Federal Register of Legislation - Australian Government

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LPS 3.04 Standards/Prudential (Banking & Insurance) as made
This instrument determines Prudential Standard LPS 3.04 Capital Adequacy Standard.
Administered by: Treasury
General Comments: Prudential Standard LPS 3.04 Capital Adequacy Standard contained in Life Insurance (prudential standard) determination No. 7 of 2007 - Prudential standard LPS 3.04 - Capital Adequacy Standard is revoked by Life Insurance (prudential standard) determination No. 8 of 2010 - Prudential Standard LPS 3.04 - Capital Adequacy Standard with effect from 13 July 2010.
Made 28 Jun 2010
Registered 13 Jul 2010
Tabled HR 28 Sep 2010
Tabled Senate 28 Sep 2010
Date of repeal 01 Jan 2013
Repealed by Life Insurance (prudential standard) determination No. 17 of 2012

Life Insurance (prudential standard) determination No. 8 of 2010

Prudential Standard LPS 3.04 Capital Adequacy Standard

Life Insurance Act 1995

 

I, John Roy Trowbridge, Member of APRA:

 

(a)        under subsection 230A(5) of the Life Insurance Act 1995  (‘the Act’), REVOKE Prudential Standard LPS 3.04 Capital Adequacy Standard made by Life Insurance (prudential standard) determination No. 7 on 27 November 2007; and

 

(b)        under subsection 230A(1) of the Act, DETERMINE Prudential Standard LPS 3.04 Capital Adequacy Standard in the form set out in the Schedule, which applies to all life companies, including friendly societies.

 

 

 

This instrument takes effect on the date of its registration on the Federal Register of Legislative Instruments.

 

Dated    28 June 2010

 

 

[Signed]

 

John Roy Trowbridge

Member

 


Interpretation

 

In this Instrument:

 

 

APRA means the Australian Prudential Regulation Authority.

friendly society has the meaning given in section 16C of the Act.

life company has the meaning given in the Dictionary to the Act.

 

SRR Act means the Financial Sector Legislative Amendment (Simplifying Regulation and Review) Act 2007.

 


Schedule

 

Prudential Standard LPS 3.04 Capital Adequacy comprises the 43 pages commencing on the following page.


Schedule

Part 1

Effective from 1 January 2008, the SRR repealed Part 5 and Division 4 of Part 6 of the Act. Those provisions of the Act established and regulated the actuarial standards and the LIASB.  Prudential Standard LPS 3.04 Capital Adequacy Standard (Prudential Standard LPS 3.04) re-created Actuarial Standard 3.04 as a prudential standard made under subsection 230A(1) of the Act.  There is no intention to alter any substantive aspect of Actuarial Standard 3.04, however, some modification is necessary to take account of the changes to the Act brought about by the SRR Act.  Consequently, Prudential Standard LPS 3.04 comprises Actuarial Standard 3.04, reproduced as the 43 pages of Part 2 of this Schedule, subject to the following:

1.             Subject to paragraph 2. below, a reference in Actuarial Standard 3.04 to a power being exercised or exercisable by the LIASB is taken to be a reference to that power being exercised or exercisable by APRA.

2.             A reference to anything done by the LIASB, where that thing was done prior to 1 January 2008, shall continue to be read as a reference to the LIASB.

3.             Any approvals granted or matters agreed to by APRA under Actuarial Standard 3.04 and effective immediately prior to the commencement of Prudential Standard LPS 3.04 will continue to be effective under the corresponding provisions of Prudential Standard LPS 3.04, unless such approvals are revoked by APRA.

 

 


Part 2

JULY 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Actuarial Standard 3.04

 

CAPITAL ADEQUACY STANDARD

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Life Insurance

Actuarial Standards Board


TABLE OF CONTENTS

                                                                                                                        Page

INTRODUCTION.. 2

 

The Standard    2

Application of the Capital Adequacy Standard. 3

 

 

PART A – PRINCIPLES.. 4

 

SECTION 1        The Capital Adequacy Standard. 4

SECTION 2        Scenarios of Adverse Conditions. 5

SECTION 3        The Liability Risks. 8

SECTION 4        The Capital Adequacy Assumptions. 11

SECTION 5        Asset Risks. 14

SECTION 6        The New Business Reserve. 19

 

 

PART B – METHODOLOGIES.. 20

 

SECTION 7        Determination of the Capital Adequacy Requirement 20

SECTION 8        The Capital Adequacy Liability. 22

SECTION 9        Current Termination Value. 22

SECTION 10      The Inadmissible Assets Reserve. 23

SECTION 11      The Resilience Reserve. 29

SECTION 12      The New Business Reserve. 36

SECTION 13      Transitional Arrangements. 37

SECTION 14      Materiality. 38

 

 

PART C – ACTUARY’S STATEMENT.. 40

 

SECTION 15      Statement Relating to the Determination. 40

 

 

ATTACHMENT 1 – CAPITAL ADEQUACY ASSUMPTIONS.. 41

 


INTRODUCTION       

 

The Standard

 

The Capital Adequacy Standard is established under the Life Insurance Act 1995, and is an integral component of the financial reporting regime for life insurance companies implemented under that Act.

 

The Prudential Standards establish a two tier capital requirement on the statutory funds of the life company with each tier considering the capital requirements in a different set of circumstances.  The first tier is intended to ensure the solvency of the company.  The second tier is intended to secure the financial soundness of the company as a going concern.  It is expected in most circumstances that this second tier will provide an additional buffer of capital above this minimum requirement.  However it will not always transpire that an additional buffer is necessary.

 

This standard looks at the second tier capital requirement.

 

The purpose of this prudential standard is to ensure, as far as practicable, that there are sufficient assets in each statutory fund of a life company to provide adequate capital for the conduct of the business of the fund in accordance with this Act and in the interests of the owners of policies referable to the fund.

 

Therefore, the purpose of the Capital Adequacy Standard is to prescribe the capital requirement of a statutory fund to ensure that the obligations to, and reasonable expectations of, policy owners and creditors are able to be met under a range of adverse circumstances, in the context of a viable ongoing operation.

 

This capital requirement - the Capital Adequacy Requirement - is not required to be disclosed in either the regulatory financial statements (in accordance with the life insurance reporting standards determined under the Financial Sector (Collection of Data) Act 2001)) or the general purpose financial statements (in accordance with accounting standard AASB 1038 Life Insurance Contracts) of the company.  It will, however, be disclosed to the Australian Prudential Regulation Authority (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.

 

This Standard adopts a less prescriptive approach (than the Solvency Standard) to the determination of the Capital Adequacy Requirement in recognition of the differing business strategies of 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.

 

Application to Friendly Societies

 

The Act was amended in 1999 to extend its application to friendly societies that undertake life insurance business.  This standard is applicable to all life companies (registered under the Act) including friendly societies.  In its application, the standard will, at times, make distinction between life companies that are friendly societies and other life companies.

 

Interaction with Management Capital Standard

 

It is noted that certain risks related to the life business of a friendly society are incurred in the management fund. Such risks are recognised and provided for in the Management Capital Standard.

 

Further, life companies other than friendly societies may count an amount of the net assets of the shareholders’ fund in offsetting some aspects of the Capital Adequacy Requirements of the statutory funds (refer to section 12 for detail).

 

Therefore, the Solvency Standard, Capital Adequacy Standard and the Management Capital Standard involve a degree of interaction and should be considered together.

 

 

Application of the Capital Adequacy Standard

 

The Capital Adequacy Standard is made for the purposes of section 70 of the Life Insurance Act 1995.

 

It applies:

a)   in respect of all life insurance business of a registered life company, other than that written in a statutory fund which includes only business written overseas in  one or more Approved Countries; and

b)   in respect of the life insurance business of an eligible foreign life insurance company, other than life insurance business carried on outside Australia; and

c)    at all times from 31 December 2005.

 

The Standard is written in the context of Australian legislation and bases of taxation.  Appropriate adjustment must be made, for example to allow for different bases of taxation, where this Standard is being applied to overseas business.

 


PART A – PRINCIPLES

 

SECTION 1       The Capital Adequacy Standard

 

Overview

 

The Solvency Standard requires that the statutory fund of a life company has available a minimum level of net assets in excess of its liabilities - the Solvency Requirement - to provide for the security of the policy owners’ guaranteed entitlements under a range of adverse conditions.

 

However, the prudent regulation of the life insurance industry requires that the level of security offered to policy owners exceed that of a standard which secures solvency.  The Capital Adequacy Standard requires that each statutory fund has available sufficient additional assets to provide confidence in the longer term financial strength of the fund.  A fund that is capital adequate would have the ability to write new business, in an unfettered manner, with the expectation of remaining solvent into the future.

