GPS 117 Capital Adequacy: Asset Concentration Risk Charge

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About this standard

This standard requires a general insurer or Level 2 insurance group to maintain adequate capital for its asset concentration risks. General insurers and Level 2 insurance groups must have processes to maintain this capital in line with their business complexity and risk profile. This standard supports GPS 110 Capital Adequacy, which is a core standard in the Financial Resilience Pillar. It applies to all general insurers and Level 2 insurance groups.

Objectives and key requirements of this Prudential Standard This Prudential Standard requires a general insurer or Level 2 insurance group to maintain adequate capital against the risks associated with asset concentration in its activities. The ultimate responsibility for the prudent management of capital of a general insurer or Level 2 insurance group rests with its Board of directors. The Board must ensure that the general insurer or Level 2 insurance group maintains an adequate level and quality of capital commensurate with the scale, nature and complexity of its business and risk profile, such that it is able to meet its operations under a wide range of circumstances. The Asset Concentration Risk Charge is the minimum amount of capital required to be held against asset concentration risks. The Asset Concentration Risk Charge relates to the risk of concentration in exposures to a particular asset, counterparty or group of related counterparties resulting in adverse movements in the general insurer’s or Level 2 insurance group’s capital base. This Prudential Standard sets out the method for calculating the Asset Concentration Risk Charge. This charge is one of the components of the Standard Method for calculating the prescribed capital amount for general insurers and Level 2 insurance groups.

Preamble

Insurance (prudential standard) determination
No. 7 of 2023
Prudential Standard GPS 117 Capital Adequacy: Asset Concentration Risk Charge Insurance Act 1973 I, Helen Rowell, a delegate of APRA :
under subsection 32(4) of the
Insurance Act 1973
(the Act), revoke Insurance (prudential standard) determination No. 4 of 2022, including Prudential Standard GPS 117 Capital Adequacy: Asset Concentration Risk Charge, made under that Determination; and under subsection 32(1) of the Act determine Prudential Standard GPS 117 Capital Adequacy: Asset Concentration Risk Charge , in the form set out in the Schedule, which applies to:
all general insurers and authorised NOHCs; and a subsidiary of a general insurer or authorised NOHC , where that subsidiary is a parent entity of a Level 2 insurance group . This instrument commences on 1 July 2023. Dated: 24 May 2023 [Signed] Helen Rowell Deputy Chair Interpretation In this instrument:
APRA means the Australian Prudential Regulation Authority. authorised NOHC has the meaning given in section 3 of the Act. general insurer has the meaning given in section 11 of the Act. Level 2 insurance group has the meaning given in Prudential Standard GPS 001 Definitions. parent entity has the meaning given in Prudential Standard GPS 001 Definitions. subsidiary has the meaning given in Prudential Standard GPS 001 Definitions.
Schedule
Prudential Standard GPS 117 Capital Adequacy: Asset Concentration Risk Charge, comprises the document commencing on the following page.
Prudential Standard GPS 117
Capital Adequacy: Asset Concentration Risk Charge Authority This Prudential Standard is made under section 32 of the Insurance Act 1973 (the Act).
Application and commencement
This Prudential Standard applies to each:
general insurer authorised under the Act ( insurer ); and Level 2 insurance group as defined in Prudential Standard GPS 001 Definitions ( GPS 001 ).
Where a requirement is made in respect of a Level 2 insurance group, the requirement is imposed on the parent entity of the Level 2 insurance group.
This Prudential Standard applies to insurers and Level 2 insurance groups ( regulated institutions ) from 1 July 2023.
Interpretation
Terms that are defined in
GPS 001 appear in bold the first time they are used in this Prudential Standard.
For the purposes of this Prudential Standard:
‘Eligible Collateral Items’ are cash, government securities or debt obligations (i.e. loans, deposits, placements, interest rate securities and other receivables) where the counterparty has a counterparty grade of 1, 2 or 3 as defined in Attachment C of GPS 001 ; ‘non-reinsurance exposures’ are the on- and off-balance sheet exposures of an insurer or Level 2 insurance group other than exposures to a reinsurer; ‘reinsurance exposures’ are the on- and off- balance sheet exposures of an insurer or Level 2 insurance group to reinsurance assets ; and ‘residual maturity’ is the remaining time until the expiration or the repayment of a financial instrument. Where this Prudential Standard provides for APRA to exercise a power or discretion, this power or discretion is to be exercised in writing. Definitions Two or more counterparties will form a ‘group of related counterparties’ if they are linked by:
cross guarantees; common ownership or management; the ability of a counterparty to exercise control (defined in accordance with the Australian Accounting Standards ) over the other(s), whether direct or indirect; financial interdependency such that the financial soundness of any of them may affect the financial soundness of the other(s); or other connections or relationships that exist between counterparties, that in the regulated institution’s assessment, constitute exposure to the counterparties as a single risk. In respect of any overseas entities within a Level 2 insurance group carrying on international business , identification of asset or counterparty exposures is to be carried out on a best endeavours basis using information held by entities within the Level 2 insurance group, or otherwise publicly available information, in a manner consistent with the group’s documented risk management policies. For the purposes of the limits in respect of non-reinsurance exposures in Attachment A, exposures are classified depending on whether or not the counterparty is APRA-regulated or part of an APRA-regulated group. A counterparty meets this requirement if the specific counterparty or its ultimate parent is:
authorised by APRA under the Act as a general insurer or authorised NOHC ; or authorised by APRA under the Banking Act 1959 as an authorised deposit-taking institution (ADI) or authorised NOHC of an ADI; or registered by APRA under the Life Insurance Act 1995 as a life company or authorised NOHC of a life company. For the purposes of the limits in Table 2(c) of Attachment A, exposures are classified as either short-term or long-term. ‘Short-term’ means a residual maturity of less than or equal to one year. ‘Long-term’ means perpetual or a residual maturity of greater than one year. subsidiary subsidiary has the meaning given in Prudential Standard GPS 001 Definitions.

