Circular No 07/27

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Circular No 07/27

Contact Officers:
 Chris Richardson (02) 6215 7901
email: chris.richardson@phiac.gov.au

Replaces Circular: NA

22 October 2007

PDF Format:

Circ 07/27
HEALTH BENEFITS FUND ASSETS - ASSURANCE AND DISCLOSURE REQUIREMENTS

This circular is one of a number that PHIAC expects to release covering the application of the prudential framework for private health insurers.

This circular emphasises the need for insurers to make regular informed assessments of the characteristics of the assets of their health benefits fund(s) consistent with sound business practice and legislative requirements and introduces modified reporting requirements for insurers.

Private health insurers will be aware of media coverage highlighting liquidity issues which have impacted some fund investments. The press has reported a lack of liquidity in some sectors flowing from defaults in the US securities market, particularly associated with some mortgage backed securities (e.g., Collateralised Debt Obligations).

These events highlight the critical importance of asset assessments in determining the actual or potential impact that investment and allocation issues have on the business of the health benefits fund. The failure to undertake regular informed assessments could potentially lead to cash flow deficiencies that result in the suspension of benefit payments and require regulatory intervention. For example, a lack of liquidity in the market could mean that insurers are unable to realise the balance sheet value of certain investments - a forced sale of these investments could lead to a significant reduction in their realisable value.

PHIAC seeks to ensure that insurers have adopted and applied sound business practice in relation to the management of their assets, that insurers are appropriately applying the Solvency and Capital Adequacy Standards, and that appropriate disclosures are made.

PHIAC expects that:

  • The insurer has in place an investment policy that appropriately addresses matters such as the investment objectives of each health benefit fund it operates, the risk tolerance and the types of assets in which the fund can invest.

  • The investment policy is consistent with the requirements of section 137-20 of the Private Health Insurance Act, 2007.

  • Assessments of the assets of each health benefits fund are made to determine the likelihood and potential impact on the business of the health benefits fund of the risks to which the fund is exposed, including any underlying exposure. This assessment includes consideration of risks such as:

    • Asset/liability mismatching, particularly in respect of the assets backing the insurance liabilities and additional prudential capital requirements.

    • The overall distribution of assets vis-à-vis asset class, duration, range of individual assets.

    • Credit / counterparty risk (e.g. investment grade).
      Liquidity risk (including degree of market activity and realisation risks).

    • Volatility risk (e.g. risk of significant short term variations to the balance sheet value or risk of changes to future expected cash flows from the asset).

    • Characteristics of individual investments (e.g. financial leverage).

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  • Where investment or fund managers have been engaged, the risk assessment includes consideration of:

    • investment mandates, risk management statements and audit statements;

    • the credit rating of the investment or fund managed.

  • The assessments have particular regard to the context of the Solvency and Capital Adequacy Standards.

  • The assessments are conducted by persons that are appropriately skilled, experienced and unbiased.

  • The insurer has in place a documented process to track compliance with the investment policy and legislative requirements.

Insurers are reminded that the principles contained in Clauses 8 and 9 of both the Solvency Standard and the Capital Adequacy Standard require that:

  • each insurer regularly review the assets of the fund to ascertain the existence and extent of risk

  • the potential impact of that risk on the business of the fund be assessed, and

  • the insurer reflects that impact in its capital reserves.

PHIAC notes that the current level of disclosure provided by some insurers in their PHIAC 2 returns is not sufficient to identify the nature of the risks to which fund assets are exposed, or whether the Standards have been applied appropriately.

Insurers will be aware that assessment of asset risks is being considered as part of PHIAC’s current review of the solvency and capital adequacy standards. In order to inform this process and to ensure that an appropriate assessment of risk is being applied by insurers in the interim, PHIAC will require each insurer to:

  • provide assurance that the insurer has undertaken a rigorous assessment of the assets of the fund (refer attachment 1), and

  • disclose, to the greatest extent practicable, detail of the assets of the fund and underlying exposure in the PHIAC 2 quarterly report.

    For example, PHIAC expects that pooled investments would be identified by name with the underlying risks separately identified - enhanced cash investments should be sub-categorised to reflect the investment mandate.

PHIAC believes that these additional disclosures can be accommodated with minor amendments to the existing reporting format. PHIAC wishes to avoid the need to significantly change the PHIAC 2 return.

A version of the PHIAC 2 return incorporating these minor amendments is available on the PHIAC website. PHIAC acknowledges the short period to the September reporting deadline. However, insurers are encouraged to use the latest version of the template for the September 2007 quarter returns wherever possible. Insurers that have not used the revised template for the September quarter must provide the declaration as an attachment to the return.