With the flood of recent natural disasters, APRA has clarified the type of aggregate reinsurance arrangements that require its approval. Accordingly, it is timely for insurers to review their reinsurance arrangements to determine whether such approval is required.
In recent years, Australia and New Zealand have amply demonstrated their propensity for catastrophic losses flowing from natural hazards. This is in contrast to a period of relatively benign North American weather conditions rendering the global market awash with capital.
Given the local exposure, reinsurance remains one of the key weapons in the armoury of APRA regulated insurers to manage and protect capital. While insurer retentions on reinsurance programs have gradually been creeping up, protection against catastrophic losses remains critical and a variety of mechanisms have been developed to address catastrophe exposure while retaining more everyday risk.
One such mechanism is aggregate cover with drop-down retentions for multiple losses.
In this regard, APRA has recently provided guidance on the treatment of aggregate reinsurance cover for the purpose of an insurer’s insurance concentration risk charge under Prudential Standard GPS116 Capital Adequacy: Insurance Concentration Risk Charge.
GPS 116 provides that aggregate reinsurance includes:
- aggregate reinsurance cover that protects the regulated institution from an accumulation of retained losses from multiple events of a certain size; and
- aggregate stop–loss reinsurance cover that protects the regulated institution from an accumulation of retained losses from multiple events on a part or totality of its portfolio.
GPS116 requires an insurer to apply to APRA if it wishes to recognise potential reinsurance recoverables from aggregate reinsurance cover for the calculation of its natural perils vertical requirement. GPS116 also permits an insurer to adjust the natural perils horizontal requirement for potential recoverables from aggregate reinsurance where the methodology of doing so is agreed by APRA.
Despite increased retentions, as noted above, some contracts contain clauses that allow for the retention to be reduced for a second or subsequent loss occurrence (often referred to as “drop-down” or “subsequent event retention” clauses). This is particularly prevalent for property catastrophe excess of loss reinsurance contracts.
APRA has clarified that such drop-down covers will be considered an aggregate reinsurance arrangement requiring APRA approval for the purpose of GPS116. Whatever title may be given to the reinsurance contract, if it operates as aggregate reinsurance cover as defined in GPS116, APRA approval will be necessary.
It is therefore timely for insurers to review their reinsurance arrangements to identify any aggregate contracts requiring APRA approval.
The recent guidance demonstrates APRA’s desire to retain strict control and knowledge of the way insurers treat reinsurance recoverables for the purpose of their capital requirements. Although obtaining APRA approval is not likely to be controversial, it adds a further layer of regulatory control for such arrangements.
Nevertheless, in a world of natural hazards, APRA would no doubt argue that one cannot be too careful.