Asset Concentration Risk Charge principles

This Prudential Standard sets out the method for calculating the Asset Concentration Risk Charge for a regulated institution using the Standard Method to determine its prescribed capital amount .

The Asset Concentration Risk Charge relates to the risk of a regulated institution’s concentrations in exposures to a particular asset, counterparty or group of related counterparties resulting in adverse movements in the regulated institution’s capital base .

For the purposes of the Asset Concentration Risk Charge, exposures include all on- and off-balance sheet exposures of the regulated institution. On-balance sheet exposures of the institution should be net of any regulatory adjustments expressly related to the item that are required under Prudential Standard GPS 112 Capital Adequacy: Measurement of Capital .

All exposures should be converted to Australian dollars (AUD) as at the reporting date.

The portion of any exposure which is subject to the Asset Concentration Risk Charge must not be subject to the Asset Risk Charge as defined in Prudential Standard GPS 114 Capital Adequacy: Asset Risk Charge . The portion of any exposure which is not subject to the Asset Concentration Risk Charge must be subject to the Asset Risk Charge.

If a look-through basis has been used for assets under GPS 114 , the same look-through basis must be used for the purposes of this Prudential Standard.

For
Category C insurers
, the Asset Concentration Risk Charge must be applied to the assets in Australia only of the Category C insurer, consistent with reporting standards made under the Financial Sector (Collection of Data) Act 2001 .

Asset Concentration Risk Charge calculation

The Asset Concentration Risk Charge for each exposure of a regulated institution to a particular asset, counterparty or group of related counterparties is the amount by which this exposure exceeds the limits set out in Attachment A. Separate treatment applies for reinsurance exposures and non-reinsurance exposures . A differing treatment also applies for collateral, guarantees and reinsurance recoverables due from non-APRA-authorised reinsurers as set out in paragraphs 22 to 34.

non-reinsurance exposures

‘non-reinsurance exposures’ are the on- and off-balance sheet exposures of an insurer or Level 2 insurance group other than exposures to a reinsurer;

For non-reinsurance exposures to unrelated parties that are part of an APRA-regulated group (Table 2(c) of Attachment A), the Asset Concentration Risk Charge is calculated as the maximum amount after applying each of the sub-limits to the relevant exposures.

