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Corporations (National Guarantee Fund Levies) Amendment Bill 2007

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2004-2005-2006-2007

 

THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA

 

 

 

HOUSE OF REPRESENTATIVES

 

 

Financial sector legislation amendment

(discretionary mutual funds and direct offshore foreign insurers) bill 2007

corporations (national Guarantee fund levies) amendment bill 2007

 

 

 

 

EXPLANATORY MEMORANDUM

 

 

 

 

(Circulated by the authority of the Minister for Revenue and Assistant Treasurer,

the Hon Peter Dutton MP)



 



T able of contents

Glossary.............................................................................................................. v

General outline and financial impact............................................................ 1

Chapter 1            Discretionary Mutual Funds............................................... 7

Chapter 2            Direct Offshore Foreign Insurers —

Insurance Act...................................................................... 13

Chapter 3            Direct Offshore Foreign Insurers — Corporations Act. 29

Chapter 4            Capping of Levies — National Guarantee Fund.......... 33

Chapter 5            Regulation impact statement: Discretionary Mutual Funds            37

Chapter 6            Regulation impact statement: Direct Offshore Foreign Insurers    69

 



 



The following abbreviations and acronyms are used in this explanatory memorandum.

Abbreviation

Definition

AFSL

Australian Financial Services Licence

APRA

Australian Prudential Regulation Authority

APRA Act

Australian Prudential Regulation Authority Act 1998

ASIC

Australian Securities and Investments Commission

ASX

Australian Securities Exchange

Authorised insurer

Insurer authorised under section 12 of the Insurance Act 1973 to carry on insurance business in Australia.

Corporations Act

Corporations Act 2001

Corporations Regulations

Corporations Regulations 2001

DMFs

Discretionary Mutual Funds

DOFIs

Direct Offshore Foreign Insurers

FSCODA

Financial Sector (Collection of Data) Act 2001

Insurance Act 

Insurance Act 1973

Insurance Regulations

Insurance Regulations 2002

 

Abbreviation

Definition

Lloyd’s underwriters

Lloyd’s underwriters as defined in the Insurance Act 1973 and authorised under section 93 of that Act

NGF

National Guarantee Fund

NGF Bill

Corporations (National Guarantee Fund Levies) Amendment Bill 2007

Potts review

2004 Review of Discretionary Mutual Funds and Direct Offshore Foreign Insurers

SEGC

Securities Exchanges Guarantee Corporation

 

 



Overview

The Financial Sector Legislation Amendment (Discretionary Mutual Funds and Direct Offshore Foreign Insurers) Bill 2007 (the Bill) implements the approach to the regulation of DMFs and DOFIs announced by the Minister for Revenue and Assistant Treasurer on 3 May 2007.

Under the approach, DOFIs will be prudentially regulated under the Insurance Act.  DMFs will not be prudentially regulated but information will be collected to determine the nature and scope of their operations.

The Bill addresses an outstanding HIH Royal Commissioner’s recommendation and a regulatory gap identified in the International Monetary Fund’s 2006 Financial Sector Assessment Programme for Australia.

The Bill also makes a minor amendment to support changes made by the Corporations (National Guarantee Fund Levies) Amendment Bill 2007 (the NGF Bill).  The NGF Bill will impose a cap on levies payable for the benefit of the NGF.

1.       Discretionary Mutual Funds

The Bill introduces a regime for the collection of information on DMFs.  This will be complemented by enhanced disclosure requirements under the Corporations Regulations.

Information will be collected on both the nature and scope of DMF business.

APRA will collect information on the nature and scope of DMFs’ business and the role of DMFs in the Australian risk management market.  This collection will occur through an amendment to FSCODA.

ASIC will collect information from AFSL holders and authorised representatives, who deal in DMF products, on the business they are placing with DMFs.  This information will be collected under an existing provision in the Corporations Act through an amendment to the Corporations Regulations.

Information collected by the regulators will be used to review within three years the need to prudentially regulate DMFs.

Disclosure requirements will be strengthened through the Corporations Regulations to require DMFs to disclose the key characteristics of their product to both prospective retail and wholesale clients.

Date of effect : These amendments will commence on the day after Royal Assent.

Proposal announced : The proposals were announced by the Minister for Revenue and Assistant Treasurer on 3 May 2007.

Financial impact : It is expected that there will be minor implementation and on-going costs for APRA and ASIC, from the measures in the Bill.

Compliance cost impact : The disclosure and information collection requirements will impose a compliance cost on DMFs.  However, these costs are likely to be minimal as DMFs consulted have indicated that they already disclose the unique features of their product to most of their clients and they already collect much of the information that will be sought from them.

Summary of regulation impact statement: Discretionary Mutual Funds

Impact : The measures contained in this Bill will impact on DMFs, AFSL holders and authorised representatives (financial intermediaries) who deal in DMF products, and the regulators, APRA and ASIC.

Main points :

·          DMFs will have slightly higher administration costs as they will be required to provide information to APRA.  They will also be required to disclose to prospective retail and wholesale clients written information on the key characteristics of the DMF product.  These costs may be passed on to DMF members.  However, DMFs have indicated that they already provide the information on the key characteristics of the product to the majority of their clients and they collect information on the business they are writing.

·          It will allow some DMFs clients to make their risk management decisions based on disclosed information of the costs and benefits of using a DMF product.

2.       Direct Offshore Foreign Insurers

The Bill strengthens and clarifies the definition ‘insurance business’ in the Insurance Act to capture DOFIs that carry on insurance business in Australia either directly or through the actions of another (for example, an insurance agent or broker).

As a result, DOFIs that fit within this expanded definition will be required to be authorised under the Insurance Act.  As authorised general insurers, they will be required to comply with Australia’s general insurance standards including having a presence and assets in Australia.

Foreign reinsurers are not captured by the expanded definition and, hence, not subject to regulation under the Insurance Act unless they choose to establish a branch or subsidiary in Australia.  Lloyd’s underwriters are not captured under this expanded definition, but they will remain subject to regulation under Part VII of the Insurance Act.

The Bill includes a regulation making power that will enable limited exemptions to be made under the Insurance Regulations to allow risks that cannot be placed through an authorised insurer to be placed with insurers not authorised in Australia.

The general insurance prudential standards made under the Insurance Act will be modified by APRA to take account of the risk profiles of the different categories of authorised insurers.  The modifications of the general insurance prudential standards will be risk-focused.