 

The Capital Adequacy Requirement is determined by considering the various risks undertaken within the statutory fund which could impact the longer term security of the policy owners’ entitlements, and requiring the provision of a prudent level of reserve against such risks.

 

These risks, and an assessment of the prudent provision, are considered in the context of an ongoing operation; a fund open to new business and meeting policy owner expectations in a competitive market.

 

A statutory fund that meets the Capital Adequacy Requirement would be considered by the Australian Prudential Regulation Authority to be a financially strong fund - however this does not imply an absolute guarantee of security to policy owners.

 

 

1.1         At any time, the value of the assets of the statutory fund of a life company must be of an amount considered sufficient to allow the company to continue to meet, into the future, its:

a)   obligations to, and the reasonable expectations of,  policy owners referable to the fund; and

b)   obligations to creditors referable to the fund.

 

The amount of assets so required is referred to as the Capital Adequacy Requirement.

 

1.2         The Actuary, in determining the Capital Adequacy Requirement must consider, in respect of both existing and expected future policy owners, the company’s liability in respect of:

a)   the guaranteed benefits under the policy in accordance with the policy document and the law; and

b)   any additional guarantees or obligations implied by the promotional material of the company; and

c)    the reasonable expectations of the policy owners in respect of benefits under the policy in accordance with past practice of the company.

 

1.3         The Actuary, in determining the Capital Adequacy Requirement, must make an assessment of the effect of the company’s realistic new business plans on the future solvency of the statutory fund.

 

 

 

SECTION 2       Scenarios of Adverse Conditions

 

Overview

 

In assessing the Capital Adequacy Requirement of a statutory fund consideration is given to:

 

·      the risks which may affect the value of the liabilities under policies; and

·      the risks which may affect the value of the assets supporting those liabilities.

 

The Capital Adequacy Requirement broadly comprises the following components:

·      the Capital Adequacy Liability;

·      the Other Liabilities;

·      the Inadmissible Assets Reserve;

·      the Resilience Reserve; and

·      the New Business Reserve.

 

The Capital Adequacy Liability

A calculation of the value of the liabilities under the policies on the basis of assumptions which are more conservative (anticipate a more adverse experience) than best estimate assumptions.

 

The Other Liabilities

The value of the liabilities of the statutory fund to other creditors, but excluding approved subordinated debt arrangements and amended as required to satisfy the principles of this Standard.  In particular, where such other liabilities relate to future cash flows that are uncertain, then their assessment is to be based on assumptions that are more conservative than best estimate, as per the Capital Adequacy Liability

 

The Inadmissible Assets Reserve

A reserve against the risks associated with:

·      holdings in associated or subsidiary Financial Services entities; and

·      concentrated asset exposures.

 

The Resilience Reserve

Mismatching of asset and liability exposures necessitates the provision of a reserve for adverse movements in asset values to the extent they will not be matched by a corresponding movement in the liabilities.

 

When determining the impact of the various risks and adverse conditions on the financial position on the fund, it is required to assess their impact consistently on all assets and liabilities affected. This includes both beneficial and adverse combined effects.

 

The New Business Reserve

Provision for planned business operations over a prescribed future period of three years, with the intention of securing the continued solvency of the fund over that period.

 

 

2.1         The Capital Adequacy Requirement must provide for a value of the liabilities of the statutory fund in respect of obligations to policy owners and creditors, on a basis that is more conservative than best estimate and that considers scenarios of adverse experience.

 

2.2         The Capital Adequacy Requirement is, in principle, to be determined on a basis that is consistent with the net realisable market values of the assets and other liabilities of the statutory funds, including allowance for realisation costs and, if considered appropriate under the relevant adverse scenarios, discounting of all future cash flows.

 

2.3         In considering scenarios of adverse experience and adopting a basis for the Capital Adequacy Requirement, the Actuary must allow for all material risks associated with both the liabilities and the assets of the fund, including the interdependencies between these risks that the Actuary considers might apply under such adverse conditions. This is regardless of whether such risks are discussed in the rest of this Standard or not.

 

2.4         Where the particular combination of risks affecting a company is not explicitly considered within this Standard, the Actuary must establish additional amounts within the Capital Adequacy Requirement, beyond the amounts prescribed. The additional reserve must reflect the purpose and principles of the Standard. It must provide a level of reserving that is consistent with that applying under this Standard in respect of the risks explicitly considered under this Standard. For this purpose the Actuary may regard the prescribed requirements set out within this Standard,


when applied to a typical life company with the combination of risks explicitly considered in this Standard, as designed to provide a level of reserves which broadly meets the following requirements:

a)   Able to cover a combination of adverse circumstances that would be expected to arise once every 400 years;

b)   Allowing a general time frame of 12 months in which the circumstances arise and the actions under (c) and (d) below follow;

c)    The reserve required at the end of the period in (b) is able to be determined in accordance with the Capital Adequacy Requirement of this Standard, but allowing for the implementation of plausible risk reduction actions by management at, or after, that time (for example, raising premium rates, exiting risky asset positions or other arrangements as would be permitted).  This includes allowance for discretions in line with paragraph 3.2. For those risks that cannot be eliminated, sufficient reserve will still be required as set out in this Standard; and

d)   Allowance for management corrective action during the period in (b) is considered to be limited to highly reliable actions only, with conservative response time allowances.

 

2.5         The criteria of paragraph 2.4 are to be applied allowing for the benefit of any diversification across all risks affecting the company.  For the purposes of paragraph 2.4, those risks requiring additional resilience reserves to be established under section 11.11 using the principles of paragraph 5.2.5 are considered to be adequately addressed by those additional reserves.

 

2.6         The guideline in paragraph 2.4 is intended as a guide when allowing for risks that are not explicitly dealt with under the prescribed basis in this Standard.  It is not intended as an alternative basis for issues that are otherwise and adequately dealt with in the prescribed basis.  For the avoidance of doubt, the Capital Adequacy Requirement must not be less than that calculated using the basis prescribed in the rest of the Standard, but may be more where there are material risks that are not explicitly dealt with under the prescribed basis.

 

2.7         In determining the Capital Adequacy Requirement, the availability of tax deductions and the values placed on tax assets and tax liabilities, need to reflect what is assessed as likely to be realised in the underlying scenario, subject to the overriding requirement set out in paragraph 9.7.

 

2.8         In considering scenarios of adverse experience and adopting a basis for the Capital Adequacy Requirement, the use of discretions and of policy owner retained profits that are assumed by the Actuary must be appropriate, justifiable and equitable.

 

2.9         It is the principles that are paramount in determining the Capital Adequacy Requirement; methodology is incidental to the principles.  However, this does not override the requirement of paragraph 2.6 that the Capital Adequacy Requirement must not be less than that calculated using the prescribed method.

 

 

 

SECTION 3       The Liability Risks

 

Overview

 

The risks associated with the liabilities under policies are discussed in this section.

 

The risks pertaining to each element of the capital adequacy liability include the risk of mis-estimation of the mean, the risk of deterioration of the assumed mean, the risk of adverse statistical fluctuations about the mean and the risk of unexpected changes in the underlying distribution of experience.

 

Available discretions in policies may mitigate the effects of some of the liability risks for the company.  Discretions typically fall into one of the following categories:

 

·      reductions in Bonuses or Discretionary Additions;

·      increases to expense charges where the maximum level is linked to an inflation index;

·      one-off increase to expense charges, subject to the contractual maximum; and

·      increases to premium rates, either in line with insurance claims experience or at the company’s discretion (including rider premiums on contemporary products).

 

Equally, some assets, such as reinsurance, may react in response, favourably or unfavourably, to changes in the liabilities. These effects are to be taken into account.

 

 


3.1         The Capital Adequacy Liability

 

3.1.1      The Capital Adequacy Liability must make provision for the risks pertaining to each element in respect of which an assumption is required in valuing the policy liabilities.  The assumptions, including the risk margins, are referred to as the Capital Adequacy Assumptions.

 

3.1.2      The margin for risk included in each Capital Adequacy Assumption is to be determined by the Actuary as the appropriate level within the quantitative range prescribed.  The Actuary is to determine the appropriate margin after consideration of the qualitative factors. (See section 4).

 

3.1.3      The Capital Adequacy Assumption must not be less than the minimum in the prescribed range, but may be less than the corresponding Solvency Assumption.  The risk margin included in the Capital Adequacy Assumption may be greater than the high margin in the prescribed range.