In the case of reinsurance exposures (both on-balance and off-balance sheet) to a group of related counterparties, exposures need to be compared and aggregated against each of the limits in Table 1 of Attachment A. This means that:

reinsurance exposures within the group that have a counterparty grade of 5 or below are compared to the limit (Table 1(c)) and an amount is determined;

reinsurance exposures of grade 5 and below that are not part of the calculation in sub-paragraph (a) are then added with those with a counterparty grade of 4 and compared to the limit (Table 1(b)), and a further amount is determined; and

reinsurance exposures of grade 4 and below that are not part of the calculation in sub-paragraphs (a) or (b) are then added to those with a counterparty grade above 4 and compared to the limit (Table 1(a)).

The total Asset Concentration Risk Charge for the reinsurance exposure is the sum of the amounts from each sub-paragraph above.

The total Asset Concentration Risk Charge is the sum of each resulting risk charge for each exposure of the regulated institution.

Treatment of collateral and guarantees as risk mitigants

A regulated institution that holds certain types of collateral against an asset, or where the asset has been guaranteed, as a means of reducing risk may apply a different approach to determining the Asset Concentration Risk Charge for that asset. Where the assets in question are reinsurance recoverables due from non-APRA-authorised reinsurers, different rules regarding treatment of collateral and guarantees apply (refer to paragraphs 28 to 34).

Collateral

Subject to paragraph 24, where a regulated institution possesses eligible collateral against an asset (other than reinsurance recoverables due from non-APRA-authorised reinsurers), it may treat the underlying asset as an exposure to the Eligible Collateral Item. This means that the asset is included in the limits in Attachment A with respect to the collateral, rather than the underlying counterparty.

For the purposes of paragraph 23, collateral is recognised only to the extent that it takes the form of a registered charge, registered mortgage or other legally enforceable security interest in, or over, an Eligible Collateral Item. Eligible Collateral Items are cash, government securities, or debt obligations (i.e. loans, deposits, placements, interest rate securities and other receivables) where the counterparty has a counterparty grade of 1, 2 or 3. The Eligible Collateral Item must be held for a period not less than that for which the asset is held.

Eligible Collateral Items

‘Eligible Collateral Items’ are cash, government securities or debt obligations (i.e. loans, deposits, placements, interest rate securities and other receivables) where the counterparty has a counterparty grade of 1, 2 or 3 as defined in Attachment C of GPS 001 ;

Where the fair value of the collateral does not cover the full value of the asset, the collateral counterparty rating can only replace that part of the asset that is covered by the collateral. The remaining portion of the asset must be treated as an exposure to the underlying counterparty.

Guarantees

Subject to paragraph 27, where a regulated institution possesses an asset (other than reinsurance recoverables due from non-APRA-authorised reinsurers) that has been explicitly, unconditionally and irrevocably guaranteed for its remaining term to maturity by a guarantor with a counterparty rating (or for governments, the long-term foreign currency credit rating) of grade 1, 2 or 3, it may treat the underlying asset as an exposure to the counterparty providing the guarantee. This means that the asset is included in the limits in Attachment A with respect to the guarantee, rather than the underlying counterparty.

Guarantees provided to a regulated institution by its own parent or a related entity are not eligible for the treatment provided for in paragraph 26.

Reinsurance recoverables due from non-APRA authorised reinsurers

Collateral

Subject to paragraphs 29, 30 and 33, where a regulated institution possesses eligible collateral in Australia against reinsurance recoverables due from a non-APRA-authorised reinsurer, it may elect to treat the reinsurance recoverable as an exposure to the eligible collateral. This means that the asset is included in the limits in Attachment A with respect to the collateral, rather than the underlying reinsurer.

For the purposes of paragraph 28, eligible collateral is recognised only:

to the extent that it takes the form of:

assets held in Australia which form part of a trust fund maintained by a trustee resident in Australia;

deposits held by the regulated institution in Australia made by the non-APRA-authorised reinsurer;

a combination of the two forms of collateral specified in sub-paragraphs (i) and (ii); or

any other form of collateral as may be approved by APRA in a particular case;

if it provides effective security against liabilities arising under the reinsurance contract; and

if it is not available for distribution to creditors of the reinsurer other than the institution in the event of insolvency of the reinsurer.