To ensure the regulation of DOFIs is effective, APRA has been given additional enforcement powers in this Bill.  APRA will now be able to investigate persons it believes are carrying on insurance business without being authorised and those persons aiding, abetting, counselling or procuring this activity.  These investigation powers include a power to access the premises of persons and a power to gather information from persons under investigation. 

APRA will have the power to seek an injunction from the Federal Court of Australia restricting unauthorised activity. 

To complement these changes, the Bill includes a prohibition in the Corporations Act on AFSL holders and authorised representatives from dealing in a general insurance product, unless it is from an authorised insurer, a Lloyd’s underwriter or subject to an exemption.

Under the Corporations Act, information will be collected from AFSL holders and authorised representatives on business placed with insurers that are not authorised in Australia.

Date of effect : These amendments will commence on 1 July 2008.

Proposal announced : The proposals were announced by the Minister for Revenue and Assistant Treasurer on 3 May 2007.

Financial impact : It is expected that APRA and ASIC will incur minor implementation costs. 

Compliance cost impact : DOFIs will be required to become authorised under the Insurance Act and comply with Australia’s prudential regime if they wish to carry on insurance business in Australia. 

Australian financial service licence holders and authorised representatives who deal in general insurance products will be required to place their client’s insurance risks with an Australian-authorised insurer unless the risk is one for which an exemption is granted.  Where an exemption is in place, AFSL holders and authorised representatives will be able to place that business with an overseas insurer.

Existing authorised insurers will be subject to the modified prudential standards.  However, the proposed prudential standards will not impose a greater cost on existing authorised insurers and for some, depending on their risk profile, may result in a lowering of some prudential requirements.

Summary of regulation impact statement: Direct Offshore Foreign Insurers

Impact : The measures contained in this Bill will affect DOFIs, Australian insureds that use DOFIs, AFSL holders and authorised representatives who deal in general insurance products (financial intermediaries), Australian authorised insurers, and APRA and ASIC.

Main points :

·          Under the proposed approach, unless an exemption applies, DOFIs will be required to become authorised under the Insurance Act or cease operating in the Australian market.  However, APRA, in applying Australia’s prudential standards, will take into consideration the risk profile of the DOFI.

·          At a minimum all DOFIs that operate in Australia will be required to have a presence in Australia and keep assets in Australia that meet the necessary capital requirements.  This will enable Australian policyholders to access the Australian assets in the event that the DOFI fails.

·          This may have an impact on Australian insureds, as some DOFIs may choose to cease writing Australian business rather than becoming authorised. 

·          At the same time, there will be an exemption for those entities that cannot obtain appropriate insurance through an authorised insurer, allowing those Australian insureds to continue to access overseas insurers.

·          Existing authorised insurers will also be subject to the modified prudential standards.  However, the proposed prudential standards will not impose a greater cost on existing authorised insurers and for some, depending on their risk profile, may result in lower prudential regulatory requirements.

·          Australian financial service licence holders and authorised representatives who deal in general insurance products will be unable to place risks with unauthorised DOFIs unless an exemption applies.

3.       Capping of Levies — National Guarantee Fund

The NGF Bill imposes a cap on levies payable for the benefit of the NGF in any financial year, equal to the minimum amount of the National Guarantee Fund (NGF). 

The NGF provides investor protection for certain transactions on the Australian Securities Exchange (ASX).  Levies are able to be collected when the fund falls below the amount required to be retained in the fund.  This amount is the ‘minimum amount’ of the fund set through the Corporations Act. 

The change provides greater certainty about the global liability of the ASX and market participants to refill the National Guarantee Fund and removes this potential for unlimited liability to refill the NG F. 

The Bill also makes a minor change to the Corporations Act to support the NGF Bill.  The NGF Bill is therefore included with the Bill as a package of reforms, noting that the capping of levies is unrelated to the reforms dealing with DOFIs and DMFs.

Date of effect : The amendments will commence on the 28 th day after the day the Act receives Royal Assent.

Financial impact : There is no financial impact.

Compliance cost impact : The changes reduce the complexity of doing business.

 



C hapter 1   

Discretionary Mutual Funds

Outline of chapter

1.1                    Items in Schedule 1 of this Bill amend FSCODA to allow APRA to collect information from DMFs on the role they play in the Australian risk management market and to determine to what extent these entities pose a prudential risk.

1.2                    The information will be used to review within 3 years whether it is appropriate to prudentially regulate these entities. 

1.3                    To complement the information collection under the amendments in Schedule 1 of this Bill, information will also be collected under proposed amendments to the Corporations Regulations from AFSL holders and authorised representatives that use DMF products. 

1.4                    Consumer protection measures currently applying to retail clients of DMFs will be extended via theCorporations Regulations to DMFs’ wholesale clients. 

Context of amendments

1.5                    DMFs offer ‘discretionary cover’, that is, an insurance-like product that often involves a contractual obligation on the DMF to consider a claim when a risk eventuates, but provides the DMF with a discretion whether it will pay the claim. 

1.6                    DMFs provide a means of risk management that is an alternative to insurance.  DMFs sometimes meet risks for which insurance may not be available or affordable. 

1.7                    DMFs may be established as a corporation limited by guarantee or trust fund.  They are subject to the broader regulatory requirements contained in legislation and under the common law.  For example, corporations limited by guarantee are regulated by the Corporations Act as a corporation and trusts are subject to trust laws.  Some may also be associations incorporated and regulated under relevant state or territory legislation.

1.8                    Following a recommendation by the HIH Royal Commissioner that the Insurance Act be amended to extend prudential regulation to all discretionary insurance-like products, to the extent possible within constitutional limits, the Government commissioned the Potts review in 2004. 

1.9                    The Potts review found that there was no comprehensive industry or government information available on DMFs.  However, from the limited information that was available, it estimated that DMFs only account for approximately 0.5 per cent of the general insurance market. 

1.10                Since the Potts review there have been structural and cyclical changes to the Australian general insurance market that have altered the impetus for regulation.  These include: tort law reforms, a softening of the insurance market and a fuller understanding of the impact of the Financial Services Reform Act 2001 .

1.11                As a result of these changes, and after further consultation with industry, the Government announced on 3 May 2007 that DMFs will not be subject to prudential regulation at this time.  Instead, they will be monitored and information on their role in the Australian general risk market will be collected from DMFs and AFSL holders and authorised representatives who deal in DMF products.