 

3.1.4      Where the benefits under the policy are dependent on the performance of the underlying net assets and related liabilities, the Capital Adequacy Liability must, in principle, be aligned with the net realisable market value of those assets and related liabilities.

 

3.2         Allowance for Discretions

 

3.2.1      In assessing the amount of the Capital Adequacy Liability the Actuary must only assume the application of discretions available under policies where the application is considered appropriate, justifiable and equitable:

a)   under the adverse conditions being assumed;

b)   having regard to the principles in paragraph 1.2; and

c)    having regard, in the case of participating business, to the provisions of the Life Insurance Act which govern the purpose of policy owners’ retained profits and distributions there from.

 

3.2.2      The extent and timing of the assumed application of discretions must be consistent with normal company practice in the circumstances of the adverse scenario being considered.

 

3.2.3      It would normally be expected that the Capital Adequacy Liability in respect of a participating category of business would not be less than the total of the relevant Policy Liabilities (less the component representing the value of expected future Shareholder Profit Share, after allowing for the effect of the adverse conditions being assumed) plus policy owners’ retained profits.  However, if the Actuary is satisfied that, after allowing for the application of discretions as in paragraph 3.2.1, less than this total amount is


required to satisfy the reasonable benefit expectations of the relevant in force policyholders, then the excess may be regarded as being available to support the Capital Adequacy Requirements of any non-participating categories of the statutory fund provided that this support is on commercial terms.   

 

3.2.4      In applying the provisions of this section to friendly societies, discretions must be taken to be those discretions explicitly provided for in the existing rules of the benefit fund and not the broader discretions that may be accessed through a process of amending those rules.  Any representations made in the relevant product disclosure documents must also be taken into account in determining the level of discretion to be applied.

 

3.3         Other Liabilities

 

3.3.1      Where the other liabilities of the statutory fund (other than a deficit in respect of a defined benefit superannuation fund to which the entity, or an associated entity, is an employer sponsor) are determined based on estimates of future cash flows, these must be reassessed and discounted to the valuation date on a basis consistent with the overall scenarios of adverse experience being considered (per Section 2 and as reflected in the Capital Adequacy Liability).

 

3.3.2      Where the entity, or associated entity, is an employer sponsor of a defined benefit superannuation fund and the other liabilities of the statutory fund include a deficit in respect of that fund, and the deficit has been determined using the corridor approach as defined under accounting standard AASB 119 Employee Benefits, the deficit is to be reduced (increased) by the amount of any Unrecognised Actuarial Gains (losses).

 

 

Termination Value Minimums

 

3.4         The Capital Adequacy Requirement must provide that, for a Related Product Group, a minimum value is held in respect of the Capital Adequacy Liability equal to the total Current Termination Value for all policies in the group.

 

3.5         Reinsurance

 

3.5.1      In order for the credit and inadmissible asset risks involved with reinsurance arrangements to be properly identified and assessed, the requirements of this Standard are to apply on a gross of reinsurance basis, with the gross liability requirements and any related reinsurance values separately quantified. That is, the Capital Adequacy Liability and the impact of the risks, adverse scenarios and termination value minimums are to be assessed on a gross of reinsurance basis.

 

3.5.2      Any reinsurance arrangements are to be valued consistent with their associated gross liabilities under the scenario or test being considered. For example, if the related gross liability requirement is assessed under a termination value scenario, a similar approach is to be taken with the reinsurance.

 

3.5.3      Where a reinsurance arrangement gives rises to an asset of the fund in the context of the scenario or test applicable, the value of the arrangement is to be treated as an asset of the fund within this Standard. The credit that can be taken for that reinsurance asset is then subject to the asset inadmissibility rules of this Standard (see paragraph 5.1.5).

 

3.5.4      A corresponding treatment is to apply in the context of other similar risk mitigating arrangements and contracts, that while not legally reinsurance, have similar effects.

 

 

 

SECTION 4       The Capital Adequacy Assumptions

 

4.1         Investment Earnings & Liability Discount Rates

 

For both insurance contracts and investment contracts, the Capital Adequacy Assumption for gross investment yield and liability discount rate will be as determined in paragraph 5.5.1 of the Valuation Standard, but subject to a maximum rate of the Mid Swap Rate.

 

4.2         Quantitative Range for Margins for other Assumptions

 

4.2.1      The quantitative range prescribed in respect of the margins for risk to be included in each of the Capital Adequacy Assumptions is set out in Attachment 1.

 

4.2.2      The margin must be applied such as to produce a more conservative estimate of the liability than best estimate.

 

4.2.3      The Capital Adequacy Assumption for inflation must be consistent with the Capital Adequacy Assumption for investment earnings, subject to it being no less than the Best Estimate Assumption for inflation.  This assumption is to be applied to all future cash flows that are subject to inflation, including Maintenance Expenses.

 

4.2.4      Allowance for tax on investment earnings must be  appropriate to the adverse circumstances of the Capital Adequacy Liability and


must be based on an asset profile which under the adverse circumstances of the Capital Adequacy Liability, would be expected to yield a return equal to Capital Adequacy Assumptions for gross investment earnings referred to in paragraph 4.1 above. The allowance for tax on other than investment items must be made in accordance with Best Estimate Assumptions.

 

4.3         Qualitative Factors for Assessing Margins

 

4.3.1      In assessing the margin for Capital Adequacy Assumptions the Actuary must have regard for the particular circumstances of the company.  The margin adopted must, in the Actuary’s opinion, appropriately reflect the level of risk for the Related Product Group.

 

4.3.2      The qualitative factors relevant to the Actuary’s considerations will vary depending on the assumption being assessed, but should at least include the following matters:

a)      the availability of relevant and reliable data on which to base the assessment;

b)      the currency and reliability of relevant company experience investigations;

c)      the stability of, or emerging trends in, the company’s experience over time; and

d)      the extent to which relevant company policy (investment policy, underwriting policy etc) is clearly defined and adhered to.

 

4.3.3      Where all of the qualitative factors indicate that the risk exposure is low, then a margin closer to the Minimum Margin may be adopted.  Where the qualitative factors indicate that the risk exposure is high, then a margin closer to the High Margin should be used.  The result should be that if two statutory funds with differing risk profiles both hold assets equal to the Capital Adequacy Requirement then the probability of ruin should be comparable for each fund.

 

4.4         Servicing Expenses

 

4.4.1      In the case of a friendly society, the margin to be included in the Capital Adequacy Assumption for Servicing Expenses is Nil: the servicing expense risk is borne, and hence provided for, in the management fund.  (Refer to the Management Capital Standard.)

 

4.4.2      For other life companies, a risk margin must be included for Servicing Expenses.  The margin must not be applied to any component of those expenses which is contractually agreed for the life of the policy, for example, renewal commission.


4.4.3      When determining Servicing Expenses for each policy, the allocation of the total expenses of the company must be undertaken in accordance with the principles established in section 13 of the Valuation Standard.

 

4.4.4      In particular, where a service agreement or other contractual arrangement exists, the Actuary must assess the adequacy of the expenses thereunder in reflecting the long term, sustainable costs of operating the business and adjust the Capital Adequacy Assumption accordingly. (Refer to paragraph 13.9.1 of the Valuation Standard).

 

4.4.5      The Capital Adequacy Assumption for Investment Management Expenses must be based on an asset profile which under the adverse circumstances of the Capital Adequacy Liability would be expected to yield a return equal to the Capital Adequacy Assumption for gross investment yield referred to in paragraph 4.1. The Capital Adequacy Assumption must also include a margin for risk above this base requirement.  However, if the life company has contractually agreed to pay a higher Investment Management Expense regardless of the asset profile adopted, then this higher expense must be assumed.

 

4.4.6      Where the entity, or associated entity, is the employer sponsor of a defined benefit superannuation fund, and a surplus exists in the fund which is being utilised to reduce contributions to the fund, consideration needs to be given, when determining the expected servicing costs, to the extent to which that contribution reduction would continue in the context of the scenario being considered.

 

4.5         Investment-Linked Policies

 

4.5.1      In the case of a friendly society, the margin to be included for investment-linked business is Nil: the additional risks that may be borne by the company in conducting investment-linked business are borne, and hence provided for, in the management fund.  (Refer to the Management Capital Standard.)

 

4.5.2      For life companies other than friendly societies, a risk margin must be included to reflect the additional risks that may be borne by the company in conducting investment-linked business.

 

 

 


SECTION 5       Asset Risks

 

Overview

 

The risks associated with the assets supporting the liabilities are discussed below.

