). Failure to meet any criterion will preclude ELE treatment.
Surety bond alternative treatment requires APRA approval and Appointed Actuary endorsement: a regulated institution cannot unilaterally treat surety business as insurance for prudential purposes without APRA’s written approval and an Appointed Actuary confirmation (Attachment A paras 5-8). Acting on an internal actuarial view without approval risks non‑compliance.
Category C territorial limitation: Category C insurers apply the Asset Risk Charge to assets in Australia only (para 20). Applying the charge to global assets where Category C status applies would be inconsistent with the Standard.
Interplay with GPS 117 concentration limits: assets in excess of concentration limits must not be stressed under GPS 114 (para 17(b)). Institutions must ensure they apply GPS 117 limits before GPS 114 stress scopes.
Default factors for unsecured loans to insiders: certain unsecured loans carry a 100 per cent default factor (para 72), and these loans are excluded from other stresses (footnote 7). Misclassification of insider loans can therefore produce materially different capital requirements.

Each of the above items is a concrete operational rule in GPS 114. Errors of interpretation, omission of directional stress runs, inadequate documentation of collateral or guarantees, inadequate intra‑group consolidation for Level 2 groups, or failure to obtain APRA approvals where required can all change the Asset Risk Charge materially and create supervisory risk.

GPS 114 imposes a prescriptive calculation and documentation regime. A practical compliance checklist driven by the Standard’s text would include the following steps and controls:

Governance and responsibility

Board accountability: ensure the Board understands its ultimate responsibility for capital management and that processes are in place to maintain capital commensurate with risk (Objectives and key requirements).
Delegation and sign‑offs: document who is responsible for each part of the Asset Risk Charge calculation, valuation inputs, and APRA interactions.

Scope and classification

Confirm entity status: determine whether the entity is a general insurer, an authorised NOHC, parent of a Level 2 group or part of a Group covered by GPS 001 (Application and commencement para 2; Interpretation para 5).
Identify Category status: establish if the insurer is Category C and therefore limit Asset Risk Charge to Australian assets (para 20).
Apply GPS 117 concentration limits and exclude assets in excess of those limits (para 17(b)).

Data, valuation and measurement bases

Fair value measurement: measure assets at fair value for stress tests, except where non‑financial assets, short‑term receivables and intercompany items are allowed to follow Australian Accounting Standards (para 19; footnote 2).
Insurance liabilities: use net insurance liabilities as per GPS 340 for stress calculations other than default (footnote 2). For default, use reinsurance central estimates under GPS 340 (para 69).
Effective exposure: identify and quantify effective exposures for off‑balance sheet items (para 15, 21; Attachment A). Include required regulatory CET1 adjustments per GPS 112 (footnote 1).

Model and stress application

Seven stress tests: implement the seven stresses precisely per paras 31-77. For each applicable asset or liability, compute the fall in capital base and floor each risk charge component at zero (paras 10-11).
Bidirectional stresses: run real interest rate, expected inflation and currency stresses in both directions, and include both results in aggregation where non‑zero (paras 34-36, 39-40, 42-43, 80).
Asset class rules: split hybrids into debt and equity components (para 23); treat repos and securities lending per para 25; apply ADI term deposit floors as permitted (para 26); include derivatives in all stresses and apply OTC default charge (paras 27-29).
Credit spread/default calibrations: apply Tables 1-2 for spreads and defaults (paras 55, 68) and the special rules for securitised exposures, re‑securitisation, floating vs fixed assets and guaranteed assets (paras 56-64, 59-61, 63-64).

Aggregation and tax

Aggregation: apply the aggregation formula in para 78 with the correlation matrix in Table 5 (para 79). For bidirectional stresses, perform the multiple aggregations and select the largest aggregate as required (para 80).
Tax benefits: compute tax benefits separately (para 12), apply the scaling formula in para 13 and confirm the deduction is permissible only to the extent deferred tax liabilities (as calculated under GPS 112) can absorb the tax benefits (para 14).

Collateral, guarantees and reinsurance

Collateral eligibility: document legal form and counterparty grade of collateral; only registered charges/mortgages/security interests over Eligible Collateral Items are recognised (Attachment B paras 3-4).
Guarantee documentation: ensure guarantees are explicit, unconditional, irrevocable, legally enforceable and from eligible guarantors (Attachment B para 5). Exclude parent/related guarantees except where Attachment B allows for Level 2 special cases (Attachment B para 9).
Reinsurance recoverables: apply special default factors for non‑APRA authorised reinsurers (paras 74-76), account for available collateral/guarantees per Attachment B paras 6-10 and ensure overdue recoverables are handled per para 76.

