APRA’s proposed lowering of reinstatement requirements favourable for ILS: Fitch

According to Fitch Ratings, the proposal from the Australian Prudential Regulation Authority (APRA) to remove the requirement for reinsurance arrangements to have a reinstatement in place could be a favourable move for the insurance-linked securities (ILS) market, allowing more risk to be transferred to investors from Australia’s insurance sector.

As we reported earlier this month, the Australian Prudential Regulation Authority is consulting with industry over changes to regulations to make it easier for insurers in the country to access alternative forms of reinsurance capital.

The APRA has seemingly recognised that regulations are hindering access to alternative reinsurance solutions including insurance-linked securities (ILS) in Australia and that market participants would appreciate easier access to solutions such as catastrophe bonds.

As we highlighted in that article, one key issue that could be addressed by the APRA is the fact reinsurance must come with a reinstatement provision.

That is the most obvious hindrance to the use of catastrophe bonds and ILS, given most arrangements do not come with reinstatements as standard and retrofitting a reinstatement cover to an ILS transaction can add unwanted cost.

So the moves to consult and consider changing this restriction seems very positive for the insurance-linked securities (ILS) market and the potential for the major Australian insurance companies too be able to access instruments like catastrophe bonds more readily to support their risk transfer needs.

Fitch Ratings commented, “APRA launched consultations on planned reforms that would require general insurers to buy all-perils reinsurance coverage, while lowering reinstatement requirements and removing the requirement to hold reinstatement premiums as part of the insurance concentration risk charge (ICRC). Any new standards would not come into effect until June 2026.

“The initiative may be designed in part to encourage insurers to explore alternative reinsurance arrangements, such as catastrophe bonds and other insurance-linked securities – something APRA reminded insurers was possible in August 2023.

“Take-up for alternative reinsurance arrangements has so far been limited in Australia, despite a burgeoning global market.

“This may partly reflect the current regulations around reinstatement requirements for catastrophe reinsurance. Alternative reinsurance structures typically do not have such reinstatements, so APRA’s proposed lowering of reinstatement requirements could be favourable for this part of the sector.”

Fitch Ratings also said, “More reinsurance options would give insurers greater scope to manage their net exposure without greatly increasing net retentions and probable maximum loss (PML) values. This should support insurers’ credit profiles by helping them maintain net catastrophe exposure within manageable levels. Our Fitch Prism Global model score – a key input into our assessment of insurers’ capitalisation – captures catastrophe risk via net PML. Factors that help to avoid significant increases in net PML would support current rating levels.

“Insurers could face a greater risk of negative capital and earnings effects if there are successive severe catastrophes (such as one-in-200-year losses), and they are not covered via reinstatements. We believe this risk remains low. Such events should be extremely rare, though the changing frequency and severity of natural disasters underlines uncertainty over this assumption.”