 

Adverse Market Movements

To the extent that the value of liabilities is not directly linked to the value of the underlying assets, an adverse movement in the value of the assets effectively reduces the level of reserves supporting the liabilities.  It is prudent that a company recognise this risk and hold sufficient reserves such that the obligations to policy owners and creditors would still be able to be met following an adverse market movement.

 

The risk of adverse market movements is one of many potentially offsetting risks.  It is presumed that, for the asset and liability profile of a typical life insurer, a Resilience Reserve set at the level of sufficiency described in section 5.2 will, with additional reserves determined independently in respect of other risks, produce an overall Capital Adequacy Requirement at the level of sufficiency described in paragraph 2.4.

 

Holdings in Associated and Subsidiary Financial Services Entities

Associated and subsidiary Financial Services entities may be exposed to essentially the same environmental and systemic risks as the life insurer. The value of such an entity in excess of its net tangible assets cannot therefore be relied upon to meet the capital requirements of the life insurance company under adverse circumstances. Furthermore, the value taken for such a holding is not to double count any legislated capital requirement of the entity itself.

 

Asset Concentration

Diversification is an important principle of prudent investment.  To the extent the asset exposure of a statutory fund is excessively concentrated in a particular asset, or with a particular obligor, a reserve is required against the part of the value of that exposure considered by the Actuary to be excessive.

 

Credit Risks

In general, it is considered that the combined effect of adopting the net market value of the assets and the reserves for asset concentration would address the average costs of default and marketability/liquidity risks.

 

Where a fund has significant exposure to non-sovereign credit risks, the Actuary is to provide an appropriate reserve allowance for such credit risks, along with any other asset risks.


Liquidity Risks

The Actuary’s general responsibility in assessing and advising management on the financial operations of the company would include consideration of liquidity risks.

 

Overall Asset Risks

Notwithstanding the prescribed limits of this Standard, the Actuary must have regard to the particular circumstances of the company.  If in the opinion of the Actuary the overall portfolio of assets of the statutory fund has too little diversification, is too illiquid or has too great an exposure to one obligor of low credit standing, the Actuary must increase the reserves appropriately.

 

Furthermore, the asset and other liability values disclosed in the regulatory financial statements may not be equal to the net market values of those assets and other liabilities, allowing for realisation costs. A reserve for the difference between the reported and net realisable market values of the assets and other liabilities is to be included. However, no reserve is needed in respect of those assets backing liabilities which are directly linked to the net value of the assets and other liabilities as reported in the regulatory financial statements and where the liabilities would correspondingly change if the reported net values were changed.

 

Note:

It is not the intention of these reserves to limit the investment practices of life companies.  Rather it is to ensure that the risks associated with particular investment strategies are appropriately assessed and provided for.

 

 

5.1         Reserve for Inadmissible Assets

 

5.1.1      The Capital Adequacy Requirement must provide a reserve - the Inadmissible Assets Reserve - in respect of:

a)   holdings in an associated or subsidiary entity which is a Financial Services entity;

b)   non-realisable (in the context of the capital adequacy tests) intangible assets;

c)    the risks arising from asset concentration;

d)   reinsurance assets which may not be fully recoverable in the context of the scenarios of adverse experience; and

e)   alignment necessary to ensure assets and liabilities are based on net market value.

 


5.1.2      Holdings in Associated and Subsidiary Entities which are Financial Services Entities

 

Where the associated or subsidiary entity is a Financial Services entity the Actuary must establish a reserve to the extent that the value of the entity exceeds its net tangible assets.

 

Furthermore, where the associated or subsidiary entity is subject to prudential regulation which requires the maintenance of minimum capital (e.g. a financial institution or a health insurance institution), the Actuary must establish a further reserve to the extent that the net tangible assets of the entity are required to meet that capital requirement and are not, therefore, available to support the life insurance company.

 

5.1.3      Non-Realisable Intangible Assets

 

The Capital Adequacy Requirement must provide a reserve equal to the value of any intangible assets held that are related to the business of the statutory fund itself and are not independently realisable, for example deferred acquisition costs assets.

 

5.1.4      Asset Concentration Risks

 

The Capital Adequacy Requirement must provide a reserve against the adverse impact of a concentration of funds in a particular asset, with a particular obligor or with related parties.

 

5.1.5      Allowance for Reinsurance

 

To the extent that a reinsurance arrangement represents an asset of the statutory fund under the scenarios of adverse experience being considered, then it is to be treated as such and is to be subject to the asset inadmissibility and resilience reserve rules of the Standard. In applying the asset concentration limits of the Standard:

a)   All exposures to a reinsurer or reinsurance group are to be considered a single counterparty exposure (within the practical context of the application of the limits concerned); and

b)   Where arrangements with a reinsurer involve both liability and asset components, these may be taken as a single net exposure to the extent they are subject to a legally enforceable right of off-set.

                       

5.1.6      Alignment to Net Market Value

 

The inadmissible assets reserve must, in principle, include the net difference between the value disclosed in the regulatory financial statements and the net realisable market value of all assets and financial liabilities (other than policy liabilities) of the statutory fund.

 

5.2         Resilience Reserve

 

5.2.1      The Actuary must assess the resilience of the statutory fund and provide for an appropriate reserve - the Resilience Reserve.

 

5.2.2      Resilience is assessed as the ability of the statutory 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 the assets relative to the value of the liabilities.

 

5.2.3      In determining the value of liabilities in the post shock environment the Actuary must only assume the application of discretions available under policies where the application is considered appropriate, justifiable and equitable:

a)   under the adverse conditions being assumed; and

b)   appropriate having regard to the principles in paragraphs 1.2 and 3.2.

 

5.2.4      It is considered appropriate, for this purpose, for the Actuary to assume the full application of discretions available in respect of the Termination Value under the policies.

 

5.2.5      The Resilience Reserve as determined under the prescribed rules of Section 11 is based on the impact of market changes on the position of a statutory fund with a simple asset and liability profile.  Where the fund is materially exposed to changes in investment market conditions that are not captured by the application of the prescribed rules, a corresponding additional provision must be made by the Actuary.  The additional reserve must reflect the purpose and principles of the Standard. It must provide a level of reserving that is consistent with that applying under this Standard in respect of the changes in investment market conditions explicitly considered under this Standard. For this purpose, the Actuary may regard the prescribed requirements set out within this Standard, when applied to the asset and liability profile of a typical life office, as designed to provide a level of reserves which broadly meets the following requirements:

a)      Able to cover adverse changes in investment market conditions that would be expected to arise once every 100 years;

b)      Allowing a general time frame of 12 months in which the circumstances arise and the actions under (c) and (d) below follow;

c)      The reserve required at the end of the period in (b) is able to be determined assuming that a matched asset and liability profile is achieved and that the Capital Adequacy Requirement of this Standard is otherwise satisfied at, or after, that time.  This includes making allowance for discretions in line with paragraph 3.2; and

d)      Allowance for management corrective action to achieve a matched asset and liability profile during the period in (b) is considered to be limited to highly reliable actions only, with conservative response time allowances.

 

5.3         Asset Exposure

 

5.3.1      The Actuary in assessing the asset risks:

a)    must take account of the effective exposure of the fund to various asset classes, regardless of the physical asset holdings of the fund; and

b)    must consider exposure to counterparty risks including, but not limited to, futures and options, swaps, hedges, warrants, forward rate and repurchase agreements; and

c)    must take account of the underlying exposure of the fund to assets by adopting a “look through” approach in respect of each unlisted or controlled investment entity that represents more than 1% in value of the statutory fund.  For this purpose, an investment entity is an entity whose assets are solely investments, where the sole purpose of the entity is investment activities and where the investor investing in that entity has security directly linked to those assets; and

d)   must, where investments covered by (c) are geared, treat the debt as if it were a liability of the life insurance company, with appropriate allowance made for the sensitivity of the underlying assets and liabilities to market movements; and

e)   may adopt the ‘look through’ approach as set out in paragraphs (c) and (d) above where the investment is in a listed unit trust. Alternatively, the Actuary is required to treat the holding as a single investment in the equity investment class as defined in the General Standard; and

f)     must assess the characteristics of the remaining admissible component of an investment where, following application of Section 10 of this Capital Adequacy Standard, only part of the investment is admissible, by looking through to the underlying assets and liabilities where necessary and applying the Resilience Reserve requirements of Section 11 accordingly.

