Schedule 1 Capital Adequacy Standard
(section 3)
Part 1 Introduction
1.1.1 This Standard
(1) This Standard is established for the purposes of Division 3B of Part VI of the National Health Act 1953 (the Act), and is an integral component of the prudential reporting and management regime for registered health benefits organizations under the Act.
(2) The Act specifies a two tier capital requirement for the health benefits fund of an Organization with each tier considering the capital requirements in a different set of circumstances.
(3) The first tier is intended to ensure the basic solvency of the health benefits fund. The second tier is intended to secure the financial soundness of the health benefits fund in a going concern sense. It is expected that in most circumstances this second tier will provide an additional buffer of capital above the minimum solvency requirement.
(4) The Solvency Standard looks at the first tier capital requirement, referred to as the Solvency Requirement. This Capital Adequacy Standard looks at the second tier capital requirement, referred to as the Capital Adequacy Requirement.
(5) The amount by which the Capital Adequacy Requirement exceeds the Reported Liabilities is the Capital Adequacy Reserve.
(6) The stated purpose of the Capital Adequacy Standard under section 73BCH of the Act is:
‘to ensure, as far as practicable, that there are sufficient assets in the health benefits fund conducted by a registered organization to provide adequate capital for the conduct of the health insurance business in accordance with this Act and in the interests of the contributors to the fund.’.
(7) Therefore, the purpose of the Capital Adequacy Standard is to prescribe the capital requirement of a health benefits fund to ensure that the obligations to, and reasonable expectations of, contributors and creditors are able to be met under a range of adverse circumstances, in the context of a viable ongoing operation.
(8) The Capital Adequacy Requirement is thus based on an ongoing view of a Fund (and Organization) where the requirement is for the Fund to demonstrate that it has sufficient capital to fund its business plans, absorb short term adverse experience from time to time, and continue to remain solvent.
(9) The Capital Adequacy Requirement will not be disclosed in the financial statements of the Organization. It will however be disclosed to PHIAC on a confidential basis and will be used as an indicator of the longer term financial position of the Organization.
(10) This Standard generally adopts a less prescriptive approach than the Solvency Standard, in recognition of the differing business strategies of Organizations. Reliance is placed on the due diligence of the Board to appropriately assess the Capital Adequacy Requirement of the Fund in accordance with the principles of this Standard.
1.1.2 How to use and interpret this Standard
(1) The Capital Adequacy Standard is a legislative instrument in accordance with section 73BCG of the Act.
(2) The Capital Adequacy Standard is comprised of the specifications in this Standard and those in the Health Benefits Organizations — Interpretation Standard 2003 (the Interpretation Standard) referred to in this Standard. The Interpretation Standard forms a direct part of this Standard as if the text of the Interpretation Standard was reproduced explicitly in the text of this Standard.
(3) In this Standard and the Interpretation Standard, the following conventions apply:
(a) the legislative requirements prescribed in this Standard are shown in bold type;
(b) commentary is shown in normal print directly following the legislative sections to which it relates;
(c) some sections of the Standard are also preceded by an overview — shown in normal print — intended as a plain English introduction to the principles which are developed in greater detail in the relevant section.
(4) The commentary and overview can be used as an aid to interpretation, and to the intent of this Standard. In addition, circulars and other advice released periodically by PHIAC will provide further background and an insight to its considerations in the development of this Standard.
(5) Terminology used in this Standard, to the extent it is not specifically defined, takes the same meaning as that in the National Health Act 1953. In other cases, the words and phrases set out in the Interpretation Standard have the specific meaning assigned in this Standard.
1.1.3 Application of the Capital Adequacy Standard
(1) This Capital Adequacy Standard is made for the purposes of section 73BCG of the National Health Act 1953.
(2) This Standard applies:
(a) in respect of all health insurance business of a registered health benefits organization; and
(b) on and from 1 July 2003.
(3) Transitional arrangements apply for health benefit organizations registered on the day the Health Benefits Organizations — Capital Adequacy Standard 2000 commenced (see Division 2.3).
