New Health insurance capital standards

As if life and general insurance capitals changes weren’t enough, PHIAC has released an initial consultation paper on changes to health insurance standards. In this guest post,  health actuaries David Torrance and Ben Ooi have more:

PHIAC has released a Capital Standards Review Consultation Package with responses due by 1 October 2012. Included in the package are:

• Consultation Paper, which gives a high-level overview of the case for change and explains some of the likely impacts of the changes on insurers,
• Technical Annexure, which provides detail of the specific changes, and how they would improve the performance of the Standards, and
• Quantitative Impact Study (QIS) (link is excel download) – which seeks each insurer’s input to assist in quantification of the changes across the industry.

Without stating it explicitly, a number of the proposed changes are not dissimilar to those being made by APRA for the life insurance and general insurance industries. PHIAC will require a comprehensive new way of calculating the capital adequacy requirement (the stress test). The stress test required (to replace the renewal option reserve and the resilience reserve in the capital adequacy requirement) will include risk margins appropriate to the insurer.

The new capital adequacy requirements will be complicated to calculate and highly subjective as they will require stochastic modelling of the fund over an 18 month period, requiring assumptions about probability distributions for claims, expenses and investment income. While this may be appropriate for internal capital modelling and internal capital targets, it is quite complex for prudential capital, particularly for small insurers. This is a significant change and will require significant actuarial input initially and potentially each quarter to complete the statutory PHIAC 2 Return.

Three stress tests need to be performed:

• 3 months for solvency purposes.
• 12 months for capital adequacy purposes.
• 18 months to see if an Appointed Actuary’s report is required.

A supervisory adjustment can be added by PHIAC where they consider the standard does not address the risks associated with an insurer’s operations.

In addition, there is an explicit inclusion of an allowance for operational risk. As the amount of this requirement is based on the average of last year’s actual and next year’s forecast gross growth rate, it is not really a charge for operational risk, but an additional charge for funds that are growing.

A Board endorsed capital management policy will be required to be submitted to PHIAC. Some of the components of this policy are similar to the APRA requirements of its Internal Capital Adequacy Assessment Process and will require substantial work and Board input and ownership (e.g. determination of an appropriate risk appetite).

Some other changes include a change of intent for the solvency standard to be more of a liquidity standard. There are also some changes to the percentages allowed for Admissible Assets.

From our initial review of the consultation paper, we are likely to make comment on a number of technical aspects of the proposed standards including:

• The appropriateness of the level of sufficiency at 95% to 99%. There is a material difference between the capital required for a 95% level of sufficiency and a 99% level of sufficiency. At a 95% level of sufficiency, statistically at least 1 insurer would fail the capital adequacy requirement each year. We note that APRA targets a 99.5% level of sufficiency.
• Allowing for dividends in determining the capital requirements.
• Taking into account the specific asset holdings of subsidiaries in assessing concentration risk.
• The definition of “industry benefit inflation” to be adopted in determining appropriate premium increases under the stress test. At face value this appears to be an inappropriate metric to adopt for these purposes.
• The lack of diversification factors.
• The definition of growth in the operational risk capital requirement.

PHIAC requires comments by 1 October 2012 and seeks each insurer’s input to assist in quantification of the changes across the industry via the Quantitative Impact Study (QIS). As noted above, determining the impact of these changes is not straightforward and will require significant analysis and modelling to determine appropriate probability distributions for each of the risks, and then aggregate them in a rigorous way.

The current intent is for final standards to be released in June 2013, which is significantly faster than the process that APRA has used for life and general insurers.