 

5.3.2      As indicated in paragraph 5.2.5, the Resilience Reserve calculation assumes largely generic asset structures.  Where the Actuary can demonstrate that an asset can be disaggregated into two or more identifiable sub-assets, the Actuary may treat the sub-assets separately and hence categorise them into different asset sectors according to their substance for the purpose of applying the Resilience Reserve requirements in Section 11, provided that it is demonstrated to APRA’s satisfaction that:


a)      The substance of the sub-assets warrants their proposed asset sector categorisation;

b)      The entire cash flows of the overall asset are fully reflected by the aggregated sub-assets;

c)      The resilience parameters adopted appropriately reflect the substance of the sub-assets;

d)      Where the sub-asset is equivalent in nature to an interest bearing security it is appropriately credit risk rated;

e)      The resilience shocks applied to the sub-assets do not give a result in aggregate less than the prescribed shock for the overall asset under a scenario where all yields rise;

f)       The diversification factor is not reduced (i.e. the diversification factor is to be calculated assuming that the asset is not disaggregated);

g)      The requirements of paragraphs 5.2.5 and 5.3.1 continue to be satisfied; and

h)      The overall asset continues to be treated as a single counterparty exposure for the purposes of Section 10.

 

 

 

SECTION 6       The New Business Reserve

 

6.1         The Capital Adequacy Requirement must provide for a reserve in respect of any additional capital required to ensure that the statutory fund will be able to meet the Solvency Requirement over the next three years, given:

a)   levels of projected business over that period in accordance with the realistic business plans of the company; and

b)   experience during that period in accordance with Best Estimate Assumptions.


PART B – METHODOLOGIES

 

SECTION 7       Determination of the Capital Adequacy Requirement

 

7.1         The Capital Adequacy Requirement for a statutory fund is to be calculated as follows:

 

(a)  CALCULATE CAPITAL ADEQUACY LIABILITY

Subject to paragraph 7.2, for each policy in force, determine the Capital Adequacy Liability and aggregate this across all policies in the Related Product Group.

 

 

(b)  CALCULATE CURRENT TERMINATION VALUE

Subject to paragraph 7.3, for each policy in force, determine the Current Termination Value and aggregate this across all policies in the Related Product Group.

 

 

 (c)  MINIMUM OF CURRENT TERMINATION VALUE

Determine the greater of the amount in (a) and the amount in (b) and aggregate across the statutory fund.

 

 

(d)  ADD OTHER LIABILITIES

Increase the amount determined in (c) by the Other Liabilities of the statutory fund.

 

 

(e)  ADD RESERVE FOR INADMISSIBLE ASSETS

Increase the amount determined in (d) by the reserve for Inadmissible Assets for the statutory fund.

 

 

(f)  ADD RESILIENCE RESERVE

Based on the Admissible Assets of the statutory fund, increase the amount determined in (e) by the Resilience Reserve for the statutory fund.

 

 

(g)  MINIMUM OF SOLVENCY REQUIREMENT

For the statutory fund determine the greater of the

amount determined in (f) and the Solvency Requirement for the statutory fund.

 

 

 

 

(h)  ADD NEW BUSINESS RESERVE

Increase the amount determined in (g) by the additional capital requirements for new business in respect of the statutory fund.

 

 

(i)  TRANSITIONAL ADJUSTMENT

For the statutory fund determine the amount of any transitional adjustment required to the Capital Adequacy Requirement and deduct it from the amount determined in (h).

 

 

7.2         Where the Actuary is satisfied that the total Capital Adequacy Liability for a Related Product Group will be less than the total Current Termination Value, no calculation in part (a) of paragraph 7.1 is required.

 

7.3         Where the Actuary is satisfied that the total Current Termination Value for a Related Product Group will be less than the total Capital Adequacy Liability, no calculation in part (b) of paragraph 7.1 is required.

 

7.4         Although reinsurance arrangements or other similar risk mitigation arrangements (per paragraph 3.5.4) that represent an asset of the fund under the scenario or test being considered are to be assessed as a asset under this Standard (per paragraph 3.5), to the extent the value of such an arrangement under this Standard differs from its value reflected in the financial statements of the fund, the difference is to be included as an offset or addition as appropriate within paragraphs 7.1(a), (b) and (c) above. The inclusion of part or all of such a reinsurance asset within these calculation steps above does not negate its consideration for inadmissibility reserving (per paragraph 10.5).

 

7.5         Allowance must be made by the Actuary in each of the steps in the above calculation process, as appropriate, for claims which have been incurred but not reported (IBNRs) and claims which have been reported but not admitted (RBNAs).

 

7.6         The performance of each subsequent step in the calculation process described in paragraph 7.1 must not reduce the progressive result from its amount at the completion of the previous step, with the exception of step 7.1(e), in circumstances where the Reserve for Inadmissible Assets is negative as a result of the alignment to Net Market Value under paragraph 10.6, and step 7.1(i).

 

7.7         The overall capital adequacy calculation methodology involves systematically considering the values and risks underlying the reported values set out in the regulatory financial statements and assessing appropriate reserving adjustments or margins for each.


The methodology requires that all such reserving adjustments, are allowed for by means of increases to the Capital Adequacy Requirement rather than decreases in the value of the assets against which the Capital Adequacy Requirement is compared.

 

 

 

SECTION 8       The Capital Adequacy Liability

 

8.1         For both insurance and investment contracts, the Capital Adequacy Liability is determined by using the methods used to determine the Best Estimate Liability, as prescribed in section 5 of the Valuation Standard, but:

a)   allowing for current and future Bonuses subject to the appropriate application of discretions; and

b)   adopting Capital Adequacy Assumptions.

 

8.2         Where the benefits under the policy are dependent on the performance of the underlying net assets and related liabilities, the Capital Adequacy Liability (before application of the Current Termination Value Minimum) must be aligned with the net realisable market value of those assets and related liabilities. However, to the extent that the Capital Adequacy Liability adopted for this Standard in respect of that policy is based on asset values disclosed in the regulatory financial statements and would correspondingly change in value if such net realisable asset or related liability values were adopted for the financial statements, then this adjustment may be ignored in respect of that policy, along with the equivalent adjustment under paragraph 10.6.

 

 

 

SECTION 9       Current Termination Value

 

9.1         The Current Termination Value must be determined as the Termination Value on the reporting date. For investment linked business, the unit price published or promulgated on the reporting date is to be used.

 

9.2         Where the Termination Value is determined as the amount paid on voluntary termination, the Actuary must have regard for the reasonable expectations of policy owners based on the company’s current practice at the reporting date.

 

9.3         The Current Termination Value must not be less than the Minimum Termination Value determined in accordance with the Solvency Standard (except that in the case of investment-linked business, the Minimum Termination Value for this purpose does not include the prescribed risk margin specified in that standard).

 

9.4         If the company’s obligation under the policy involves:

a)   deferred payment of the termination value;

b)   payments by instalment over a period; or

c)    payment in the form of an income stream;

 

then the Termination Value must be determined as the present value of those future payments, using assumptions consistent with this Standard. Tax relief on payments may be taken into account if available under the relevant scenario and if the corresponding calculation of the best estimate liability is based on valuing net of tax payments.

 

9.5         If there is an unsettled lump sum insurance claim on a policy, the best estimate of the amount potentially payable, taking appropriate account of claims settlement costs and reinsurance recoveries, is to be counted as the Termination Value.

             

9.6         Where appropriate, the determination of the Termination Value at the reporting date is to include allowance for Bonuses declared as at that date.

 

9.7         For the purposes of calculating the Termination Value at the reporting date, no allowance is to be taken for any additional tax relief that may arise because of an assumed termination of the policy and payment of the difference between the Termination Value and the policy liability.

 

 

 

SECTION 10     The Inadmissible Assets Reserve

 

10.1       The Inadmissible Assets Reserve for the statutory fund is determined as the sum of:

a)   the reserve prescribed in respect of holdings in associated and subsidiary entities which are Financial Services entities;

b)   defined benefit superannuation fund surpluses;

c)    non-realisable (in the context of the capital adequacy tests) intangible assets; 

d)   the reserve prescribed in respect of asset concentration risks and reinsurance asset recoverability; and

e)   the alignment necessary to ensure assets and other liabilities are based on net market value.

 


10.2       Holdings in Associated and Subsidiary Financial Services Entities

 

10.2.1    The prescribed reserve in respect of holdings in associated and subsidiary entities that are Financial Services entities is to be determined by the Actuary as the amount by which the value of the entity in the regulatory financial statements exceeds its net tangible assets.  This reserve is to be further increased by the amount of any prudential capital requirements of the entity in the jurisdiction in which it operates.  The total reserve required need not be more than the value of the entity in the regulatory financial statements, provided that there is no recourse to the life company in relation to the entity’s obligations.

