RE: Proposed New Capital Standards

Transcription

1 22 October 2012 Mr Shaun Gath Private Health Insurance Administration Council Level 2, Brisbane Avenue Barton ACT 2600 Dear Shaun, RE: Proposed New Capital Standards CBHS is pleased to submit the results of its quantity impact study ( QIS ) demonstrating the potential impact on our capital and solvency requirements and provide some comments and observations resulting from the QIS process. A separate response to PHIAC s invitation to comment generally on the proposed new Capital Standards has been provided. CBHS appreciates the strategy being adopted by PHIAC in the proposed capital standards and is supportive of the change. As PHIAC is well aware, over the last 2 years CBHS has placed considerable emphasis on risk management. In this time we have improved the risk management framework, specifically in areas such as operations, systems and investments. Risk management remains a focus for the Board and Management, hence as an organisation we understand the direction being taken by PHIAC. In attempting to interpret the new capital standards we have identified two different methodologies which produce two very different results. After consideration and discussion at our recent Board meeting we have decided to submit a QIS based on each of the two methodologies. This decision is based on the fact that we understand it is round one and hence the more feedback we as an insurer can provide, the easier it will be for your team to address the issues in subsequent rounds. In compiling these results, CBHS staff have noted some issues that we feel could be addressed in any subsequent release of the standard. 1. The current standard, and PHIAC 2 returns, provide details of the elements of the capital charges required by the current standard. This detail allows Management and the Board to appreciate the movement in capital charges. The QIS combines these numbers into one component i.e., Capital Depletion under stress for 12 or 3 months. We would suggest that separating these components would be of benefit to insurers.

2 2. The proposed standard requires a charge for Operational Risk to be calculated. CBHS understands the risk and uncertainty that high growth introduces, however, it is possible that using a growth rate of 6% or more without understanding the type of growth, or its part in the overall strategy, may penalise an insurer that is adopting a responsible strategy. We feel that potentially an assessment by the appointed actuary in the form of a margin may achieve the same outcome. 3. From CBHS perspective the admissible asset rules need further clarity with respect to the treatment of corporate bonds and funds invested in unit trusts. When assessing concentration with unit trusts, what level of analysis should the fund undertake? Is the fund required to perform a detailed look-through? What is required if the unit trust is a fund of funds? Due to the complexity and delays a look through could introduce, CBHS would recommend a simplistic approach, for example a charge based on the size of the unit trust. 4. In developing the model that could cater for the relevant calculations for the proposed standards, CBHS was required to interpret the intention of the standard with respect to the modelling of a 1 in 20 year scenario. CBHS would recommend that the standard provide guidance on the methodology of modelling a 1 in 20 year scenario. 5. Following on from 4 above, the new standard is much less prescriptive than the current standard. Taking on a risk based approach is understandable, however, it leaves a lot of room for varying interpretations by funds. This may lead to inconsistency and increased difficulty in comparing the financial strength of funds. 6. The intention of the new standard is that funds obtain a better understanding of their business by better assessing their risks. CBHS sees a risk that funds may become preoccupied with the modelling and hence the final outcome without necessarily concentrating on the initial intent which is to assess inherent risks of the business. PHIAC may look to adopt a similar model to APRA where funds may choose between using a prescriptive model or its own internally developed model. I understand this is only phase one of the development process for this new standard. CBHS offers the above points for your consideration in the future phases of development. Should you require further clarification on any of the points above or in relation to the CBHS QIS, please do not hesitate to contact Dario Molina (CFO) on Yours Sincerely Paul Gladman CC: Hadyn Bernau and Matthew Crane