Commentary The Standard has been through a due process of exposure and consultation established and managed by PHIAC, and has been the subject of consultation with the Australian Government Actuary. The Standard is a disallowable instrument and will, accordingly, have been through the Parliamentary processes, and not disallowed.
Part 2 Principles & Calculation Methods
Division 2.1 The Capital Adequacy Standard
2.1.1 Overview
(1) The Solvency Standard requires that the Fund of an Organization has available a minimum level of capital in excess of its liabilities measured on a best estimate basis — the Solvency Reserve — to provide for the security of the existing obligations to contributors under a range of adverse conditions.
(2) However, the prudent regulation of the private health insurance industry requires that the level of security offered to contributors exceed that of a standard which secures only short term solvency. The Capital Adequacy Standard requires that the Fund has available capital sufficient to provide confidence in the longer term financial strength of the Fund. A capital adequate Fund would have the ability to continue to accept contributions from new and existing members, in an unfettered manner, with the expectation of remaining solvent into the future.
(3) The Capital Adequacy Requirement is determined by considering the various risks which could impact the longer term solvency of the Fund and the security of the contributors entitlements, and requires the provision of a prudent level of reserves against such risks.
(4) These risks, and the assessment of the prudent reserves, are considered in the context of an ongoing operation; a Fund open to new and existing contributors and soundly meeting contributor obligations in a competitive market.
(5) A Fund that meets the Capital Adequacy Requirement would be considered by PHIAC to be a financially strong Fund. However this does not imply an absolute guarantee of security to contributors.
(6) In assessing the capital adequacy requirement of a Fund consideration is given to:
(a) the risks which may affect the value of its liabilities; and
(b) the risks which may affect the value of its assets supporting those liabilities; and
(c) the risks and capital financing involved in the Fund continuing to accept new liabilities in future and continuing to fund the business plans of the Organization.
(7) The level of provision against these risks is set relative to the overall objectives of the Capital Adequacy Standard.
(8) Based on the above considerations, the structure of the Capital Adequacy Requirement, before the use of any alternative sources of capital such as subordinated debt, is as follows:
| | | | | | Capital Adequacy Requirement (before subordinated debt) | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | Liability Risks | | | | Asset Risks | | | | Ongoing Fund | | |
| | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| Capital Adequacy Liability | | Renewal Option Reserve | | Inadmissible Assets Reserve | | Resilience Reserve | | Business Funding Reserve | | Management Capital | |
| | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
(9) For practical calculation purposes, the structure of the Capital Adequacy Requirement is expressed as follows:
| | | | | | Capital Adequacy Requirement (before subordinated debt) | | | | | |
| | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Capital Adequacy Liability | | Renewal Option Reserve | | Business Funding Reserve | | Inadmissible Assets Reserve | | Resilience Reserve | | Management Capital |
| | | | | |
| | | | | | | | | | | | | | | | | | |
(10) The Capital Adequacy Requirement is an assessment of the financial strength of the Fund on the basis of an ongoing operation. The Capital Adequacy Requirement must be sufficient for the Fund to be expected to remain solvent for at least the next three years after the valuation date, on the basis of assuming future experience during that period in accordance with the best estimate experience underlying the current business plans of the Organization.
2.1.2 The Capital Adequacy Liability
The Capital Adequacy Requirement must make provision for the risks pertaining to each element in respect of which an assumption is required in valuing the accrued liabilities of the Fund.
2.1.3 The Renewal Option Reserve and The Business Funding Reserve
(1) As the prescribed capital adequacy test considers the obligations of the Fund in an ongoing sense, provision for the risks associated with membership renewal and the consequences for available capital of the intended business plans of the Organization must be included.
Renewal Option Reserve
(2) Members of a Fund have an expectation to maintain and renew their membership of the Fund in future. To the extent that current contribution rates may prove inadequate to cover future benefits and related Fund expenses some prospective membership renewal reserve is needed. This would reflect the time taken to identify and verify emerging adverse experience and for appropriate corrective action to be implemented.
