The Minister for Financial Services & Regulation, Joe Hockey, today announced a major reform of the regulatory framework for the general insurance industry that will significantly modernise the prudential supervision of general insurers and enhance the protection of Australian policyholders.
"These reforms will create a more flexible and consistent regulatory regime able to respond to changes in market conditions," the Minister said. "They will place Australia at the forefront of international best practice, underpinning our status as a global financial centre."
The current prudential framework for general insurers has remained largely unchanged since the inception of the Insurance Act 1973 (the Act) 27 years ago. The Act is highly prescriptive and the prudential arrangements contained in it are now considered blunt and unresponsive in the face of market and regulatory developments that have transformed the financial sector over recent years.
It is proposed to restructure the Act to provide the Australian Prudential Regulation Authority (APRA) with the authority to make standards under the Act. This will enable the regulator to be more responsive to market developments. The new framework would be three-tiered: at the top would be the Act containing the high level prudential principles; underneath would sit the Prudential Standards; and below that a set of guidance notes.
This new standards-making power will be consistent with similar powers conferred on APRA under the Banking Act 1959 and the Life Insurance Act 1995. This is consistent with the approach of the Financial System Inquiry (Wallis Report), which argued for greater consistency in the supervisory regimes across regulated financial service providers.
The Minister said the Governments decision is consistent with the recommendations made in APRAs Policy Discussion Paper Proposed Reforms to the Prudential Supervision of General Insurance Companies in Australia (April 2000).
APRA will be conducting ongoing consultations with stakeholders to develop a set of standards that have regard to good commercial practice and cost-benefit considerations while ensuring policyholders are adequately protected. The Minister said the standards are not expected to be finalised until next year.
In recognition of the fundamental nature of these reforms, it is proposed that transitional provisions be inserted into the Act to enable the new requirements to be phased in over time. In the case of regulatory capital, it is proposed that insurers will have up to five years from the commencement of the new requirements to comply.
Following reform to the Act, it is expected APRA will implement four prudential standards covering: Capital Adequacy; Liability Valuation; Reinsurance Arrangements; and Risk Management. These standards will replace the outdated prudential supervisory requirements currently contained in the Act itself.
The Capital Adequacy Standard will replace the current blunt solvency tests under the Act with a more risk responsive regime that better aligns capital requirements with each institutions individual risk profile. In addition, the minimum level of capitalisation for general insurers will be increased from $2 million to $5 million. This floor requirement is designed to ensure that all insurers have sufficient resources to put in place appropriate systems to control minimum levels of risk.
The Liability Valuation Standard is designed to improve the consistency of valuation of insurance liabilities across insurance companies. This will improve the ability of the market to adequately assess the risk-adjusted strength and ranking of each company. The Standard will require most general insurers to consult with an actuary in determining the value of their provisions for insurance liabilities. This will improve the objectivity and reliability of these provisions.
The Reinsurance Arrangements Standard will make general insurers more accountable for their own reinsurance arrangements and will require insurers to have in place a reinsurance management strategy tailored to the size, complexity and mix of their business.
The Risk Management Standard will contain new measures to improve the internal governance of general insurance companies and to encourage best practice.
Guidelines on the requirements for authorisation of new insurers under the Act will also be issued by APRA.
If all necessary legislative amendments are in place by July 2001, it is proposed the arrangements would begin in July 2002. A further two-year transition period would be provided to the industry before widespread compliance is required and incumbent insurers would have to 2007 to meet the proposed minimum capital requirements.
"I welcome continued consultation with stakeholders on the proposed reforms", the Minister said. "I encourage all stakeholders to continue to provide their comments to APRA as the process proceeds."