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AASB 17 and the LAGIC Solvency Framework

General Insurers’ activities and opportunities

With APRA’s engagement with industry around AASB 17 ramping up, the 2021 calendar year will be key for insurers and reinsurers to shape how AASB 17 requirements will interact with APRA’s financial reporting and LAGIC solvency calculations. This period also presents an opportunity for the industry to consult APRA on areas that reduce operational impacts of the change.

This blog outlines the key changes and implications for General Insurers from updates to APRA’s prudential framework as a result of AASB 17 with a focus on potential changes in capital calculations.

Below are the top five capital/solvency proposed changes that General Insurers need to be aware of:

APRA is proposing additional regulatory adjustments to the capital base to minimise impact from AASB 17 changes on the capital base as follows:

  • A liability adjustment: This being the difference between the GPS 340 liabilities and the aggregate of AASB 17 insurance and reinsurance liabilities (after deducting AASB 17 insurance and reinsurance assets).
  • Additions to Common Equity Tier 1 (CET1) capital when determining the capital base in relation to insurance contracts in place that have premiums not received and premiums due but yet to be invoiced (for exposures within premium liabilities and unclosed business).
  • Reinsurance related deductions to CET1 capital related to reinsurance contracts in place at balance date which have reinsurance premiums not paid and expected reinsurance payables (relating to premium liabilities projection period and unclosed business).
  • Additions to Asset Risk Charge (ARC) related to specific receivables.
  • Continuation of recognising deferred tax benefits from the liability adjustment to the extent that there is an offsetting deferred tax liability.

These will impact the LAGIC capital base calculation processes and the effects need to be understood for the specific GI product groups.

APRA is reviewing the dollar value exposure limits built into LAGIC such as those relating to ACRC (GPS 117). APRA is proposing to factor in inflation and introduce an indexation mechanism to the dollar exposure limits to futureproof the requirement. This is a sensible proposal and will benefit insurers who regularly reach the ACRC dollar limits merely through inflationary growth in their asset concentrations.

Since the introduction of LAGIC in 2013, RBA’s inflation calculator on a representative basket of goods estimates a 14% increase in costs (up until end of 2019). This change is expected to be higher allowing for elapsed time until the new prudential standards are introduced. General Insurers may wish to consider discussions with APRA around the inflation mechanism for ACRC limits and the factors that will flow into this mechanism by class of business (e.g. CPI vs. AWE vs. Other).

APRA is proposing to require all insurers to use the standard method and will remove the option to use an Internal Capital Model (ICM) for calculating regulatory capital.

We note that a range of insurers have continued to develop and use economic capital modelling for a variety of business uses (pricing, reinsurance design, Asset-Liability Matching etc) but not for APRA solvency calculations perspective.

APRA has indicated that in the majority of cases, costs of using an ICM outweighed the benefit of adopting it for APRA LAGIC purposes in terms of management time and prescribed capital amounts saved. Whilst this reduces options available to insurers, it won’t in our view, change management outcomes in terms of managing to both economic and regulatory capital views for a variety of business and regulatory purposes.

APRA is proposing to explicitly require General Insurers to deduct the difference between fair value and reported value of assets, for the purposes of determining the capital base.

Currently under GPS 114, APRA requires that the stress tests informing the asset risk charge should be applied to the fair value of assets. However, this is not explicitly reflected in GPS 112 (Measurement of Capital).

This change may not have significant impacts on General Insurers who already use fair value of assets when determining LAGIC elements, however, APRA is seeking feedback on where there are situations where General Insurers are not using fair value.

APRA is reviewing whether the current risk charges are appropriate, and what the potential alternatives could be. We view that this could impact General Insurers who have high levels of reinsurance support such as whole of account quota shares and where the operational risk charge can be a prominent element of the PCA (given that operational risk charge is calculated on the gross position).

General Insurers may benefit from consultation with APRA around this area of the risk charges, particularly as operational risk is generally more effectively dealt with via appropriate and robust preventative governance and controls frameworks rather than holding capital.