1.12                Once sufficient information has been collected and within three years of the commencement of Schedule 1 of this Bill, a review will be conducted to determine whether it is appropriate to prudentially regulate DMFs.

1.13                In the meantime, the consumer protection provisions that apply to DMFs in dealing with their wholesale and retail clients will be strengthened through an amendment to the Corporations Regulations.  This will provide consumers with sufficient information about the risks and benefits of DMFs to make informed decisions about the products they are purchasing. 



Summary of new law; comparison of key features of new law and current law

New law

Current law

APRA will monitor and collect information from DMFs on their role in the Australian risk market and whether they pose a prudential risk

No information is collected from DMFs, or AFSL holders or authorised representatives that deal in DMF products. 

There will be no change to the existing regulation of these entities under FSCODA.

FSCODA currently collects infromation from corporations registered under the Act, APRA-regulated entities and medical defence organisations.

 

Detailed explanation of new law

1.14                Schedule 1 amends the object of FSCODA to enable APRA to collect information on DMFs. [Schedule 1, items 1 and 2]

1.15                The object provides that APRA can collect information both to assist in the prudential regulation of bodies in the financial sector and to assist in the prudential monitoring of bodies in the financial sector.  [Schedule 1, items 1 and 2]

1.16                To achieve this expanded object, FSCODA authorises APRA to determine the reporting standards for registered corporations under the Act and other bodies that it regulates or monitors.  This will now include DMFs.  [Schedule 1, items 3 and 4]

1.17                This will allow APRA to develop reporting standards to collect quantitative and qualitative information from DMFs.  The information that can be collected under the Act from DMFs can include any information that APRA believes may assist it in determining whether it would be appropriate to prudentially regulate DMFs.

1.18                APRA will also have the power to collect information on the role DMFs play in Australia’s risk management market and the class of business individual DMFs write (for example, public liability). 

1.19                To meet the definition of DMF in the Act, DMFs must satisfy all of the following conditions:

·          It must be a fund for making payments to contributors on the happening of an event, where there is uncertainty as to whether, or when, the event will happen.

·          Two or more persons must contribute to the fund out of which payments may be made in respect of liabilities, losses, damages or expenses of the contributors.

·          The fund must be governed by rules under which any such payment for the benefit of a contributor is subject to a discretion of a person or body. 

·          A contributor cannot have a right in law or equity to a payment from the fund.  However, a contributor will have a right in law to have their claim considered by the fund. [Schedule 1, items 3 and 4]

1.20                In this definition, it is intended that the phrase ‘on happening of a specified event, where there is uncertainty as to whether, or when, the event will happen’ will be interpreted to have the same meaning as this phrase has for the purposes of insurance contracts.  [Schedule 1, item 4, subsection 5(5)]

1.21                The entities to be captured by the definition provide risk cover on a discretionary basis to a group of individuals, companies or government entities. [Schedule 1, items 3 and 4]

1.22                DMFs structure in a range of ways but common features include:

·          Each member of the group makes contributions to a common fund, which is used to finance the payment of liabilities of members with respect to specified risks (at least up to a certain loss level);

·          In return for the payment of contributions, members have a legal right to submit a claim for indemnity and have that claim considered by the relevant entity.  However, in each case, the relevant entity may approve the claim at its discretion and use the pool of funds from the membership subscription to pay part or all of the claim. 

·          The entity may take out insurance to cover:

-         any part of a contributor’s claims in excess of the fund retained by the entity; or

-         to cover the situation where multiple claims exhaust the fund; or

-         to cover a contributor’s claim, with the fund having a discretion to cover any excess part of the claim not met by insurance.

·          In some funds, the entity may also place a call on its members to contribute additional funds to the pool, if the pool is exhausted.

1.23                These entities may operate by means of a public company limited by guarantee or may be established under a discretionary trust.  However, the definition of a DMF is not to be taken as being limited to these legal structures.  [Schedule 1, items 3 and 4]

1.24                It is not intended to capture funds that are not financial services business.  For example, it is not intended that a family agreeing to pool money to pay for the replacement of a roof after a cyclone be captured under the definition of DMF. 

1.25                The definition of DMFs is not intended to capture state insurance arrangements ; f or example, a DMF set up under statute by the state law society to provide its members with professional indemnity cover.  State insurance is to be given the meaning it has under the Constitution.  [Schedule 1, item 5]

1.26                APRA may determine the reporting standards for and collect reporting documents from the DMFs caught under the definition under section 13 of FSCODA.

1.27                These reporting standards are legislative instruments for the purposes of the Legislative Instruments Act 2003

1.28                DMFs that do not meet the reporting requirements outlined in section 13 of the Act may be subject to the penalties contained in sections 13, 14 and Part 3, Division 3 of the Act.  For example, under section 13 a financial entity that fails to comply with a requirement to provide APRA with a reporting document within a particular timeframe may be liable to a maximum fine of 50 penalty units.  Similarly, under section 14 of the Act, a principal executive officer of a financial sector entity that fails to notify the governing body of the entity in writing that is has not complied with the reporting requirement outlined above may be liable to a maximum fine of 50 penalty units. 

1.29                Part 3 Division 3 outlines administrative penalties that may apply in lieu of prosecution for certain offences, including a failure to comply with the reporting requirements outlined above.

1.30                Schedule 1 provides for regulations to be made deeming entities that do not satisfy the DMF definition to be DMFs for the purposes of the Act and to exempt entities that meet the DMF definition from being DMFs for the purposes of the Act.  [Schedule 1, item 4]

1.31                This regulation-making power is necessary because at this time there is only a limited understanding of the various ways in which DMFs may be structured.  In order to determine whether prudential regulation of DMFs is warranted a comprehensive collection of information on the range of existing DMFs is necessary.

Application and transitional provisions

1.32                The amendments will commence on Royal Assent.  [Clause 2]

1.33                However, the first collection of information will not occur until APRA has developed, in consultation with DMFs, its reporting standards.  Subject to consultation with DMFs, it is anticipated that DMFs will commence providing information from a period beginning 1 January 2008. 

1.34                A 1 January 2008 commencement date for the reporting standards will allow DMFs to put the systems in place to provide the information to APRA. 