 

10.2.2    To the extent the benefits under the policy are contractually linked to the performance of the assets held, these assets include  holdings in associated and subsidiary entities and:

a)      those holdings take the form of equities as part of an index or typical balanced investment portfolio; and

b)      the extent of the exposure to those holdings is consistent with the stated investment objective of the fund;

c)      those holdings comply with Section 43 of the Life Insurance Act; and

d)      the Actuary is satisfied that there has been appropriate disclosure to policy owners of the risks to which they are exposed;

 

              no reserve is required under paragraph 10.2.1.

 

 

10.3       Defined Benefit Superannuation Fund Surpluses

 

            Where the entity is an employer sponsor of a defined benefit superannuation fund, no value is to be ascribed to any surplus of that fund which might otherwise be recognised as an asset of the statutory fund.

 

 

Intangible Assets

 

10.4       The regulatory financial statements of the statutory fund may include intangible assets, such as deferred acquisition cost assets, deferred origination cost assets, the value of in-force business and any goodwill asset.  Where the values of such assets are not realisable independent of the business in-force, such assets are to be treated as inadmissible.

 


10.5       Asset Concentration Risks and Reinsurance Recoverability

 

10.5.1    Except as allowed under paragraph 10.5.2, the prescribed reserve for asset concentration risks is determined as the amount by which the value of any single asset (aggregating, where necessary, individual assets that are exposed to common risks, such as strata titles in the same property) or single credit exposure (with a particular obligor or related party) exceeds the following limits:

 

 

 

Asset Exposure

 

Limit

(a)

Is guaranteed by an Australian State or Federal government:

 

No limit

(b)

Is guaranteed by a national government being the national government of the country in whose currency the liabilities of the statutory fund are denominated:

 

No Limit

(c)

Is guaranteed by an overseas provincial government (equivalent in status to an Australian State government), being a government in the country in whose currency the liabilities of the statutory fund are denominated:

 

The greater of:

i) 25% of VASF; and

ii) AUD 20 million.

(d)

Is secured by bank bills:

 

The greater of:

i) 25% of VASF; and

ii) AUD 20 million.

 

(e)

Is secured by bank deposits:

The greatest of:

i) 50% of VASF less the value of the assets of the fund secured by bank bills;

ii) 25% of VASF; and

iii) AUD 20 million.

 


 

(f)

Is secured by a life insurance policy with a Specialist Reinsurer registered under the Act:

 

The greater of:

i) 25% of VASF; and

ii) AUD 20 million.

 

(g)

Is secured by a life insurance policy with a Reinsurer in respect of overseas business which is:

i) a Reinsurer in the same country as that in which the business is written; and

ii) is the parent or sister company of a Specialist Reinsurer:

 

The greater of:

i) 25% of VASF; and

ii) AUD 20 million.

 

(h)

Is secured by a life insurance policy, other than  a reinsurance policy covered by (f) or (g) above, with a registered life company that is an associated or subsidiary entity:

 

No limit

(i)

Is secured by a life insurance policy, other than  a reinsurance policy covered by (f) or (g) above, with a registered life company that is not an associated or subsidiary entity:

 

The greater of:

i) 25% of VASF; and

ii) AUD 20 million.

 

(j)

Is outstanding premiums receivable by a reinsurer under a reinsurance policy with a registered life company:

 

The greater of:

i) 25% of VASF; and

ii) AUD 20 million.

 


 

(k)

Is a mortgage which is:

i) 100% mortgage insured with an authorised insurer under the Insurance Act 1973; or

ii) a first mortgage of an amount not exceeding 70% of the market value of the security; or

iii) made up of a first and all of any subsequent mortgages on the same security, the combined value of which does not exceed 70% of the market value of the security:

 

5% of VASF

(l)

Is:

i) any other actively traded security;

ii) a non-traded security, loan, or reinsurance arrangement with a grade of 1, 2 or 3 per Attachment 1 of the General Standard;

iii) real estate; or

iv) other income producing real property asset:

 

5% of VASF

 

(m)

Is any asset not covered by any of the above categories:

 

1% of VASF

 

 

VASF = value of the assets of the statutory fund as per the regulatory financial statements.

 

10.5.2    In the case of a Specialist Reinsurer, the following increased admissible asset limits apply in respect of retrocessions by that Specialist Reinsurer to an overseas parent, associated, or subsidiary company which, with APRA’s agreement, has been identified as an appropriate retrocessionaire for the purposes of this paragraph:

a)      where the retrocessionaire has a current counterparty grade of 1, 2 or 3 per Attachment 1 of the General Standard – No limit;

b)   where the retrocessionaire does not have a current counterparty grade of 1, 2 or 3 per Attachment 1 of the General Standard,


but had such a grade at the time the retrocession arrangement was entered into;

i)          within the first 3 months after the downgrade below grade 3 – No limit.

ii)        within the next 9 months - 65% of the reinsurance asset.

iii)      within the second 12 months after the downgrade - 35% of the reinsurance asset; and

iv)      thereafter, the retrocession arrangements are to be treated as per paragraph 10.5.1.

c)  in all other circumstances, the retrocession arrangements are to be treated as per paragraph 10.5.1.

 

10.5.3    Notwithstanding the prescribed limits of paragraph 10.5.1, if in the opinion of the Actuary the overall portfolio of assets of the statutory fund has too little diversification, is too illiquid or has too great an exposure to obligors of low credit standing, the Actuary must add to the reserve for inadmissible assets an amount considered appropriate to adequately protect the interests of the policy owners.  In particular, where the fund has a significant cumulative exposure through different classes of assets to a single obligor or related obligors the Actuary is to reduce the limit for that obligor in respect of any particular asset class by the exposure to that same obligor that is allowed as admissible in respect of all lower asset classes (assuming a hierarchy of classes from (a) (highest) to (m) (lowest) in paragraph 10.5.1).

 

10.5.4    Where the policy liabilities are in respect of investment-linked benefits linked to the asset or credit exposure in question and the Actuary is satisfied that there has been full disclosure to policy owners of the risks to which they are exposed, no reserve is required under paragraph 10.5.1.

 

10.5.5    Where the asset or credit exposure is in respect of bank bills or bank deposits, bank for this purpose means:

a)      a deposit taking institution authorised by APRA under the Banking Act 1959; and

b)      in the case of overseas business, a bank in the same country as that in which the business is written, provided that country has capital requirements in respect of banking business comparable to those in the Banking Act 1959.

 

10.5.6    Where the reserve in respect of inadmissible assets is   reduced by deferred tax provisions or other liabilities relevant to the inadmissible portion of the asset, the reduction must only be to the extent those provisions/liabilities are assessed as likely to be realised.

 

10.5.7    In order for an insurance or reinsurance arrangement to qualify for treatment under subparagraph 10.5.1(f), (g), (h) or (i), or


paragraph 10.5.2, it must, subject to a 6 month grace period from risk inception, comprise an executed and legally binding contract.  Draft or incomplete documentation can at best qualify under paragraph 10.5.1(m).

 

10.6       Alignment to Net Market Value

 

10.6.1    The inadmissible assets reserve is to include the net difference between the value disclosed in the regulatory financial statements and the net realisable market value (irrespective of whether this difference is positive or negative) of all assets and financial liabilities (other than policy liabilities) of the statutory fund. Net realisable market value means the mid market value (or equivalent estimated fair value) less (plus for liabilities) any marginal transaction costs that would be incurred on realisation.

 

10.6.2    To the extent that the liabilities adopted for this Standard are based on asset values disclosed in the financial statements and would correspondingly change in value if such net realisable asset or related liability values were adopted for the financial statements, then this adjustment may be ignored in respect of those assets and liabilities along with the equivalent adjustment in paragraph 8.2. This adjustment is also not required in respect of assets already deemed inadmissible under this Standard.

 

 

 

SECTION 11     The Resilience Reserve

 

11.1       The Resilience Reserve is determined as the additional amount that needs to be held before the happening of a prescribed set of changes in the economic environment, such that after the changes the admissible assets of the company are able to meet the policy owner and other liabilities of the statutory fund, including the assessed liability risks in accordance with this Standard.

 

11.2       While the Resilience Reserve is determined at a statutory fund level, it is recognised that the prescribed set of changes (the adverse scenario) which determines the Resilience Reserve for each particular fund may differ depending on the type of business and other circumstances of that fund.  In determining the Resilience Reserve of a particular statutory fund, it is permitted to recognise the potential release of Resilience Reserves from other statutory funds as a consequence of the particular adverse scenario being considered.  However, to the extent such recognition is taken, the Actuary must ensure that:

a)  it is limited to the amounts that would be readily available from other statutory funds while leaving each of those funds


complying with the capital adequacy standard after the adverse scenario assumed; and

b)  the potential release from other statutory funds is only recognised once in reducing the Resilience Reserves of the company; and

c)  the total Resilience Reserves of the company, when reductions across all statutory funds are taken together, must not be less than that which would result from the application of the resilience calculation at the company level.