Off‑balance and structured investments

Effective exposure workstreams: document and test assumptions used to convert off‑balance sheet notional amounts into effective exposures (Attachment A).
Look‑through requirements: for trusts and controlled investment entities, decide whether look‑through or equity treatment applies; apply mandatory look‑through if unlisted and geared (para 24).
Securitisation and re‑securitisation: identify structured exposures and apply the appropriate spread/default calibration; consult APRA for material securitisations for Level 2 groups (Attachment D para 2).

ELE and special approvals

ELE applications: if seeking ELE treatment, prepare evidence against the Attachment C criteria (control, transferability, risk management integration, books/records, third party liabilities, on‑lending arrangements and business activities) and be ready to furnish full access to APRA (Attachment C paras 1-4).
Surety bond approval: prepare Appointed Actuary confirmation and submit an application to APRA if planning to treat surety business as insurance for prudential purposes (Attachment A paras 5-8).

Documentation, audit and review

Maintain supporting records: valuation models, market data, legal opinions for collateral/guarantees, trustee documentation for trusts/SPVs, Appointed Actuary confirmations and consolidation worksheets for Level 2 groups.
Internal and external audit: ensure audit programmes include Asset Risk Charge methodology, ELE look‑through processes and collateral legal enforceability checks (Attachment C para 4(c)-(d)).
Governance sign‑off: require Board or delegated committee sign‑off on assumptions that materially affect capital (Objectives and key requirements).

APRA engagement

Notify APRA where required: for unlimited exposure arrangements (Attachment A para 3), to seek ELE or surety bond approval (Attachment C para 3; Attachment A para 7), to consult prior to material securitisations (Attachment D para 2), or to rely on prior exemptions (para 82).
Seek written confirmations: where possible, secure written APRA views or approvals to reduce supervisory uncertainty, particularly for non‑standard collateral forms, international law transferability issues for ELEs, or significant model changes.

Following these steps links the Standard’s technical prescriptions with practical controls and APRA engagement. The complexity of bidirectional stresses, the interplay with GPS 112 and GPS 340, and the collateral/guarantee evidentiary requirements mean that compliance is both model‑intensive and documentation‑heavy. Institutions should maintain a runbook of stress runs, data sources, and approval correspondence to demonstrate compliance in supervisory review.

Deep Dive

What it does

Current sections

Insurance (prudential standard) determination No. 4 of 2023

meta-content-style-type: text/css meta-content-type: application/xhtml+xml; charset=utf-8 meta-generator: Aspose.Words for .NET 22.10.0 meta-keywords: "[SEC=UNOFFICIAL]" title: Prudential Standard GPS 114

Authority

Application and commencement

Level 2 insurance groups

Interpretation

Asset Risk Charge

Asset Risk Charge calculation

Aggregated risk charge component

Risk charge components

Tax benefits

Assets and liabilities to be stressed

Off-balance sheet exposures

Collateral and guarantees

Treatment of specific asset classes

Derivatives

Extended Licence Entity

Real interest rate stress

Expected inflation stress

Currency stress

Equity stress

Property stress

Credit spreads stress

Default stress

Aggregation formula

Adjustments and exclusions

Previous exercise of discretion

Attachment A – Off-balance sheet exposures

Direct credit substitutes

Surety bonds

Attachment B – Treatment of collateral and guarantees as risk mitigants

Collateral

Guarantees

Collateral, guarantees and letters of credit in respect of reinsurance recoverables due from non-APRA authorised reinsurers[11]

Attachment C – Extended Licensed Entity

Attachment D – Level 2 insurance groups

Tax benefit

Currency stress

Default stress

Source text: opening excerpt

meta-content-style-type: text/css meta-content-type: application/xhtml+xml; charset=utf-8 meta-generator: Aspose.Words for .NET 22.10.0 meta-keywords: "[SEC=UNOFFICIAL]" title: Prudential Standard GPS 114

Main concepts

Who it affects

Key duties and rights

Penalties and enforcement

How it interacts with other laws

Amendment history

Litigation history

Gotchas

How to comply

Authority

Application and commencement

Level 2 insurance groups

Interpretation

Asset Risk Charge

Asset Risk Charge calculation

Aggregated risk charge component

Risk charge components

Tax benefits

Assets and liabilities to be stressed

Off-balance sheet exposures

Collateral and guarantees

Treatment of specific asset classes

Derivatives

Extended Licence Entity

Real interest rate stress