Consequential amendments

1.35                There will be an amendment to the definition section, section 31 of the Act, to include DMF as a defined term in the Act.  [Schedule 1, item 6]



C hapter 2   

Direct Offshore Foreign Insurers — Insurance Act

Outline of chapter

2.1                    Items 3 to 52 in Schedule 2 of this Bill amend the Insurance Act to expand and clarify the existing definition of ‘insurance business’ to capture DOFIs that carry on insurance business in Australia, either directly or through the actions of another.

2.2                    Foreign reinsurers are not captured by the expanded definition and hence not subject to regulation under the Insurance Act unless they choose to establish a branch or subsidiary in Australia.  Lloyd’s underwriters are not captured under this expanded definition, but they will remain subject to regulation under Part VII of the Insurance Act.

2.3                    The Bill includes a mechanism to exempt risks that cannot be adequately insured by authorised insurers.

2.4                    To enable APRA to effectively enforce the expanded definition of ‘insurance business’, this Bill includes powers to allow APRA to investigate the activities of persons it believes are carrying on insurance business in Australia without being authorised or persons aiding, abetting, counselling or procuring these activities.

Context of amendments

2.5                    The HIH Royal Commissioner in his comments on DOFIs, noted a possible gap in APRA’s regulatory reach.  He found that it might be possible for an insurer, for example an insurer who has been refused authorisation by the APRA, to move offshore and issue insurance policies through an agent or broker in Australia in an attempt to avoid the operation of the Insurance Act.  In response, the Government commissioned the Potts review in 2004. 

2.6                    The Potts review found that the current regulatory treatment of foreign insurers operating in Australia lacked consistency.  Foreign insurers were treated in different ways depending on whether they were foreign insurers authorised by APRA operating in Australia, Lloyd’s underwriters authorised under section 93 of the Insurance Act, or DOFIs.  This meant that the degree of protection afforded to Australian policyholders with similar insurance risks would vary depending on the country of origin of the insurer they selected.

2.7                    DOFIs are foreign insurers that carry on insurance business in Australia, either directly or via an insurance agent or broker, without establishing a subsidiary or branch.  These DOFIs are not subject to the provisions of the Insurance Act because they are not considered to be ‘carrying on insurance business in Australia’ under sections 9 and 10 of the Insurance Act.  However, these DOFIs may be subject to prudential and consumer regulation in their home jurisdiction.

2.8                    To the extent that they are carrying on a financial services business in Australia as defined under the Corporations Act, DOFIs are subject to consumer protection regulations in Australia.  They are required to hold an AFSL and comply with the conditions of that licence, set out in Chapter 7 of the Corporations Act. 

2.9                    Under the Corporations Regulations, DOFIs must inform purchasers of particular insurance products (generally those aimed at retail clients) through their Product Disclosure Statement (PDS) that they are a foreign insurer and not prudentially regulated in Australia.

2.10                Currently only insurers carrying on insurance business in Australia are subject to FSCODA.  However, DOFIs that do not operate through such a structure are not subject to any information collection requirements on their activities in Australia.

Summary of new law

2.11                Schedule 2 expands the definition of ‘insurance business’ in the Insurance Act to capture anyone that carries on insurance business in Australia, either directly or through the actions of another (for example, an insurance agent or broker). 

2.12                As a result, all DOFIs that fit within this expanded definition will have to become authorised under the Insurance Act if they wish to carry on insurance business in Australia.  As authorised general insurers, they will be required to comply with Australia’s general insurance prudential standards.

2.13                Foreign reinsurers, who do not choose to establish a branch or subsidiary in Australia, will not be caught by this expanded definition.  They will be able to continue to operate in Australia without being authorised. 

2.14                Lloyd’s underwriters will not be caught under the expanded definition but will continue to be regulated under Part VII of the Insurance Act. 

2.15                In addition, the Bill provides a framework that enables the creation of limited exemptions in the regulations to allow risks that cannot be placed through an authorised insurer in Australia to be placed with insurers not authorised in Australia.

2.16                Under existing powers in the Insurance Act, APRA will modify its existing general insurance prudential standards to take into account the different risk categories of authorised insurers.  APRA will develop a risk-focused prudential framework to apply to all authorised general insurers.

2.17                To ensure that the regime can be effectively enforced, the Bill includes additional enforcement powers to enable APRA to investigate persons it believes are carrying on insurance business without being authorised and those persons aiding, abetting, counselling or procuring this activity.  These investigative powers include a power to access the premises of persons and a power to gather information from persons it is investigating. 

2.18                APRA will be able to seek an injunction from the Federal Court restricting this unauthorised activity. 

2.19                To complement these changes, the Bill includes a Corporations Act prohibition on AFSL holders and authorised representatives from dealing in a general insurance product unless it is from an authorised insurer, Lloyd’s underwriter or an exemption applies (as mentioned above).

2.20                Information will be collected from AFSL holders and authorised representatives under proposed amendments to the Corporations Regulations, on business they place with insurers that are not authorised in Australia, where an exemption applies.

2.21                Once DOFIs become authorised, they will be required, as authorised insurers, to provide information to APRA under FSCODA.



Comparison of key features of new law and current law

New law

Current law

Carrying on insurance business in Australia

The current definition is expanded so that a person is taken to carry on insurance business in Australia if the person carries on business outside Australia that would be considered to be carrying on insurance business if it was carried on in Australia and they act in Australia through another person.

‘Incidental business’ referred to in the current definition of ‘insurance business’ is deemed to include: Inducing others to enter into contracts; or publishing or distributing; or procuring the publication or distribution of a statement relating to the person’s willingness to enter into a contract of insurance as an insurer. 

‘Insurance business’ is currently defined in section 3 of the Insurance Act as ‘undertaking liability, by way of insurance (including reinsurance), in respect of any loss or damage, including liability to pay damages or compensation, contingent upon the happening of a specified event, and includes any business incidental to insurance business as so defined.’

Business incidental to insurance is not currently defined under the Act.

Exemption

Expands the current exclusions to include: contracts of insurance specified in regulations made under this Act, or in a determination made under regulations, will not be ‘insurance business’ for the purposes of the Insurance Act.

The definition of insurance business currently excludes insurance regulated under other Australian law (for example, health insurance and life insurance) or specific circumstances (for example, insuring a religious organisation).

Enforcement powers

A new Part VA will give APRA the power to investigate, enter the premises of, or gather information from, entities it believes are or may be carrying on insurance business in Australia without being authorised or who are or may be aiding, abetting, counselling or procuring that activity.

APRA will be able to apply to the Federal Court for an injunction to stop the activities referred to above.