3 22 October 2012 Mr Shaun Gath Private Health Insurance Administration Council Level 2, Brisbane Avenue Barton ACT 2600 Dear Shaun, RE: Proposed New Capital Standards CBHS is pleased to provide a response to PHIAC s invitation to comment on the proposed new Capital Standards. A separate response including the results of the quantity impact study ( QIS ) is being provided, but the Board believes this process is critical enough to warrant general commentary on the proposed standards and their potential impact on our capital and solvency requirements and the industry in general. Introduction CBHS has been analysing and interpreting the requirements of the proposed standards and compiling the QIS since PHIAC released its proposal in July The standards and the QIS results have been the subject of significant discussion at two Board meetings since their release. The Board and Management of CBHS understand and fully support PHIAC s desire to align the prudential capital regime with the current and future context of the industry. Risk management is a focus for the Board and Management, so we understand the direction being taken by PHIAC. Whilst we note your comments in the invitation that the industry is dynamic, well resourced and increasingly sophisticated we are also aware that PHIAC has identified a number of key drivers of the failure of health insurance funds which include (broadly speaking): an inappropriate focus on financial implications and risks associated with growth; poor asset management and inadequate capital management planning. It is against this backdrop that we make our comments on our review of the standards and the impact of the QIS results.

4 General Comments The Board is conscious that the financial stability of the CBHS health benefits fund is influenced by a combination of: good governance practices, an active risk management framework, the use of target key financial ratios to guide and link key decisions such as setting budgets and pricing (new and at pricing review) including net underwriting targets, an appropriate investment framework, and capital management planning. Over the past decade the Board has worked with Management and the Appointed Actuary in all the above areas to protect and enhance the fund s financial stability and long-term sustainability. Specific to the issue of capital management, the Board has adopted a Capital Management Policy ( CPM ) that stipulates a target capital adequacy coverage ratio range well in excess of the prudential capital adequacy reserve requirements. It is against this target that the Board always assesses the impact of it pricing recommendations / decisions and the enhancement of member benefits. By way of context at 30 June 2012 CBHS had a capital adequacy reserve requirement of $44.8m, excess assets of $73.2, a capital adequacy coverage ratio of 1. 64x and a capital adequacy capital / risk multiple of The 2012 Financial Condition Report notes that CBHS has maintained a capital adequacy coverage ratio well in excess of 1.5x requirements in the last 5 years. This demonstrates the benefits of the Board s CPM and overall governance approach. In short, we believe that the end result of any new capital standard should not materially impact the level of the capital adequacy or solvency reserve requirements or the Board s ability to manage its capital in accordance with its target capital adequacy ratio reserves. You will note that our current capital adequacy reserves equates to the equivalent of 22.5% of annual premium and whilst this is not a specific ratio we target, we believe it is important in respect of relativities for any new standards. QIS results and comments CBHS (in consultation with our Appointed Actuary) has identified two different methodologies to determine the value of the stress test components of the capital requirement: 1. A bottom-up approach. This was the initial approach undertaken by our Management team and attempted to derive a distribution of claiming patterns using a stochastic model to achieve 95 th percentile. The results of this first QIS resulted in an increase of minimum capital required by CBHS by $6million (from a current requirement of $44.8m). 2. A second approach, suggested by our Appointed Actuary, focuses on the forecasting accuracy of claims and applies a risk margin at the 95 th percentile to the actual result. The approach resulted in a very material reduction in the minimum capital required, by $39.4m to only $5.4m. We understand that this approach was consistent with the recommendation of a number of Appointed Actuaries to their funds.

5 The different methodologies clearly provide two very different results and highlight the potential issues associated with allowing significant interpretation at the fund level. We would not have envisaged any increase in minimum capital is required; but conversely we doubt prudence would allow us to rest easily with the alternative answer. We note that under this second approach, the results of the QIS represent a capital level equivalent to less than 1% of annual premium - a capital level that is unlikely to align to the objectives of any prudential capital regime. The Board endorsed the submission of both these results in support of making the point that whilst a risk based approach is understandable, it leaves room for varying interpretations by funds. This may lead to inconsistency and increased difficulty in comparing the financial strength of funds, as well as potential diluting the financial strength of the industry. We look forward to subsequent phases of the development process for this new standard and the opportunity for further input. Should you wish to discuss our comments any further please do not hesitate to contact either of the undersigned. In relation to details of the specific CBHS QIS please feel free to contact Dario Molina (CFO) on Yours Sincerely Kerry Brinkley Michelene Hart Board Chairman Audit Committee Chairman Ph: Ph: CC: Hadyn Bernau and Matthew Crane