 

11.3       The Resilience Reserve is determined by reference to the Admissible Assets of the statutory fund. It is not necessary to hold resilience reserves for that part of an asset which is inadmissible nor the free assets (in excess of the Capital Adequacy Requirement) of the fund.  Hypothecation of assets to particular liabilities of the fund is permitted.

 

11.4       Where hypothecation is applied it must be applied to the subcategory level within the fund.  Hypothecation to a lower grouping than subcategory is not permitted.

 

11.5       The Resilience Reserve allows explicitly for the beneficial implications for asset risks of diversification across asset sectors.  Where hypothecation is applied, diversification must be applied at the hypothecated group level.

 

11.6       Determination of Resilience Reserve

 

11.6.1    The Resilience Reserve, where hypothecation is applied, is determined in accordance with the following formulae:

 

Resilience Reserve, determined as:

 

                          L + RR  =   å( Lt’  x  1/ft )

 

where

 

RR        =       resilience reserve

 

L            =       the liability held for the statutory fund for Capital Adequacy purposes to reflect all liability risks (including other liabilities ie as at             step 7.1(d)) prior to the prescribed change in     economic environment and asset values (and equals å Lt )

 

Lt           =       the liability held for the subcategory t for capital adequacy purposes to reflect all liability risks (including other liabilities) prior to the prescribed change in economic environment and asset values

 

L’           =       value of that liability after the prescribed change

 

ft            =       At” / At

 

A            =       value of admissible assets of the statutory fund prior to the prescribed change (and equals å At )

 

At           =       value of admissible assets of the subcategory t prior to prescribed change

 

At’          =       value of the admissible assets of the subcategory t at the Adjusted Yield.

 

At”         =       adjusted value of assets of the subcategory t (At’) reduced by the sum of the Adverse Exchange Movement factor and the Credit Risk Default Factors.

 

Adjusted Yield for subcategory t is determined as:

 

         Current Yield + Credit Risk Yield Movement

         + DFt x Prescribed Yield Change

 

where

         DFt =  { Ö(Et2 + Pt2 + Ft2 + It2) } / (Et+ Pt + Ft+ It)

 

unless application of the diversification factor in determining the Adjusted Yield for a given asset sector would have the effect of increasing the overall resilience reserve, in which case the Actuary may adopt

DFt = 1

for that asset sector for all scenarios.

 

where

 

DFt           =       the diversification factor for subcategory t

 

Et, Pt                   the proportionate holding of assets of subcategory t in the asset sectors Equities and Property respectively each multiplied by the factor for that sector:

                        (Prescribed Increase in Yield / Current Yield)

 

Ft, It                 the proportionate holding of assets of subcategory t in the asset sectors Interest Bearing and Indexed Bonds respectively each multiplied by the factor for that sector:

                        { (Asset Value at Current Yield / Asset Value at Yield after prescribed increase) - 1}

 

Note                1. DFt is determined in the scenario of a prescribed increase in yields across all sectors, and is used to determine the Adjusted Yield in that and all other scenarios.

                        2. In determining Ft, cash is included in the interest bearing sector.

 

11.6.2    The adverse change in yield must not be less than the adverse change in yield for the relevant asset sector determined in accordance with the Solvency Standard.

 

11.6.3    Where no hypothecation is applied, the above formulae for determination of the Resilience Reserve must be applied as if there is a single subcategory being the statutory fund itself.

 

11.6.4    While for the determination of At’ the most adverse scenario must be assumed, in determining the diversification factor the dynamics of that formula require that an increase in yields across all sectors be used (regardless of the fact that for certain classes of business this may not reflect the most adverse scenario).

 

11.6.5    The Resilience Reserve must not be less than zero.  Where hypothecation has been applied, the Resilience Reserve determined for a particular subcategory may be negative.

 

11.7       Prescribed Yield Change

 

11.7.1    The prescribed changes to the economic environment are movements, up or down, in yields as per the table below, which reflect corresponding movements in the value of instruments within those respective sectors:


 

INVESTMENT SECTOR

PRESCRIBED YIELD CHANGE

%

Equities

+ or – (0.50 + (0.4 x Yield))

Property

+ or - 2.50

Interest Bearing

+ (1.30 +(0.25 x Mid Swap Rate))

 

or – (0.20 + (0.25 x Mid Swap Rate))

Indexed Bonds

+ or - 1.00

CURRENCY

ADVERSE EXCHANGE MOVEMENT

All

15% reduction in value of assets exposed to a denomination other than that of the liabilities.

 

 

11.7.2    For the purposes of the above table, Mid Swap Rate is the current Mid Swap Rate as determined for the purposes of paragraph 4.1.

 

11.7.3    Yield, as referred to in this Section 11, is determined in respect of the holdings of the statutory fund and is to be taken to mean:

a)      for Equities, dividend yield based on the dividend yield under the ASX200 Index as at the valuation date, unless the Actuary justifies otherwise;

b)      for Property, rental yield, based on most recent leases in force and determined net of expenses;

c)      for Interest Bearing Securities, redemption yield (running yield in the case of irredeemable securities); and

d)      for Indexed Bonds, real yield.

 

11.8       Credit Risk

 

11.8.1    An addition to the resilience reserves is to be made for credit risk in respect of interest bearing and indexed bond assets, including cash deposits and floating rate assets.  This will be achieved by a reduction in the value of assets under the relevant adverse scenario.  The change will not affect the value of liabilities under the adverse scenario unless the benefits under the policies are contractually linked to the performance of the assets held. 

 


 

11.8.2    In calculating At”:

 

a)      The applicable Credit Risk Yield Movement from the table below is first included in the Adjusted Yield as determined in paragraph 11.6.1 to determine At’. The duration used for this purpose may differ from that used to determine sensitivity to interest rate shocks (e.g. floating rate instruments not immediately redeemable may be regarded as dead short for the application of the prescribed yield change, but may have a longer term for the credit risk yield movement, depending on the extent to which credit risk deterioration can be mitigated).

b)      Each of the values determined in a) above (i.e. At’) is then reduced by the sum of the applicable Credit Risk Default Factor taken from the table below and the Adverse Exchange Movement factor from the table in paragraph 11.7.1.

 

 

Credit factors to apply to fixed interest and cash
investments

Counterparty
Grade

Credit Risk Default Factor

Credit Risk Yield Movement

1 (OECD government)

0.0%

0.0%

1 (other)

0.0%

0.30%

2

0.0%

0.40%

3

0.25%

0.60%

4

1.75%

0.90%

5

4.00%

1.00%

6

11.00%

1.10%

7

17.00%

1.10%

 

 

 

11.8.3    In calculating the Adjusted Yield under paragraph 11.6.1 the Credit Risk Yield Movement is always positive, even though the Prescribed Yield Change may be positive or negative, depending on the relevant adverse scenario being tested. 

 

11.9       Determination of L’

 

11.9.1    In determining the change to the discount rate for valuing the liabilities, it is the Prescribed Yield Change for the interest bearing investment sector determined under paragraph 11.7.1 which is relevant.  The Adjusted Yield as defined in paragraph 11.6.1 (including diversification and credit risk adjustments) is relevant only for asset values or for changes to the benefits to be valued where those benefits are contractually linked to the performance of the assets held.  In the case of changes to those benefits to reflect the combined effect of the Adjusted Yield, the Credit Risk Default Factor and the Adverse Exchange Movement factor allowance may be made for discretions in accordance with paragraphs 5.2.3 and 5.2.4.

 

11.9.2    In determining the Resilience Reserve required, other assets and liabilities whose value is dependent on the value of investment assets, such as tax assets and liabilities, must be adjusted in a manner consistent with the action the company would take were asset values to change by the prescribed amount.  However, in scenarios where asset values are assumed to fall, any resulting tax benefit may only be taken into account to the extent that the Actuary is satisfied that the tax benefit would actually be realised.

 

11.9.3    In calculating L’ no adjustment is required for any potential impact that the Prescribed Yield Change would have on the value of a deficit held in respect of a defined benefit superannuation fund for which the entity, or an associated entity, is an employer sponsor. 