Where the fair value of the collateral does not cover the full value of the reinsurance recoverables, only the part of the value of the reinsurance recoverables that is covered by collateral may be assigned the counterparty grade of the collateral. The remaining portion of the reinsurance recoverable must be treated as an exposure to the underlying reinsurer.

Guarantees

Subject to paragraph 33, where a regulated institution possesses a guarantee or letter of credit in respect of the reinsurance recoverables due from a non-APRA-authorised reinsurer, it may elect to treat the reinsurance recoverables as an exposure to the guarantor or the issuer of the letter of credit (as applicable). This means that the asset is included in the limits in Attachment A with respect to the guarantor or issuer of the letter of credit, rather than the underlying reinsurer. This paragraph applies only if:

the guarantor or issuer of the letter of credit is an ADI or, in the case of a Category E insurer , its parent entity or other related entity provided the entity has a counterparty rating of grade 1, 2 or 3;

the guarantee or letter of credit is explicit, unconditional and irrevocable;

the guarantor or issuer of the letter of credit is obliged to pay the institution in Australia; and

the obligation of the guarantor or issuer of the letter of credit to pay the institution is specifically linked to performance of the reinsurance contract or contracts under which the reinsurance recoverables arise.

Except in the case of a Category E insurer, a guarantee or letter of credit provided to a regulated institution by its parent entity or other related entity is not eligible for the treatment provided for in paragraph 31.

The collateral, guarantee or letter of credit referred to in paragraphs 28 and 31 must be effective for the expected period for payment of claims under the reinsurance contract under which the reinsurance recoverables arise. If this is impractical, the collateral, guarantee or letter of credit must be effective for a period of at least 24 months but be renegotiable each year to allow at least 12 months to identify alternative arrangements if the collateral, guarantee or letter of credit cannot be renegotiated.

A regulated institution may elect to not apply the treatment for reinsurance recoverables from non-APRA-authorised reinsurers in paragraphs 28 and 31 and instead apply the counterparty grade of the non-APRA-authorised reinsurer in order to determine the Asset Concentration Risk Charge. APRA may require a institution to apply a specified treatment to reinsurance recoverables from non-APRA-authorised reinsurers supported by collateral, guarantee or letter of credit, rather than the treatment that would otherwise apply under this paragraph.

Adjustments and exclusions

A regulated institution may apply to APRA to vary the application of the limits in Attachment A. In deciding whether to grant the application, APRA will have regard to the type of exposure, the term of the exposure, the ability for the institution to mitigate the Asset Concentration Risk Charge by other means and any other matters which APRA considers relevant. APRA may grant approval for such variation subject to conditions and may specify any period of time for such variation.

APRA may adjust or exclude a specific requirement in this Prudential Standard in relation to a regulated institution.

Previous exercise of discretion

A regulated institution must contact APRA if it seeks to place reliance, for the purposes of complying with this Prudential Standard, on a previous exemption or other exercise of discretion made by APRA under a previous version of this Prudential Standard.

Attachment A – Asset exposure limits

This attachment sets out the Asset Concentration Risk Charge limits for exposures to single assets, counterparties and groups of related counterparties.

Table 1: Reinsurance exposures

Exposure – reinsurance counterparty or group of counterparties AUD limit (a) Exposures to reinsurers with a counterparty grade of 1, 2 or 3 No limit (b) Exposures to reinsurers with a counterparty grade of 4 50% of capital base (c) Exposures to reinsurers with a counterparty grade of 5, 6 or 7 25% of capital base

Table 2: Non-reinsurance exposures

Exposure – asset, counterparty or group of counterparties AUD limit (a) Governments with a counterparty grade 1 or 2 [1] No limit (b) Related parties that are APRA-regulated or part of an APRA-regulated group [2] Greater of $22.5 million and 100% of capital base (c) Unrelated parties that are APRA-regulated or part of an APRA-regulated group [3] :
Short-term exposures
[4]
Long-term exposures
[5]
Total exposure
Greater of $22.5 million and 100% of capital base Greater of $11.2 million and 50% of capital base Greater of $22.5 million and 100% of capital base (d) All other exposures 25% of capital base

[2]

As defined in paragraph 9 of this Prudential Standard .