Capital Standards for the Statutory FundCapital Standards for the Statutory Funds

Capital Standards for the Statutory Funds

The Life Act establishes a two tier capital requirement on the statutory funds of the life insurance company with each tier considering the capital requirements in a different set of circumstances. The first tier – the Solvency Standard - is intended to ensure, as far as possible, the payment of the liabilities of the company. The second tier – The Capital Adequacy Standard - is intended to secure the financial soundness of the company as a going concern.

Just as there are two tiers of capital requirement, the LIASB in developing these standards proposed two philosophies - discrete and independent; one for each of the standards. The result is that the Capital Adequacy Standard is not necessarily a stronger Solvency Standard; or more importantly, the Solvency Standard is not necessarily a weaker Capital Adequacy Standard. Each capital requirement stands on its own, serves different purposes and brings its own consequences. This is consistent with the intentions and provisions of the Life Act.

The essential features of the philosophy of the Solvency Standard are as follows:

The Solvency Standard

 considers capital needs in the context of an extended run off situation either under judicial management or following transfer of the business to another insurer, at a high level of confidence

 assumes the statutory fund is closed to new business

 aims to meet obligations to policy owners (and creditors) while the fund withstands shocks (adverse experience).

For Capital Adequacy, the essential features are:

The Capital Adequacy Standard

 considers capital needs in the context of an active and viable ongoing concern

 assumes the statutory fund is open to new business

 aims to meet reasonable expectations of policy owners (and creditors) while the fund withstands larger shocks (significant adverse experience).

The LIASB acknowledges that, as a consequence of these philosophies, it is possible that in certain circumstances no additional capital is required for capital adequacy purposes over the Solvency Requirement. The circumstances in which this may arise (for example, a slowly growing fund or a declining fund) do not suggest any inconsistency with the underlying philosophies.

The Solvency Requirement is disclosed in the financial statements of the life insurance company and is intended to be used as an indicator of the financial position of the company. To provide certainty of interpretation and facilitate consistency and comparability across the industry, the standard adopts a primarily prescriptive approach to the determination of the Solvency Requirement.

The Capital Adequacy Requirement is not required to be disclosed in the financial statements of the company. It will, however, be disclosed to APRA (on a confidential basis) and will be used as an important indicator of the longer term financial position of the company, and a trigger for closer regulatory monitoring in respect of short term solvency. The Capital Adequacy Standard adopts a less prescriptive approach to the determination of the Capital Adequacy Requirement in recognition of the differing business strategies of the companies. Reliance is placed on the professionalism of the Actuary for appropriate assessment of the Capital Adequacy Requirement of a company in accordance with the principles of this Standard.