1 APRA & Developments in General Insurance Robert Thomson Monday 13 September 2004

2 Today My Background APRA – some history APRA’s mission and role New GI regime

3 My Background Macquarie University Worked in life insurance field (Australia & NZ) in variety of actuarial roles Joined regulator in 1998 Mostly doing general insurance work now Also studying law

4 APRA – some history Formed 1 July 1998 Resulted from the recommendations of the Wallis Inquiry Need for greater consistency of regulatory approach

5 Pre-APRA Supervision Reserve Bank of Australia (RBA) –Banks Insurance & Superannuation Commission (ISC) –Insurers (both life and general) –Superannuation funds State government based regulators –Credit unions, building societies –Friendly societies

6 Post-APRA Supervision Parliament Ministry Reserve Bank RBA Board APRA Members APRA Australian Securities & Investments Commission  Monetary Policy  Systemic Stability  Payment Systems  Prudential Regulation  deposit taking  insurance  superannuation  M arket integrity  Consumer protection  Corporations

7 APRA’s Mission Establish and enforce prudential standards and practices designed to ensure that: -under all reasonable circumstances; -financial promises made by institutions are met; -within a stable, efficient and competitive financial system

8 APRA’s Role APRA is the prudential regulator for the Australian financial system APRA covers around 85% of the assets in the Australian financial system This is approximately $2,000,000,000,000!

9 Prudential Regulation? Prudential regulation is basically the promotion of prudent management of financial institutions: -Aiming to ensure that institutions have high quality systems for identifying, measuring and managing their risks -Setting standards (including capital requirements) with the aim of maximising the likelihood that institutions will remain financially sound and able to honour their commitments -Developing future policy for financial services

10 General Insurance An industry where APRA has introduced significant changes to the level of prudential oversight: -Governance -Risk management -Capital requirements -Liability valuation methods

11 New GI Actuarial Regime Commenced 1 July 2002 Requires all general insurers (with some exceptions) to have an Approved Actuary Provides a framework for consistent and realistic valuations of liabilities, both: -Outstanding Claims Liabilities -Premium Liabilities

12 New GI Actuarial Regime Area of increasing complexity Scope for significant research and theoretical development work Growing demand for actuaries

13 Outstanding Claims Liabs Amount required for claims that have already occurred but are outstanding at the balance date: -Known claims not yet paid -Incurred but not reported claims (IBNR)

14 Premium Liabilities Amount required for claims that will occur: -After the balance date -Under policies where the risk exposure has not yet expired at the balance date

15 Short Tail Classes Relatively quick notification of claims: -Cars, homeowners -Unpaid claims can be estimated with high degree of accuracy

16 Long Tail Classes Much slower notification of claims: -Workers’ compensation, public liability, professional indemnity -Claims estimation much more uncertain, due to additional factors of lack of data; superimposed inflation; claims handling costs

17 Calculation APRA’s Prudential Standard GPS210 requires actuaries to use a two step methodology: -Central estimate; plus -Risk margin

18 Central Estimate Reflects the mean of the range of likely outcomes of the claims distribution for the class of business Probability of sufficiency of 50% Neither an optimistic nor a pessimistic estimate

19 Risk Margin Additional amount added to the central estimate Safety margin to increase the probability of sufficiency beyond 50% GPS210 requires a risk margin sufficient to increase the probability of sufficiency to 75% (at the total portfolio level, allowing for diversification among lines of business)

20 Factors affecting Risk Margin Robustness of claims models Volume and reliability of data Past experience (either insurer or industry) Characteristics of the line of business

21 Example Estimate the amount of money you will spend on petrol next year -What variables affect the result? -What assumptions will you make? -How do you estimate the probability of sufficiency of your estimate? -There can be many reasonable results, depending upon the assumptions used

22 APRA’s role? To assess the work of the Approved Actuary for each insurer To monitor industry-wide practices relating to central estimates and risk margins To carry out research on current and future developments To liaise with other regulators