The Australian Prudential Regulation Authority (APRA) has listed business interruption (BI) insurance as one of its key focus areas in an information paper outlining its Supervision Priorities for the next 12-18 months.

APRA says it has been closely monitoring the insurance industry’s exposure to BI policies, given the uncertainty that has arisen over policy wordings.

The Insurance Council of Australia is seeking to overturn an NSW Court of Appeal test case decision that found two policy wordings citing the now repealed Quarantine Act 1908 could not be used to exclude cover for disruptions caused by the COVID-19 outbreak.

“Some of these matters are currently being tested in the courts, and early indicators are that insurers may be liable for exposures beyond their original intent because of insufficient attention to the precision of policy terms and conditions,” APRA says.

“The ongoing uncertainty has caused challenges for insurers and policyholders and resolving that uncertainty as quickly as possible is critical, to allow all parties to move forward.

“APRA is working with peer regulators, industry and other stakeholders towards this objective.”

The prudential regulator says it expects insurers to reserve prudently for potential claims, and pay all legitimate claims in a timely fashion.

“APRA has undertaken intense monitoring of the potential impact BI could have on insurers and this will continue into 2021,” the regulator says. “Entities can expect APRA to maintain a close watch over the BI legal proceedings and seek regular updates on insurers’ exposures, provisioning levels, stress testing and the extent of support from reinsurers, in an effort to assess the potential impact on capital levels.

“APRA is also assessing the readiness of insurers to deploy recovery options in the event of a severe adverse outcome and will be monitoring steps being taken by insurers to facilitate the availability and affordability of appropriate cover into the future.”

APRA, which also released an information paper on its Policy Priorities, says the implementation of AASB 17 - a new accounting rule for insurance contracts that will take effect in January 2023 – is among its focus areas.

The new rule is expected to result in amendments to a number of prudential standards, requiring APRA to make the necessary adjustments.

“If APRA were to make no adjustments, this would result in a divergence between the accounting and prudential standards which would require insurers to maintain dual valuation, actuarial, accounting and reporting systems,” APRA says.

“This would be a significant impost on the insurance industry.”

Other Policy Priorities’ areas that will also relate to the insurance industry are climate-related financial risk, governance and risk management, remuneration, stress testing, operational resilience and the Financial Accountability Regime.

APRA also released its 2020 Year in Review report, providing an overview of its efforts to protect the financial system as the COVID-19 pandemic disrupted the economy.

The general insurance industry’s capital position remained robust but looking ahead, APRA warns of potential strain on insurance affordability and availability as the Government unwinds its fiscal support.

It says the increased frequency and intensity of natural disasters associated with climate change will require greater attention to mitigation and disaster preparedness to ensure that general insurance remains accessible and affordable.

The Black Summer event alone cost the industry some $6 billion in catastrophe claims.

“With respect to these weather-related claims, the financial toll on general insurers was largely at the expense of earnings rather than capital,” APRA said. “Still, significant risks may lie ahead from a combination of lower business volumes, increased claims activity and more expensive reinsurance.

“Against this backdrop, APRA is planning to increase its engagement with insurance consumer groups on these challenging issues.”

The regulator also touched on the BI issue, affirming it remains in constant engagement with insurers and other stakeholders to have an “accurate understanding of any potential prudential impact”.

Click here for APRA’s Policy Priorities, here for Supervision Priorities and here for 2020 Year in Review.