Prudential Practice Guide

GPG 240 — Insurance Risk

February 2006

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Australian Prudential Regulation Authority
Disclaimer and copyright
This prudential practice guide is not legal advice and
users are encouraged to obtain professional advice
about the application of any legislation or prudential
standard relevant to their particular circumstances and
to exercise their own skill and care in relation to any
material contained in this guide.
APRA disclaims any liability for any loss or damage
arising out of any use of this prudential practice guide.
This prudential practice guide is copyright. You may
use and reproduce this material in an unaltered form
only for your personal non-commercial use or non-
commercial use within your organisation. Apart from
any use permitted under the Copyright Act 1968, all
other rights are reserved. Requests for other types of
use should be directed to APRA.

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About this guide

Prudential Standard GPS 220 Risk Management

(GPS 220) sets out APRA’s requirements of general
insurers (insurers) in relation to risk management.
This prudential practice guide aims to assist insurers
in complying with those requirements in relation to
insurance risk and, more generally, to outline prudent
practices in relation to insurance risk management.
Subject to the requirements of GPS 220, insurers
have the flexibility to configure their insurance risk
management framework in the way most suited to
achieving their business objectives.
Not all the practices outlined in this prudential
practice guide will be relevant for every insurer and
some aspects may vary depending upon the size,
complexity and risk profile of the insurer.

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Insurance risk Pricing
1. Insurance risk is the risk that inadequate or 5. The pricing of an insurance product involves
inappropriate underwriting, claims management, the estimation of claims costs and other
product design and pricing will expose an insurer business costs arising from the product and
to financial loss and the consequent inability to the estimation of investment income arising
meet its liabilities. from the investment of the premium income
attaching to the product. Pricing risk may
Product design occur where the claims, costs or investment
returns arising from the sale of a product are
2. Product design involves the introduction of a new inaccurately estimated.
product or the enhancement or variation of an
6. An insurer could consider incorporating
existing product.
ongoing actuarial review and involvement
3. In relation to product design and approvals, an in the pricing process and, where relevant,
insurer’s risk management framework would undertaking specific independent reviews of
typically cover the product classes and types of pricing for schemes and larger or more complex
risks in which the insurer chooses to engage. risks.
4. In this regard, the risk management framework 7. In relation to pricing, the insurer could consider
would typically include the following elements: including in the risk management framework
(a) setting a business case for new or enhanced the following elements:
products; (a) clearly defined and appropriate levels of
(b) market testing and analysis; delegation for approval of all material
aspects of pricing;
(c) cost/benefit analysis;
(b) risk identification and assessment;
(d) risk identification and assessment;
(c) a process for the reflection of emerging
(e) requirements for limiting risk through, experience in price adjustments;
for example, diversification, exclusions and
reinsurance (including confirmation that either (d) profit and loss analysis including monitoring
the existing reinsurance will provide protection the effect of price movements on the
or new reinsurance protection is being bottom line;
provided); (e) price discounting authorities;
(f) processes to ensure that policy documentation (f) a process for the insurer’s product pricing
is adequately drafted to give legal effect to the to respond to competitive and other
proposed level of coverage under the product; external environmental pressures;
(g) an implementation plan for the product, (g) a process for and the ability to monitor
including milestones; deviations of actual price from the technical
(h) clearly defined and appropriate levels of underwriting pricing; and
delegation for approval of all material aspects (h) methods for monitoring compliance
of product design; with pricing policies and procedures for
(i) post-implementation review; and proposed pricing variations.

(j) methods for monitoring compliance with

product design policies and procedures.

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Underwriting (e) risk and aggregate concentration limits; and
(f) methods for monitoring compliance with
8. Underwriting is the process by which an insurer
underwriting policies and procedures such as:
determines whether or not to accept a risk and,
if accepted, the terms and conditions to be (i) internal audit (where it is established that
applied and the level of premium to be charged. the internal audit unit has the appropriate
Weaknesses in the underwriting process and skills and experience to perform such
in the types and levels of controls and systems activities);
can expose an insurer to the risk of operational (ii) reviews by area heads or portfolio
losses which may threaten the long-term viability management;
of the insurer.
(iii) peer review of policies underwritten
9. In relation to underwriting, the risk management (including details of the staff responsible
framework would typically include the following for undertaking the peer review, the
elements: frequency of such reviews and the
(a) a statement of the insurer’s willingness and reporting arrangements for the results);
capacity to accept risk; (iv) assessments of brokers’ procedures
(b) the nature of insurance business that the and systems to ensure the quality of
insurer is to underwrite including: information provided to the insurer is of a
suitable standard; and
(i) the classes of insurance to be
underwritten; (v) in the case of reinsurers, audits of ceding
companies to ensure that reinsurance
(ii) the geographical areas in which these
assumed is in accordance with treaties
classes will be underwritten;
in place.
(iii) the types of risks that may be
underwritten and those that are to be Claims management
excluded; and
10. Claims settlement is the process by which
(iv) the criteria for the use of reinsurance in
insurance companies fulfil their contractual
the different classes of insurance business
obligations to policyholders. In the management
to be underwritten;
of the claims handling process, the following
(c) details of the formal risk assessment process in procedures would be triggered when a loss occurs
the underwriting of insurance including: and claims notification is made to the insurer:
(i) the criteria used for risk assessment; (a) verifying the contractual obligation of the
(ii) the method(s) for monitoring emerging policy to pay the claim;
experience; and (b) making an assessment of the claims liability
(iii) the method(s) by which the emerging quantum, including loss adjustment expenses;
experience is taken into consideration in and
the underwriting process; (c) ensuring the claims settlement process is
(d) the process for setting approval authorities handled promptly and efficiently within the
and the definitive limits to those authorities terms of the policy.
(including controls surrounding delegations
given to intermediaries of the insurer);

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11. Weaknesses in the controls and systems
surrounding the claims management process can
expose an insurer to additional or increased losses
which may impact upon its capital position.
12. In relation to claims management, APRA envisages
that the risk management framework would
include the following elements:
(a) clearly defined and appropriate levels of
delegations of authority;
(b) claims settlement procedures, including loss
estimation and investigation procedures;
(c) criteria for accepting or rejecting claims;
(d) dispute resolution procedures; and
(e) methods for monitoring compliance with
claims management processes and procedures
such as:
(i) internal audit (where it is established that
the internal audit unit has the appropriate
skills and experience to perform such
activities);
(ii) reviews by area heads or portfolio
management;
(iii) peer review (including details of the staff
responsible for undertaking the peer
review, the frequency of such reviews
and the reporting arrangements for the
results);
(iv) assessments of brokers’ procedures
and systems to ensure the quality of
information provided to the insurer is
of a suitable standard; and
(v) in the case of reinsurers, audits of ceding
companies to ensure that the value of
claims paid is in accordance with treaties
in place.

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