 

11.10     Application of Prescribed Yield Changes

 

11.10.1  In applying the prescribed yield changes of  paragraph 11.7 to the determination of At’ and Lt’, the Actuary must address the worst combination of rising or falling yields for the different asset sectors to which the business is realistically exposed.  At the very least, the following two scenarios must be tested:

 

a)   rising fixed interest yields (investment categories Interest Bearing and Indexed Bonds) and rising equity/property yields (investment categories Equities and Property), and

b)   falling fixed interest yields (investment categories Interest Bearing and Indexed Bonds) and rising equity/property yields (investment categories Equities and Property).

 

Where the circumstances of the fund are such that other scenarios are potentially relevant then they must also be tested.

 

11.11     Other Asset Exposures

 

11.11.1  Paragraph 5.2.5 outlines the principles to be followed where the fund is materially exposed to changes in investment market conditions that are not captured by the application of the prescribed rules of this section, and where a corresponding additional provision must be made.  In this regard, the Actuary needs to consider the impact on the fund of significant adverse changes in investment markets such as:


a)      changes in the slope and shape of the yield curve, especially those that can give rise to difficulties with the reinvestment of assets backing long term liabilities; and

b)      changes in yield, volatility and correlation parameters  that would be reflected in the fair value of derivative assets or analogous provisions in the liabilities.

 

11.11.2  The Actuary must also consider whether the impact of credit risk is adequately provided for through the combination of the prescribed asset concentration limits in paragraph 10.5 and the credit risk adjustments of paragraph 11.8 noting that the prescribed credit risk adjustments presume that the asset portfolio is highly diversified.  If credit risks are not adequately provided for, for example because of a lack of diversification, the Actuary is to adopt lower concentration limits or employ other additional reserving requirements.

 

 

 

SECTION 12     The New Business Reserve

 

12.1       In the case of a friendly society, the New Business Reserve is Nil: the risks associated with financing the business plans of the company are borne, and hence provided for, in the management fund. (Refer to the Management Capital Standard).

 

12.2       The New Business Reserve is determined as:

a) the additional amount required to ensure that the  Solvency Requirement of the statutory fund will continue to be met over the next three years, allowing for capital and profits emerging over that period from the existing business of the fund;

less

b) the New Business Capital;

less

c)   the Offset Statutory Capital.

 

12.3       Subject to paragraph 12.5, new business capital is the aggregate of:

a)   existing, binding arrangements for the external raising of capital specific to the financing of new business within the statutory fund; and

b)   capital (existing or emerging) in any other statutory fund, to the extent it is (or would be) available to be transferred to the  shareholders’ fund at that time.

 

12.4       Offset Statutory Capital applies in the case of a life company which is neither a friendly society nor an eligible foreign life insurance company. It is the amount of Statutory Capital which is appropriately utilised in meeting the new business reserve requirements of the statutory fund.

 

12.5       The New Business Reserve must not be less than zero.

 

 

 

SECTION 13     Transitional Arrangements

 

Overview

      

The Capital Adequacy Requirement determined in accordance with this Capital Adequacy Standard AS 3.04 may be significantly different from the equivalent amount determined in accordance with the previous version AS 3.03.  To allow life companies that are significantly affected sufficient time to implement any necessary changes for either reducing the Capital Adequacy Requirement or increasing the amount of assets in the Statutory Fund to cover the new Capital Adequacy Requirement it is appropriate to allow some short term transitional arrangements. 

 

These transitional arrangements will be in the form of a reduction to the amount of the Capital Adequacy Requirement, such reduction reducing to zero over the transitional period.

 

 

13.1       Where, at the date of introduction of this Standard,  the amount of the Capital Adequacy Requirement determined prior to allowing for any Transitional Adjustment (i.e. after step 7.1(h)) exceeds the Capital Adequacy Requirement that would have resulted at the same date from application of the previous version of this standard (AS 3.03) by an amount exceeding the Transitional Materiality Limit, the Actuary may, with APRA’s agreement, apply a Transitional Adjustment to the Capital Adequacy Requirement in accordance with the provisions of this section.

 

13.2       The Transitional Adjustment is determined at the date of calculation as:

 

  

   (CARCAR’)  x  t / n                      

 

 

where

 

CAR      =       the Capital Adequacy Requirement determined prior to allowing for any Transitional Adjustment (i.e. after step 7.1(h)) as at the date of calculation


CAR’     =       the Capital Adequacy Requirement that would have resulted at the same date from application of the previous version of this standard (AS 3.03)

 

t             =       the period from the calculation date to the Transition End Date

 

n            =       the period from 31 December 2005 Standard to the Transition End Date.

 

 

 

SECTION 14     Materiality

 

Overview

 

Particular values or components are considered material to the overall result of a calculation when their mis-statement or omission would cause that result to be misleading to the users of the information.

 

Materiality tests assess the significance of the particular value/component by relating it to the amount of the overall result to which it contributes.

 

 

14.1       The Capital Adequacy Requirement determined in accordance with this standard is subject to materiality standards applied at a statutory fund level.

 

14.2       The base amount for materiality purposes is the difference between the assets of the statutory fund and the Solvency Requirement of that fund.

 

14.3       While materiality must be applied at the statutory fund level, the materiality of the statutory fund relative to the size of the company overall may be taken into account.

 

14.4       In applying the materiality standards described in paragraphs 14.1 and 14.2:

a)      it is appropriate to use as the base amount for materiality purposes a rolling average of the base amount provided that the average so derived is a function of not less than three and not more than five years experience and is reflective of the current and anticipated future experience; and

b)      it is appropriate, as the base amount approaches zero, for alternative key indicators to be used in establishing materiality.

 

14.5       While assessing materiality will always be a matter of professional judgement, the following quantitative thresholds are generally to be used:

a)      variations in amounts of 10% or more of the base amount may be presumed material; and

b)      variations in amounts of 5% or less of the base amount may be presumed immaterial.


PART C – ACTUARY’S STATEMENT

 

SECTION 15     Statement Relating to the Determination

 

15.1       In respect of any determination of the Capital Adequacy Requirement the Actuary must provide in a Financial Condition Report under LPS 320 Actuarial and Related Matters, details of the calculation processes and the assumptions used in deriving the results.

 


ATTACHMENT 1CAPITAL ADEQUACY ASSUMPTIONS

 

 

 

BASE TO WHICH

 

QUANTITATIVE RANGE for MARGIN

 

MARGIN APPLIED

 

Minimum Margin

 

High Margin

 

Servicing Expenses

 

See Note 1

 

  2.5%

 

20.0%

 

 

 

 

 

Insured Lives

Best Estimate Assumption

10.0%

 

40.0%

 

Annuitants

  -  Base

 

  -   Improvements pa

               age <75

                age >74

 

Best Estimate Assumption

 

See Note 2

 

  10.0%

 

 

  2.0%

  1.0%

 

20.0%

 

 

  5.0%

  2.5%

 

Total Permanent Disability

 

Best Estimate Assumption

 

20.0%

 

 

50.0%

 

Disability Income

   -  Active Lives

 

Disabled Lives

-  Claims in Payment

 

 

Best Estimate Claims Cost Liability   -  see Note 3

 

Best Estimate Liability

 

40.0%

 

 

20.0%

 

 

80.0%

 

 

35.0%

 

 

Trauma

 

Best Estimate Assumption

 

30.0%

 

60.0%

 

Other Insured Events

 

Best Estimate Assumption

30.0%

60.0%

Voluntary Discontinuance

Best Estimate Assumption

 

25.0%

100.0%

 

Options

Best Estimate Assumption

10.0%

40.0%

 

Take-up Rate on Education Bond Business

 

 

Best Estimate Assumption

 

 

10.0%

 

 

40.0%

 

Investment-Linked Risks

 

Capital Adequacy Liability – see Note 4

 

 0.5%

 

  2.5%

 

 


Notes

 

(1)     In determining the Capital Adequacy Assumption for the Maintenance Expenses component of Servicing Expenses, the margin is to be applied to the greater of the unit costs required to cover:

·      the actual maintenance cost of servicing each policy in the twelve months prior to the valuation date, appropriately adjusted for one-off expenses; and

·      the expected  maintenance costs, on Best Estimate Assumptions, of servicing each policy in the twelve months subsequent to the valuation date.

 

(2)     The allowance for annuitant mortality improvements is applied as a percentage per annum improvement in the Capital Adequacy Assumption used in the first year.

 

(3)     The Claims Cost Liability for disability income policies is the component of the liability for active lives in respect of claims.

 

(4)     This is the Capital Adequacy Liability as determined immediately prior to the inclusion of the margin for investment-linked risks.