Business Funding Reserve
(3) A provision for planned business growth or other relevant business development strategies that are likely to absorb existing capital resources, with the intention of securing the continued solvency of the Fund over a prescribed period of three years.
2.1.4 The Inadmissible Assets Reserve
The Capital Adequacy Requirement must provide a reserve — the Inadmissible Assets Reserve — in respect of:
(a) holdings in an associated entity which is an institution itself subject to legislated minimum capital requirements; and
(b) the risks arising from asset concentration.
2.1.5 The Resilience Reserve
The Organization must assess the resilience of the Fund and provide for an appropriate reserve — the Resilience reserve. In this context, resilience is assessed as the ability of the Fund to sustain shocks to the economic environment in which it operates and which are likely to result in an adverse movement in the value of its assets relative to the value of its liabilities.
2.1.6 Management Capital Requirement
The Capital Adequacy Standard specifies requirements that are essentially proportional to the risks and size of a Fund. However, many management risks are not simply proportional to the size of a Fund and consideration needs to be given to the dimensions of the overall Organization and its risk profile outside the Fund.
2.1.7 Subordinated Debt Allowance
It is intended that the capital adequacy requirements of a Fund may be met via a combination of shareholder/member capital and retained earnings in the Fund, and other suitable means such as the use of Subordinated Debt. As any debt liability of a Fund is disclosed as part of the underlying reported liabilities of the Fund, the approach in this Standard to allow the Capital Adequacy Requirement to be reduced by the amount of Approved Subordinated Debt that may be counted for capital adequacy purposes.
Division 2.2 Capital Adequacy Requirement
2.2.1 At any time, the reported value of the assets of the Fund must be of an amount considered sufficient to allow the Fund to continue to meet, into the future, its obligations to contributors and creditors referable to the Fund. This amount is referred to as the Capital Adequacy Requirement.
2.2.2 Health Benefits Fund Capital Adequacy Requirement (HBFCAR)
(1) The HBFCAR is an intermediate calculation and is determined as:
(a) Capital Adequacy Liability; plus
(b) Renewal Option Reserve; plus
(c) Business Funding Reserve; plus
(d) Inadmissible Assets Reserve; plus
(e) Resilience Reserve; plus
(f) Management Capital Amount.
(2) The performance of each subsequent step in the calculation process described in subsection (1) must not reduce the progressive result from its amount at the completion of the previous step.
2.2.3 The Capital Adequacy Requirement is then determined as:
(a) HBFCAR; less
(b) Approved Subordinated Debt.
2.2.4 The Capital Adequacy Excess Assets measure for the Fund is determined as:
(a) Total Fund Assets; less
(b) Capital Adequacy Requirement.
2.2.5 The Capital Adequacy Reserve measure for the Fund is determined as:
(a) Capital Adequacy Requirement; less
(b) Reported Liabilities.
2.2.6 In determining the Capital Adequacy Requirement, allowance must be made for any guarantees or obligations stated or implied to Fund members arising from legislation, the Fund’s membership rules and current or past promotional material of the Fund or Organization.
2.2.7 The Capital Adequacy Requirement must provide for the value of the liabilities of the Fund in respect of current and prospective obligations to members and other creditors of the Fund, resulting from the adoption of a basis more conservative than best estimate.
2.2.8 The Capital Adequacy Requirement, in considering scenarios of adverse experience, must provide for risks associated with both the valuation of the liabilities and the valuation of the assets.
2.2.9 As the prescribed capital adequacy test considers the obligations of the Fund in an ongoing sense, provision for the risks associated with membership renewal and the consequences for available capital of the intended business plans of the Organization must also be included in the Capital Adequacy Requirement.
2.2.10 Each component of the calculations specified in this Division is to be calculated in accordance with the Interpretation Standard.
Commentary The methodologies for determining the Capital Adequacy Requirement for a Fund recognise the diversity of the private health insurance industry, in particular the potential diversity of business plans and strategies of Organizations. The Capital Adequacy Standard provides some flexibility in determination, while preserving the objectives of simplicity and comparability of results across Organizations.