APRA existing powers are limited to investigating, gathering information from and accessing premises of those entities that are authorised under the Insurance Act or who are seeking to become authorised under the Insurance Act.

APRA does not currently have the power under the Insurance Act to seek an injunction against an entity carrying on insurance business without being authorised.

 

Detailed explanation of new la w

Amending the definition of ‘insurance business’

2.22                This measure expands and clarifies the definition of ‘insurance business’ so as to ensure that any person carrying on insurance business in Australia, either directly or through brokers or others acting on their behalf (such as agents), are required to be authorised under the Insurance Act and as a result are subject to prudential regulation in this jurisdiction, including the requirement to have a presence in Australia and to hold sufficient assets in Australia to meet their liabilities here.  This is designed to protect policyholders from DOFIs that are not subject to robust prudential regulation, and therefore pose a greater risk of not paying out a claim.

2.23                The entities to be covered by this expanded and clarified definition of ‘insurance business’ are domestic insurers, foreign insurers and foreign reinsurers currently operating under the Insurance Act via a branch or subsidiary, domestic reinsurers and any other insurer that engages in conduct caught by this measure, including insurers currently referred to as DOFIs and offshore ‘captives.’

2.24                  The activities to be targeted are those leading up to and including undertaking liability under an insurance contract.  These include: undertaking liability; business incidental to undertaking liability; and the actions of intermediaries. 

2.25                This measure will expand and clarify the definition of ‘insurance business’ in two ways:

·          by expressly including a set of activities that are to be considered incidental to ‘insurance business’; and [Schedule 2, item 6, subsections 3(5) and 3(7)]

·          by deeming ‘insurance business’ carried on outside Australia to be insurance business in Australia if another person in Australia acts on behalf of that first-mentioned person, or acts as a broker of insurance provided by the first-mentioned person, in relation to that business [Schedule 2, item 6, subsection 3(6)]

2.26                Incidental activities include: inducing others to enter into contracts of insurance with the person as an insurer, publishing or distributing a statement relating to the person’s willingness to enter into a contract of insurance as an insurer and procuring the publication or distribution of such a statement.  This is not intended to be an exhaustive list. [Schedule 2, item 6, subsection (5)]

2.27                Incidental activities that take place after the insurer has undertaken the liability (that is, entered into the contract of insurance with the insured) will not be captured under the expanded and clarified definition of ‘insurance business’ in the Insurance Act.  It is not intended that the expanded and clarified definition of ‘insurance business’ capture the activities of merely handling claims, operating accounts, making payments or holding records on behalf of an overseas foreign insurer.  [Schedule 2, item 6]

2.28                For example, if an incorporated DOFI uses an Australian based agent or broker, or an agent or broker operating from outside the jurisdiction, to advertise or encourage Australians to enter into an insurance contract with the DOFI, the DOFI is taken for the purposes of the Insurance Act to be carrying on insurance business in Australia and is in breach of subsection 10(1) of the Insurance Act unless it is: authorised; a determination is in force under subsection 7(1) of the Insurance Act; or an exemption under section 3A applies.

2.29                The agent or broker in this example is not himself or herself carrying on insurance business in Australia as he or she is not the entity ‘undertaking liability.’ That is, he or she is not the entity providing the insurance to the Australia consumer or business under the insurance contract. 

2.30                An example of activity that is expressly included as being incidental to insurance business is an overseas insurer that buys an Australian distribution list and targets these people via telephone, e-mail or the Internet suggesting that they take out their insurance with the insurer.  In this example, the insurer would be deemed to be carrying on insurance business in Australia, even if the activity of sending the letter took place in the overseas country, because of the effect of the letters or emails in Australia. 

2.31                Where an Australian initiates contact with a DOFI (for example, through the Internet or by calling or visiting the DOFI directly), the DOFI will not be carrying on insurance business in Australia and will not be required to become APRA authorised.  This is because, even under the strengthened and clarified definition of ‘insurance business’ the DOFI has not been deemed to carry on insurance business in Australia.

2.32                To allow the greatest flexibility to foreign insurers who wish to continue carrying on insurance business in Australia once the definition of ‘insurance business’ is expanded and clarified, section 118 of the Insurance Act will be expanded to allow a foreign insurer to appoint a range of different legal entities as their agent in Australia.  Currently, foreign insurers, who must appoint an agent to comply with Australia’s prudential regime, can only appoint an ‘individual resident’ as their agent.  Section 118 will be expanded to allow foreign insurers to appoint an individual resident, body corporate incorporated in Australia, or any other entity specified in Insurance Regulations. [Schedule 2, items 39 to 52]

Foreign reinsurers

2.33                Currently, foreign reinsurers who choose to establish a branch or subsidiary in Australia are required to seek an authorisation to ‘carry on insurance business in Australia’ under the Insurance Act.  It is not proposed that this Bill alter this current state.

2.34                This Bill exempts offshore foreign reinsurers from the requirement to be authorised if they carry on insurance business in Australia.  This will allow Australian insurers to continue to access the global reinsurance market. 

2.35                Foreign reinsurers writing direct business in Australia would be classified as direct insurers and are required to be authorised under the Insurance Act.

2.36                This exemption applies to reinsurance business carried on by a body corporate incorporated in a foreign country and to an unincorporated body established under the law of a foreign country that may sue or be sued, or may hold property in the name of its secretary or of an office holder of the body duly appointed for that purpose.  [Schedule 2, items 4 and 5]

2.37                Incorporated bodies are included because, for example, there are some trust or trust-like structures (which may be unincorporated bodies) issuing fully collateralised reinsurance contracts.  Collateralisation comes from the sale of securities.  These arrangements are developing as capital markets become more interested in being involved in reinsurance and the securitisation of insurance liabilities.  The exemption covers these contracts.  [Schedule 2, items 4 and 5]

2.38                If a foreign reinsurer elects to set up a branch or subsidiary in Australia so as to, for example, improve its access to the Australian market, then it will be required to be authorised under the Insurance Act.  It will be required to become authorised and comply with Australia’s prudential regime. 

2.39                Similarly, and consistent with the international treatment of reinsurers, an Australian reinsurer would be required to be authorised by APRA if it sought to commence operations in Australia.

