General and life insurers must be ready for a 1 January 2013 implementation of new capital adequacy standards – the result of APRA’s life and general insurance capital standards (LAGIC) review.
On 31 May 2012 APRA released most prudential standards in final form, a few in draft form (to be issued in final form by October 2012) and a further response paper.
Driving reform is the implementation of Basel III for authorised deposit-taking institutions together with APRA’s desire to align capital standards across APRA regulated industry groups and to improve the risk sensitivity and appropriateness of all capital standards.
The LAGIC review has been in public consultation since May 2010 with the release of a first discussion paper and subsequently two quantitative impact studies, three technical papers, three rounds of submissions and responses from industry, and a suite of draft reporting forms and instructions. Given the high industry participation rate in the LAGIC review most general and life insurers (insurers) probably know something of what is coming. But one of the key changes is the implementation of an Internal Capital Adequacy Assessment Process (ICAAP).
Insurers will need to implement an ICAAP. An insurer’s ICAAP will need to be approved by the Board and significant changes will also need Board approval. The draft prudential standards state clearly that capital is the cornerstone of an insurer’s financial health and so the Board must be responsible for ensuring that an insurer has adequate capital for the scale, nature and complexity of its business and risk profile. It is expected that an ICAAP will be developed with senior management and relevant experts including the Appointed Actuary.
Insurers do not just need to meet minimum capital requirements but must continuously identify, measure, monitor and manage the risks arising from their activities to ensure they maintain capital consistent with their risk profile and risk appetite. At a minimum an ICAAP must generally have:
- adequate systems and procedures to ensure capital is maintained at a level consistent with the risks arising from the insurer’s activities;
- a strategy for ensuring adequate capital is maintained over time;
- actions and procedures for monitoring compliance with capital requirements against capital targets;
- stress testing and scenario analysis relating to potential risk exposures and available capital resources;
- processes for reporting on the ICAAP to the Board and senior management and for ensuring that the ICAAP is taken into account in making business decisions;
- policies to address the capital impact of material risks not covered by explicit regulatory capital requirements; and
- an ICAAP summary statement.
An ICAAP summary statement will be a high level document that summarises the capital assessment and management processes of the insurer. An ICAAP summary statement needs to be available to APRA on request but insurers must also produce, for annual submission to APRA, a separate ICAAP report. An ICAAP report will include, among other things, current and three-year projected capital levels relative to minimum regulatory capital requirements and targets as well as detailed information on the actual outcomes of applying the ICAAP relative to the planned outcomes in the previous ICAAP report.
Board and CEO involvement in the ICAAP is essential. The Board must endorse and the CEO must sign a declaration to accompany all ICAAP reports submitted to APRA. The Board and CEO must declare: that capital management according to the ICAAP has occurred and if not why not; that the ICAAP capital targets are adequate for the particular insurer given its size, business mix and complexity of operations; and that the information in the ICAAP report is accurate.
Exactly how an ICAAP would vary depending on risk profile and risk appetite has been the subject of submission from industry. In APRA’s latest response to submissions it indicated that while it will issue a Prudential Practice Guide in September 2012 insurers should not wait until its release before starting development of their ICAAP.
The final release of the prudential standards covering ICAAP requirements (GPS110 and LPS110) includes some expanded wording including that each insurer’s ICAAP will need to be appropriate to the size, risk and complexity of that insurer’s operations and group structure (as applicable) and the use of a group ICAAP will be acceptable so long as it meets the requirements of each individual insurer.
The new standards will be effective 1 January 2013. But if an insurer does not think it can be ready in time, transitional arrangements, on a case by case basis, are available. APRA has foreshadowed that a number of insurers may need transitional arrangements.