Division 2.3 Transitional Provisions
2.3.1 The transitional provisions set out in this Division only apply to health benefit organizations registered on the day on which the Health Benefits Organizations — Capital Adequacy Standard 2000 commenced (that is, 1 January 2001).
2.3.2 All health benefit organizations so registered will be required to meet this Standard on and from 1 January 2006. In the interim, these organizations are required to meet transitional capital adequacy requirements during calendar years 2001 to 2005 inclusive.
2.3.3 Until 1 January 2006, the Health Benefits Fund Capital Adequacy Requirement (HBFCAR) is defined as the lesser of:
(a) A + (X% x (B — A)); and
(b) B;
where:
A = the Reported Liabilities of the Fund, plus:
(a) the greater of 2 months breakeven contributions or $1 million; plus
(b) the value of any prescribed assets; plus
(c) the value of other assets not available for solvency purposes.
B = The HBFCAR determined in accordance with this Standard.
X = 17% in calendar year 2001;
33% in calendar year 2002;
50% in calendar year 2003;
67% in calendar year 2004;
83% in calendar year 2005.
2.3.4 The determination of:
(a) 2 months breakeven contributions; and
(b) the value of any prescribed assets; and
(c) the value of other assets not available for solvency purposes;
is to be made in accordance with the minimum reserving requirements for registered organizations existing prior to 1 January 2001.
Commentary
1. Where a Fund, to which the transitional arrangements apply, can meet the Capital Adequacy Requirement determined in accordance with Division 2.2 of this Standard at a date prior to 1 January 2006, then it would be appropriate for the Fund to calculate and report the Capital Adequacy Requirement determined in accordance with the requirements of Division 2.2 of this Standard.
2. During the transitional period, any Organization which is unable to meet the Capital Adequacy Requirement as described in Division 2.2 of this Standard, but is able to meet the Transitional Requirements described in Division 2.3 of this Standard, will be considered as having met the Capital Adequacy Requirement described in section 73BCI, for the purpose of Part VIA, Division 3 or Part VIA, Division 4 of the National Health Act 1953.
Division 2.4 Materiality
2.4.1 Overview
(1) In many cases in practice, the calculation processes outlined in this Standard and the Interpretation Standard will be able to be simplified by the Organization as it becomes apparent that certain components in the required calculations dominate for certain Funds in certain circumstances. It is not the intention of this Standard to require expensive calculations to be undertaken which have a negligible impact on the overall Capital Adequacy Requirement determined.
(2) However, equally, items that have a material impact on the results should not be understated.
(3) Particular values or components are considered material to the overall result of a calculation when their misstatement or omission would cause the Capital Adequacy Requirement result to be misleading.
(4) Materiality tests assess the significance of the particular value/component by relating it to the amount of the overall result to which it contributes.
(5) The Interpretation Standard specifies the appropriate materiality standard to be adopted in respect of each of the major components of the values determined under those Standards.
2.4.2 The Capital Adequacy Requirement result determined under this Standard will meet the materiality requirements of this Standard if the component calculations satisfy the materiality standard set out in the Interpretation Standard.
Division 2.5 Statement relating to the Determination
2.5.1 Report by Organization
(1) In respect of any determination of the Capital Adequacy Requirement, the Organization must provide a report setting out details of the calculation processes and the assumptions used in deriving the results.
(2) The details of the calculation methods and assumptions should include details of:
(a) the determination of the Outstanding Claims Liability;
(b) the determination of the Unexpired Risk Reserve;
(c) the determination of the Reinsurance Liability;
(d) the determination of the Reinsurance Outstanding Claims Liability;
(e) the determination of the Capital Adequacy Liability;
(f) the determination of the Renewal Option Reserve;
(g) the determination of the Business Funding Reserve;
(h) the determination of the Inadmissible Assets Reserve;
(i) the determination of the Resilience Reserve;
(j) the determination of any management capital requirement;
(k) the determination of any allowance with respect to subordinated debt as permitted.
(3) The report should also comment on the policies and procedures in place to monitor continuous application of this Standard.