2.40                Foreign reinsurers who currently have a branch or subsidiary in Australia will continue to be regulated by APRA under the Insurance Act and have to comply with Australia’s prudential regime.  However, these foreign reinsurers can choose to cease writing business through the Australian branch or subsidiary, place that business in run-off in accordance with prudential requirements, and become offshore foreign reinsurers.  If they do this, they would no longer be required to be authorised in Australia for the new reinsurance business they write.

2.41                Although offshore foreign reinsurers are exempt, they may be indirectly subject to the Australian regulatory regime through the prudential standards applied to direct insurers in respect of reinsurance obtained from those offshore foreign reinsurers. 

Lloyds Underwriters

2.42                Lloyd’s underwriters are currently regulated under Part VII of the Insurance Act. 

2.43                This Bill does not change how Lloyd’s underwriters are regulated under the Insurance Act.

Exemptions made through regulations

2.44                This Bill inserts a provision into the Insurance Act that provides for a mechanism to exempt particular kinds of contracts of insurance or particular contracts of insurance from being insurance business under the Act. [Schedule 2, item 8, section 3A]

2.45                As a result, a DOFI providing a contract of insurance or kind of contract of insurance specified in the regulations or in a determination made under the regulations will not be taken to be carrying on insurance business in Australia because the contract or contracts do not meet the definition of ‘insurance business’ under the Insurance Act.

2.46                A DOFI that supplies contracts of insurance subject to an exemption will not be required to be authorised under the Insurance Act. 

2.47                The new section provides for contracts of insurance to be specified in regulations or in a determination made under regulations.  The regulations or determination may specify the contract or contracts of insurance in terms of product (that is, the line of insurance business) or the person who is seeking the insurance.  [Schedule 2, item 8, subsection 3A(2)]

2.48                Determinations made under the regulations that specify a particular contract of insurance are reviewable in accordance with Part VI of the Insurance Act.  Part VI will be expanded to allow a person who has applied for a determination to have that determination reviewed by decision-maker. [ Schedule 2, item 8, subsection 3A(3) and items 13 to 33]

2.49                Other determinations made under regulations are legislative instruments for the purposes of the Legislative Instruments Act 2003 [ Schedule 2, item 8, subsection 3A(4)]

2.50                The details of the exemption to be included in the regulations will be finalised after consultation with stakeholders.

2.51                The purpose of the exemption is to ensure that, while all insurers who meet the expanded and clarified definition of carrying on insurance business in Australia will be required to be authorised, this approach does not unduly restrict Australian insureds access to the global insurance market, where it can be clearly demonstrated that they require continued access to this market.

2.52                Both the HIH Royal Commissioner’s report and the Potts review noted that there were many international commercial insurance arrangements that had worked satisfactorily to date.  These reports indicated that Australian insureds in these arrangements did not need additional protection from unauthorised DOFIs as they were generally sophisticated entities, like large corporationsk, who adequately assess their own risks and the risks of the insurance products they purchased.

2.53                In addition, the Australian insurance market, although robust and competitive, is widely acknowledged to be small compared to the major insurance markets in Europe and the United States of America.  Some large Australian corporations may not be able to access sufficient insurance to cover their risks in the Australian market. 

2.54                Alternatively, there may be Australian businesses and individuals who cannot obtain appropriate insurance from authorised insurers or Lloyd’s underwriters in Australia.  This may include circumstances where an insurance product is not available at all or where the product is not available with the specific terms and conditions that the Australian insured requires. 

2.55                In these cases, without access to offshore foreign insurers, the Australian insured may be faced with bearing the insurance risk themselves. 

2.56                To prevent this, regulations will be enacted to exempt specific lines of insurance or insurance for a particular client where these lines of insurance are not available from authorised insurers or Lloyd’s underwriters. 

2.57                However in developing these exemptions, the balance will need to be maintained between ensuring capacity and access to insurance and allowing the DOFI regime outlined in this Bill to be effective in protecting Australian insureds from less robust offshore foreign insurers.

Enforcement Powers

2.58                The enforcement powers in this Bill expand the existing enforcement powers under the Insurance Act to enable APRA to investigate and take action against suspected breaches of sections 9 and 10 of the Insurance Act, that is the carrying on of insurance business in Australia without being authorised. [Schedule 2, items 9, 12 and 36]

2.59                Most of the enforcement powers in this Bill will be contained within a new Part, Part VA in the Insurance Act, and allow APRA to investigate any person or body corporate it believes on reasonable grounds has engaged in, is engaging in or will be engaging in conduct in contravention of sections 9 or 10 of the Insurance Act. [Schedule 2, item 12]

2.60                APRA will also have the power, under Part VA, to investigate any person or body corporate that it believes on reasonable grounds has engaged in, is engaging in or will be engaging in conduct that constitutes aiding, abetting, counselling or procuring a contravention of sections 9 or 10 of the Insurance Act.  [Schedule 2, item 12, section 62A]

2.61                Once APRA has launched an investigation, an authorised person (defined under new section 2A) or an inspector appointed by APRA will have the power under this new Part to access the premises of the entity with either the consent of the occupier of the premises or to apply to a Magistrate for a search warrant to search for, inspect, take extracts from and make copies of any books (as defined under the Insurance Act) containing relevant information to the investigation. [Schedule 2, item 12, section 62B]

2.62                APRA or an inspector appointed by APRA may, by written notice, require a person they believe on reasonable grounds has or may have information in their control or custody relevant to the investigation, to produce all or any of the books containing information relevant to the investigation or provide APRA or the inspector with all reasonable assistance in connection with the investigation.   [Schedule 2, item 12, subsection 62C]

2.63                The information gathering power listed above also includes a power enabling APRA to require a person to appear before APRA or an inspector and answer questions put to them.  [Schedule 2, item 12, section 62C]

2.64                A person is not excused from complying with the notice issued under section 62C on the grounds that complying with that notice might tend to incriminate them.  However, if the person is an individual and before answering the questions the person informs APRA or the inspector that the evidence might incriminate them, the questions or answers cannot be used in evidence against them in any criminal proceeding other than an offence of failing to comply with the notice or an offence under section 137.1 or 137.2 of the Criminal Code. [Schedule 2, item 12, section 62D]

2.65                Where a person is being examined they may be represented by a legal practitioner and notes may be made of the examination.  The person being questioned will have a right, free of charge, to a copy of those notes if they request a copy in writing from APRA.  [Schedule 2, item 12, sections 62E and 62F]

2.66                APRA has the power to delegate the powers contained in Part VA in accordance with section 15 of the APRA Act.  An inspector may delegate their powers to an APRA member, an APRA staff member or a person included in a class of persons approved by APRA.  [Schedule 2, item 12, section 62G]

2.67                APRA is also required under Part VA to complete the investigation within a reasonable time and to provide written notice to the person who was the subject of the investigation that the investigation is complete and whether or not APRA proposes to take further action.  [Schedule 2, item 12, section 62H]

2.68                What is a reasonable time will be interpreted within the circumstances of the investigation.  For example, in a straightforward case, it will be possible to quickly assess whether or not there has been a contravention of sections 9 or 10 of the Insurance Act.  APRA will obtain clear evidence from the agent of the DOFI that the DOFI has written insurance policies for Australian insureds, in contravention of the section 10 of the Insurance Act. 

