Insurance (prudential standard) determination No. 7 of 2006 - Prudential Standard GPS 110 - Capital Adequacy
GuaranteesGuarantees
Start here
Get a plain-English read of Guarantees
Turn the raw legal text into a practical explanation grounded in Insurance (prudential standard) determination No. 7 of 2006 - Prudential Standard GPS 110 - Capital Adequacy.
Assets that have been explicitly, unconditionally and irrevocably guaranteed for their remaining term to maturity by a guarantor with a counterparty rating (or for governments, the long-term foreign currency credit rating) in Grades 1, 2 or 3 may be assigned the Investment Capital Factor that would be applicable to the guarantor.
Guarantees provided to an insurer by its own parent or a related entity are not eligible for this treatment.
Charged and encumbered assets
Subject to paragraph 17 of this Attachment, assets of the insurer that are under a fixed or floating charge, mortgage or other security are subject to an Investment Capital Factor of 100 per cent, to the extent of the indebtedness secured on those assets. This will replace the Investment Capital Factor that would otherwise apply to the secured assets.
Where the security supports an insurer’s insurance liabilities, the Investment Capital Factor of 100 per cent is applicable only to the amount by which the fair value of the charged assets exceeds the insurer’s supported insurance liabilities.
Investment Concentration Charge
For the purposes of this Attachment, two or more counterparties will form a group of related counterparties if they are linked by:
(a) cross guarantees;
(b) common ownership or management;
(c) the ability of a counterparty to exercise control (defined in accordance with Australian Accounting Standards issued by the Australian Accounting Standards Board) over the other(s), where direct or indirect;
(d) financial interdependency such that the financial soundness of any of them may affect the financial soundness of the other(s); or
(e) other connections or relationships which, according to an the insurer’s assessment, identify the counterparties as constituting a single risk.
An insurer may be exposed to an additional risk arising from an excessive exposure to a particular counterparty or group of counterparties (including in relation to reinsurance recoveries). To address the risk associated with excessive asset concentration, an insurer must hold additional capital in those cases where an insurer’s exposure to a particular counterparty, or group of related counterparties, exceeds the thresholds set out below. The aggregation of exposures to individual counterparties must be undertaken for an insurer and any entities approved as part of its ELE (refer to paragraphs 8 to 11 of this Attachment).
The thresholds referred to in paragraph 19 of this Attachment are based on the credit ratingFF of the counterpartyFF, and are as follows:
If a catastrophic event causes the outstanding reinsurance recoveries of an insurer to temporarily exceed the thresholds set out in paragraph 20 of this Attachment, the insurer may apply to APRA to suspend the application of the thresholds for a period of time. APRA may grant written approval for such suspension subject to conditions and may specify any period of time for such suspension.
An insurer must apply the relevant Investment Capital Factor to an asset or assets up to the value of the threshold, and apply a 100 per cent Capital Factor to the value in excess of this level to calculate the Investment Concentration Charge. In the case of exposures to a group of related counterparties, exposures are aggregated both against counterparties of the same grade and upwards through the rating grades, with the threshold for each grade applying to aggregate exposures summed for that grade and all lower quality grades, excluding any exposures which are already subject to a 100 per cent Capital Factor. Paragraph 23 of this Attachment describes the method to be applied in more detail.
Exposures to a group of related counterparties at the Grade 5 level are aggregated to determine the amount in excess of the Grade 5 threshold to which the 100 per cent Investment Capital Factor is applied. Those exposures to a group of related counterparties at the Grade 5 level (up to the Grade 5 threshold) are then aggregated with all exposures to that group of related counterparties at the Grade 4 level to determine the amount in excess of the Grade 4 threshold to which the 100 per cent Investment Capital Factor is applied.
The following must not be taken into account in determining the Investment Concentration Charge:
(a) premium receivables and reinsurance recoveries to which an Investment Capital Factor of zero per cent is applied; and
(b) assets to which an Investment Capital Factor of 100 per cent is applied.
Off-Balance sheet transactions
An insurer can be exposed to various investment risks through transactions or dealings other than those reflected on its balance sheet.
As a general rule, an insurer must not be exposed to an obligor 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. If an insurer does enter into an arrangement with an obligor that does not have appropriate limits it must:
(a) notify APRA;
(b) explain how this arrangement complies with its RMS; and
(c) explain how it will be valued for the purposes of capital adequacy calculations.
Such an exposure may cause APRA to review the insurer’s MCR and adjust the insurer’s MCR in accordance with paragraph 17 of this Prudential Standard.
Direct credit substitutes
To the extent that an insurer has issued:
(a) guarantees (including written put options serving as guarantees);
(b) letters of credit; or
(c) any other credit substitute (other than insurance) in favour of another party
the insurer is exposed to risk of having to make payment on these instruments should the guaranteed party default or fail to deliver.
An insurer must set aside capital to cover the risk of such events occurring. Within the Prescribed Method, this is to be achieved by applying, to the face value of the credit substitute, the Investment Capital Factor that would be applied to the obligation or asset over which the credit substitute has been written. Where the credit substitute is supported by collateral or a guarantee, the provisions of paragraphs 13 to 15 of this Attachment may be applied.
A different approach to that contained in paragraphs 27 and 28 of this Attachment is available for surety bonds issued by the insurer. The insurer has the choice of either:
(a) treating any surety bonds the insurer has issued as a type of direct credit substitute. In this case, the insurer must determine 25 per cent of the value of the surety bond, and apply to that amount the Investment Capital Factor that would be applied to the obligation or asset over which the surety bond has been written. Where the surety bond is supported by a risk mitigation arrangement, the applicable Investment Capital Factor will be that assigned to the counterparty to that arrangement, but only to the extent that the risk mitigation arrangement applies; or
(b) seeking written approval from APRA to treat any surety bonds the insurer has issued as if they were an insurance risk (for the purposes of meeting the requirements of the Prudential Standards only). This would require the insurer to include surety bond exposures within the insurer’s assessment of insurance liabilities, as determined under GPS 310, and to apply the relevant capital factors within Attachment C.F[38]F For the purpose of calculating net outstanding claims liabilities and net premiums liabilities (as determined under GPS 310) the insurer may treat any risk mitigation arrangement as if it were reinsurance. An insurer seeking APRA’s approval for this approach would need to include with its application a confirmation from the company’s Approved Actuary that that person is able to appropriately measure the risk of the surety bond business within the insurer’s insurance liabilities.
The insurer must use the same approach for all surety bonds issued by it, and apply that approach consistently over time.
For the purposes of paragraph 29 of this Attachment, a surety bond means an undertaking given by an insurer at the request of a person (Customer) pursuant to an agreement (Surety Agreement) between the insurer 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 insurer (Principal);
(b) under the surety bond, the insurer 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 which:
(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 the payment of money by the Customer, or a person associated with the Customer, to the Principal; and
(d) under the Surety Agreement, the Customer is liable to the insurer if the insurer makes a payment or incurs a liability to the Principal or the Beneficiary under the surety bond.