APRA’s reinsurance requirements and the use of insurance linked securities 

TO: ALL GENERAL INSURERS  

APRA recognises the significant benefit that reinsurance provides to Australian insurers and policyholders. APRA is also aware that the reinsurance market has been challenged by a range of factors which include increased natural catastrophes, the war in Ukraine, and the COVID-19 pandemic. As a result, higher premiums and increased retentions are being observed.  

It is in this context that APRA is seeking to remind insurers that in addition to traditional reinsurance, APRA standards permit the use of alternative reinsurance arrangements, such as catastrophe bonds and other types of Insurance Linked Securities (ILS), in the calculation of the insurance concentration risk charge (ICRC).  

In the current reinsurance environment, insurers may wish to consider both traditional and ILS options. Insurers considering ILS options should engage with APRA early (prior to a formal approval request) to discuss their feasibility and potential impact on the insurer’s ICRC.  

APRA’s reinsurance requirements and the use of ILS under the prudential framework 

APRA’s reinsurance requirements and expectations are primarily set out in Prudential Standard GPS 116 Capital Adequacy: Insurance Concentration Risk Charge (GPS 116) and Prudential Practice Guide GPG 116 Insurance Concentration Risk (GPG 116).  Further details are provided at Appendix A. 

GPS 116, and specifically its reinstatement requirements for catastrophe reinsurance, favour traditional reinsurance solutions. These have predominately been the option adopted by Australian insurers. There has been little participation in Australian reinsurance by ILS markets, and the use of catastrophe bonds, which is a common form of ILS, is rare.  

While favouring traditional reinsurance, GPS 116 does permit the use of catastrophe bonds and other forms of ILS which may not have a reinstatement. For these to be approved, the insurer must demonstrate to APRA why their use is practical and appropriate.   

While traditional reinsurance arrangements will remain an integral part of an insurer’s overall reinsurance strategy, we recognise the benefit to considering a range of reinsurance solutions. Any ILS options, such as catastrophe bonds, will be carefully assessed by APRA to understand the impact on the ICRC. As previously noted, we encourage insurers to engage with APRA early and prior to any formal approval request when considering these. 

To ensure reinsurance requirements remain fit-for-purpose, APRA intends to review the reinsurance settings in the prudential framework over the course of 2023 and the first half of 2024. Industry input will be sought and considered in relation to any potential changes.  

Yours sincerely, 

Suzanne Smith 
Executive Board Member 

Appendix A: APRA’s requirements and guidance 

Set out below are some relevant requirements and guidance if considering the use of ILS, and reinsurance programs that do not have a reinstatement, in the calculation of the ICRC.  

Prudential Standard GPS 116 Capital Adequacy: Insurance Concentration Risk Charge  

Paragraph 15  

Subject to paragraph 16, an insurer must have at the inception date of its catastrophe reinsurance program, a contractually agreed reinstatement, of its catastrophe reinsurance arrangements that reduces its natural perils vertical requirement (determined in accordance with paragraph 18). An insurer with multiple inception dates for its catastrophe reinsurance program must consult with APRA to determine the approach to the relevant inception date in this paragraph. 

Paragraph 16 

An insurer that does not have a contractually agreed reinstatement of its catastrophe reinsurance program as required by paragraph 15 must demonstrate to APRA that it is not practical or appropriate given the nature of its reinsurance arrangements. The insurer must set out its approach to the placement of reinstatement of cover in its Reinsurance Management Strategy (ReMS). If APRA is not satisfied with the approach taken by the insurer, APRA may apply a supervisory adjustment to the prescribed capital amount in accordance with paragraph 35 of Prudential Standard GPS 110 Capital Adequacy (GPS 110). 

Paragraph 54 

If an insurer is considering the use of protections including alternative capital or risk mitigants to reduce the Insurance Concentration Risk Charge, the insurer must apply to APRA for approval to include that mitigant in the calculation of the Insurance Concentration Risk Charge. This includes, but is not limited to, the use of securitisation and catastrophe bonds. 

Prudential Practice Guide GPG 116 – Insurance Concentration Risk  

Paragraph 72 

APRA expects an insurer to take appropriate measures to ensure the reinsurance program placed contains the required contractually agreed reinstatement. There may, however, be circumstances where the insurer has not placed this requisite reinstatement. These circumstances could include:  

a) non-availability of cover for a particular layer(s) of the overall program, whether for the first or subsequent events;  

b) where cover is available but at a commercially unacceptable cost;  

c) use of reinsurance cover that only protects the insurer’s capital position for the first event and a reinstatement is not readily available or too expensive; and  

d) use of non-traditional reinsurance placements (such as catastrophe bonds or capital market structures) 

Paragraph 73 

GPS 116 requires an insurer that does not have the required reinstatement to demonstrate to APRA why it is not practical or appropriate given the nature of the reinsurance arrangements. Where an insurer has not placed reinsurance with a contractually agreed reinstatement, APRA expects the insurer to:  

a) document the layer(s) that do not have a contractually agreed reinstatement and the circumstances and rationale for not placing the reinstatement;  

b) document the capital implications of the lack of an agreed reinstatement after the first large event, and how the insurer will either fund the purchase of additional reinsurance in the prevailing market conditions post the large event, or provide capital to meet the exposure created by the absence of the reinsurance cover for a future large loss; and 

c) demonstrate the Board has considered the additional risk and the resulting capital implications and has approved and documented that it is within the insurer’s risk appetite.  

This demonstration could be included in the Reinsurance Arrangements Statement or other internal documents.