2.69                In a more complex case where, for example, the DOFI does not have an agent in Australia and does not operate through brokers, but rather directly advertises their products over the Internet, it may be more difficult to obtain sufficient evidence for APRA to satisfy itself as to whether or not there has been a contravention of section 10 of the Insurance Act.  In those situations, APRA may need to seek information from a wider range of sources and this will take more time.

2.70                This may be necessary to enable APRA to form a reasonable belief that an entity was, is, or will be carrying on insurance business without being authorised or aiding, abetting, counselling or procuring that conduct.

2.71                An inspector, if appointed to conduct an investigation under Part VA, must on completion of the investigation provide APRA with a written report as to the result of that investigation. [Schedule 2, item 12, section 62I]

2.72                In some situations, APRA may need to gather preliminary information from persons who may or may not be engaged in the unlawful conduct but who may have information on whether another entity was, is, or will be engaging in that conduct before it can commence an investigation under the new Part VA.  [Schedule 2, item 36]

2.73                For example, an accountant dealing with the financial records of an entity suspected of carrying on insurance business in Australia without being authorised is likely to have information on the activities of that entity which may assist APRA in forming a reasonable belief that the entity is engaged in unlawful conduct.

2.74                An insurance agent representing a DOFI who is carrying on insurance business in Australia without being authorised and where no exemption applies may have information on the policies, if any, that the DOFI has entered into.  That information is likely to assist APRA to form the reasonable belief necessary to launch an investigation. 

2.75                To enable effective enforcement action to be taken in these situations, the Bill contains a power that allows APRA, where it believes on reasonable grounds that a person has or may have in their custody or control information or documents relating to conduct that constitutes or may constitutes a contravention of section 9 or 10 of the Insurance Act or aiding, abetting, procuring or counselling a contravention of those sections, to send a written notice to that person requiring that person to give the information in writing signed by the person or produce the documents within a time and in a manner specified in the notice. [Schedule 2, item 36, section 115AA]

2.76                This measure is not to be taken to include a right to examine the person, rather it is limited to the person being required to provide either written answers to written questions set out in the notice (similar to an interrogatory) or documents that are relevant to whether or not there has been a contravention of sections 9 or 10 of the Act or aiding, abetting, procuring or counselling a contravention of those sections.  [Schedule 2, item 36, section 115AA]

2.77                A person will commit an offence where they fail to comply with a notice under section 115AA.  The offence has a maximum penalty of 50 penalty units.  [Schedule 2, item 36, subsection 115AB(1)]

2.78                It will not be an excuse to fail to comply with the notice issued under section 115AA because complying with that notice might tend to incriminate the person.  [Schedule 2, item 36, subsection 115AB(2)]

2.79                However, the power contains a protection against self-incrimination.  Where a person is an individual and informs APRA prior to giving the information in the form of written answers to written questions that the information might tend to incriminate them, that information will not be admissible in evidence against the person in a criminal proceeding, other than a prosecution under this section or under sections 137.1 or 137.2 of the Criminal Code.  [Schedule 2, item 36, subsection 115AB(3)]

2.80                This is designed to protect the agent in the example above who may be required to provide information to APRA under this measure even though that information could be used against the agent to prosecute them for aiding and abetting the DOFI in contravention of the law. 

2.81                APRA is provided with the power to seek restraining, consent and interim injunctions from the Federal Court of Australia with respect to unauthorised insurers and persons involved in the activities of unauthorised insurers. [Schedule 2, item 9, section 11A]

2.82                This power will enable APRA to act quickly in situations where unauthorised insurers are carrying on insurance business in Australia.  The provision permits APRA or any person whose interests are affected by the conduct of the entity to seek an injunction. [Schedule 2, item 9, section 11A]

Minor technical amendment

2.83                A grammatical correction is made to the power to investigate a general insurer, authorised non-operating holding company (NOHC) or subsidiary. [Schedule 2, item 11]

2.84                The power to enable APRA to access premises under section 115A is amended to require a warrant to be sought from a magistrate rather than a justice of the peace. [Schedule 2, items 37 and 38]



Application and transitional provisions

2.85                These measures will commence on 1 July 2008. [Clause 2]

2.86                The Bill includes a transitional measure to allow regulations to be made to specify particular entities or classes of entities to which the expanded and clarified definition of ‘insurance business’ in item 6 does not apply for a period to be specified in the regulations, not exceeding two years. [Schedule 2, subitems 7(1) and 7(3)]

2.87                To address the Corporations Act prohibition outlined in Chapter 3, entities that are set out in the transitional regulations to this Bill will be deemed for the purposes of the Corporations Act prohibition to be authorised insurers under the Insurance Act.  [Schedule 2, subitem 7(2)]

2.88                As a result, AFSL holders and authorised representatives (who would otherwise be in breach of the Corporations Act prohibition if they deal in a general insurance product that is not from an authorised insurer or a Lloyd’s underwriter or to which an exemption applies), will not be in breach of the prohibition when they deal in general insurance products from entities specified in regulations that are not yet required to be authorised under the Insurance Act.  [Schedule 2, subitem 7(2)]

2.89                This transition measure will provide the flexibility to exempt particular entities or classes of entities that may require more time to seek authorisation under the Act.

