Part Investment Risk Capital Charge - Insurance (prudential standard) determination No. 7 of 2006 - Prudential Standard GPS 110 - Capital Adequacy - Investment Risk Capital Charge | Zoe
Insurance (prudential standard) determination No. 7 of 2006 - Prudential Standard GPS 110 - Capital Adequacy
Investment Risk Capital ChargeInvestment Risk Capital Charge
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This Attachment details the calculation of the Investment Risk Capital Charge for an insurer using the Prescribed Method to determine its MCR.
The capital charge for investment risk relates to the risk of an adverse movement in the value of an insurer’s on-balance sheet assets or certain off-balance sheet obligations. Investment risk derives from a number of sources. These include:
(a) credit risk the risk of an adverse movement in the value of an asset owing to changes in the credit quality of the issuer of that asset (including the default of the issuer);
(b) market or mismatch risk the risk of an adverse movement in the value of an asset, which is not offset by a corresponding movement in the value of liabilities; and
(c) liquidity risk the risk that the reported asset value will not be readily realised in certain circumstances.
It is not possible to devise a simple capital framework that takes all of these risk factors into account in an accurate fashion. The capital charge for investment risk attempts to cover these risks by requiring insurers to hold an amount of capital against each asset that is proportional to the value of that asset. The capital factors assigned to assets are broad and for capital adequacy purposes only, and must not be taken as a substitute for individual company assessments of the risks associated with particular assets. Over and above the MCR required by this Prudential Standard, the Board and senior management of an insurer have responsibility for ensuring that adequate systems are in place to individually assess the risks in an insurer’s operations, to allocate the appropriate amount of capital to cover those risks and to suitably value the transactions that give rise to those risks.
To calculate the capital charge for investment risk, each of an insurer’s assets (and certain off-balance sheet exposures) is assigned to one of nine categories. The Investment Risk Capital Charge is determined by multiplying the balance sheet value of each asset by the appropriate Investment Capital Factor for its category (subject to any thresholds in the case of assets exceeding the specified thresholds detailed in paragraphs 18 to 21 of this Attachment). The total capital charge for investment risk is the sum of the Investment Risk Capital Charges for each individual asset. The Investment Capital Factors to be applied to each asset are presented in Table 1 of this Attachment.
For the purpose of applying the capital factors, the term “debt obligations” refers to all loans, deposits, placements, interest rate securities and other receivables. Where reference is required to credit or counterparty ratings, these must be applied in accordance with Table 2 of this Attachment.
APRA may determine in writing that the Investment Risk Capital Charge for a specified asset, or an asset of a specified class, of a particular insurer is to be calculated by applying:
(a) an Investment Capital Factor of zero; or
(b) an Investment Capital Factor specified in the determination (being greater than zero but lower than the Investment Capital Factor provided for in Table 1 of this Attachment for the asset)
if the conditions in paragraph 7 of this Attachment are satisfied. APRA’s determination shall apply for a period specified in the determination or until APRA revokes the determination. Upon the determination ceasing to apply, the Investment Risk Capital Charge for an asset covered by the determination shall be calculated by applying the Investment Capital Factor specified in Table 1 of this Attachment for that asset. For the avoidance of doubt, a determination in relation to a particular insurer may cover more than one asset, or more than one class of assets, of that insurer, and a determination may make different provision in respect of different assets or classes of assets.
APRA may only make a determination under paragraph 6 of this Attachment in relation to an asset, or an asset of a particular class, if:
(a) the asset, or each asset in the class, is:
(i) a reinsurance recovery, or other reinsurance asset, due from a reinsurer with a counterparty rating of Grade 1, 2, 3 or 4; or
(ii) an unpaid premium that is less than six months overdue; and
(b) the party liable for the relevant payment (the obligor) is a general insurer authorised under section 12 of the Act; and
(c) the obligor is related (within the meaning of section 50 of the Corporations Act) to the general insurer that holds the relevant asset; and
(d) APRA considers that it is appropriate to make the determination, having regard to relevant prudential matters within the meaning of section 3 of the Act.
Extended Licensed Entity (ELE)
In certain circumstances, an insurer may choose to hold assets in an SPV or other related entityF[35]F, rather than on its own balance sheet. Where an insurer receives approval under paragraph 10 of this Attachment, the insurer will be able to determine its Investment Risk Capital Charge (and any Investment Concentration Capital Charge) based on the individual assets of the related entity, rather than simply on the insurer’s direct exposure to that entity.
The extent to which the risk of an insurer’s exposure to a related entity is commensurate with the underlying holdings of that entity depends on the insurer’s extent of control over, and integration with, the entity as well as on the existence of any third party liabilities of the entity. Potential complications under a scenario where underlying asset holdings must be liquidated during financial stress must also be considered.
Subject to the specific requirements set out in paragraph 11 of this Attachment, an insurer may apply to APRA to have one or more related entities approved as part of its ELE. Once approved, APRA will allow the insurer to “look through” the legal structures involved, and to “consolidate” the balance sheet of the related entity with its own for the purposes of determining the Investment Risk Capital Charge. In effect, this allows the insurer to treat its own balance sheet and that of the approved related entity as a single entity for the purpose of calculating that charge.
In deciding whether to approve an entity as part of an insurer’s ELE, APRA will have regard to the following criteria in respect of the relationship between the insurer and the related entity:
(a) the related entity must be wholly owned and controlled by the insurer, with a Board of directors/trustees that is comprised entirely of members of the insurer’s Board or senior management;
(b) the insurer must demonstrate to APRA that there are no legal or regulatory barriers (including cross-border issues for a branch or if the proposed ELE is not an Australian entity) to the transfer of the assets back to the insurer;
(c) the insurer’s risk management systems and controls must be fully extended to the operations of the related entity. The senior management of the insurer must be in a position to monitor the operations of the related entity to the same extent as the operations of the insurer itself. Systems for monitoring and control over the related entity must be included within the internal and external audit programs of the insurer;
(d) the insurer 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) the related entity must not conduct any business that the insurer would otherwise be prevented from doing under the Act; and
(f) where the related entity holds or invests in assets on behalf of the insurer, the related entity must have no material third party liabilities. APRA will exempt tax liabilities and employee entitlements from this requirement.
Treatment of collateral and guarantees as risk mitigants
The capital charge for investment risk may be reduced where the insurer holds certain types of collateral against an asset, or where the asset has been guaranteed, as a means of reducing risk.