Consequential amendments

2.90                To enable APRA to use a technical expert to access information when APRA access the premises under section 62B, section 2A will be inserted into the Insurance Act to define ‘authorised person’ for the purposes of Part VA to be APRA or a person authorised by APRA, in writing, for the purposes of Part VA. [Schedule 2, item 3]

2.91                Part V will be renamed ‘Investigations of general insurers etc’ so as to clearly distinguish between investigations into the activity of authorised general insurers (Part V) and investigations into the activities of entities suspected of carrying on insurance business in Australia without being authorised under the Insurance Act or aiding, abetting, counselling or procuring that unauthorised activity. [Schedule 2, item 10]



2.92                Section 103 of the Insurance Act is also amended to ensure that Part VA does not apply to the exclusion of certain other laws of the Commonwealth, State or Territory that make provision for an investigation into the affairs of the body corporate or other person. [Schedule 2, items 34 and 35]





Outline of chapter

3.1                    Items 1 and 2 in Schedule 2 of this Bill amend the Corporations Act to prohibit AFSL holders and authorised representatives from dealing in a general insurance product that is not from an authorised insurer, Lloyd’s underwriter or where an exemption applies.

3.2                    The Corporations Act amendments are intended to complement the changes made to the Insurance Act outlined in Chapter 2 of this explanatory memorandum.

Context of amendments

3.3                    AFSL holders and authorised representatives, especially insurance agents and brokers, provide a conduit for Australian consumers and businesses to access the insurance market, including DOFIs.

3.4                    These financial intermediaries provide a valuable financial service to Australian consumers and business in assist them to obtain competitive insurance to meet their needs or place a hard to place insurance risk.

3.5                    The HIH Royal Commissioner noted a possible gap in APRA’s regulatory reach of offshore insurers and that it may be possible for an offshore insurer, for example, an insurer who has been refused authorisation by the APRA to move offshore and issue insurance policies through an agent or broker in Australia in an attempt to avoid the operation of the Insurance Act.

3.6                    The changes outlined in Chapter 2 of this explanatory memorandum enhance the integrity of general insurance prudential regulation in Australia.  The Corporations Act prohibition introduced by this Bill complements and reinforces the integrity of this general insurance regulation by limiting the extent to which AFSL holders and authorised representatives can deal in a product that is not regulated under the Insurance Act.  This maximises the likelihood that Australian individuals and businesses will benefit from the protection provided by Australia’s general insurance regulatory regime.

Summary of new law

3.7                    Schedule 2 of this Bill amends the Corporations Act to prohibit Australian financial service licence holders or authorised representatives from dealing in a general insurance product unless the product is from a general insurer authorised under the Insurance Act, a Lloyd’s underwriter or relates to an exemption under the proposed section 3A, specified in Chapter 2 of this explanatory memorandum.

Comparison of key features of new law and current law

New law

Current law

AFSL holders and authorised representatives will be prohibited from dealing in a general insurance product that is not from an authorised insurer, Lloyd’s underwriter or where the new exemption provisions apply.

Currently, the only limit on the financial service products a AFSL holders may deal in is outlined in the licence.

AFSL holders and their authorised representatives are also required to comply with the general obligations under section 912A of the Act.

Detailed explanation of new law

3.8                    This measure prohibits AFSL holders and authorised representatives from dealing in a general insurance product unless the general insurance product is issued by an authorised insurer under the Insurance Act, a Lloyd’s underwriter or an exemption in the Insurance Act applies (that is, a section 7 or a section 3A exemption). [Schedule 2, item 1]

3.9                    For example, an insurance broker, who is an AFSL holder or authorised representative, will not be able to arrange, acquire, vary or dispose of a general insurance product for their client unless that product is from an authorised insurer, Lloyd’s underwriter or they are satisfied that the general insurance product required by the client is exempt.

3.10                Where an exemption applies, the AFSL holder or authorised representative can seek to obtain insurance for the client from any insurer, but must continue to comply with existing conduct and disclosure obligations in the Corporations Act (e.g.  the requirement that any retail personal advice is appropriate). 

3.11                It is intended that the prohibition will rely on definitions already in the Corporations and Insurance Acts.  The definition of Australian financial service licensee, contained in section 761A of the Corporations Act, and the definitions of APRA-authorised general insurer and Lloyd’s underwriter, defined in section 12 and Part 7 of the Insurance Act, respectively, apply to the prohibition.

3.12                This provision would apply to all AFSL holders and authorised representatives on its face, but in practice would impact most on AFSL holders and authorised representatives that regularly deal in general insurance products.

3.13                No amendments to the exemptions in 911A(2) are proposed.  This requirement is not to apply to a person exempted under section 911A(2) from the requirement to hold an AFSL for a financial service they provide. 

3.14                Dealing is defined in section 766C of the Corporations Act.  The prohibition does not apply to providing financial product advice, as defined in section 766B of the Corporations Act.

3.15                The prohibition only applies to general insurance products as defined in section 764A(1)(d) of the Corporations Act. 

3.16                Consistent with other offences in Chapter 7 of the Corporations Act, the prohibition is an offence of strict liability.  The maximum penalty is a fine of 50 penalty units.  [Schedule 2, Item 1]

3.17                The penalty units that will attach to this offence are of a similar order to others in Chapter 7 of the Corporations Act, for example, the strict liability offence where a person (fails to give a disclosure document or statement to a retail client, that is 50 penalty units (this means 50 x 110 for a natural person and 50 x 110 x 5 for a body corporate i.e.  $27,500). 

3.18                A strict liability offence is considered necessary to maximise the defensive value of the new offence, thus maximising its role in complementing and reinforcing the regulation of general insurance. 

3.19                This offence will enforced by ASIC under its existing powers in the Corporations Act.  The three main consequences that will flow from a breach of this measure are:

·          People affected will be able to apply to the court to seek an injunction under section 1324 of the Corporations Act to stop the prohibited conduct.

·          The general penalty provisions in section 1311 and 1312 will apply to this provision.  In addition, the defence of mistake of fact in section 9.2 of the Criminal code applies to this prohibition.  This measure will not attract a term of imprisonment. 

·          A breach of this prohibition will be a breach of obligations of financial services licensees (that is, specifically section 912A(1)(c)), and may be grounds for ASIC to vary, suspend or cancel a person’s AFSL or apply for a banning order against that person.

Application and transitional provisions

3.20                This offence will commence at the same time as the Insurance Act measures, on 1 July 2008.

Consequential amendments

3.21                A new penalty provision will be inserted into Schedule 3 of the Corporations Act for a breach of this prohibition.  It will carry a maximum penalty of 50 penalty units. [Schedule 2, item 2]



Outline of chapter

4.1                   Item 1 in Schedule 1 of the NGF Bill and Item 1 in Schedule 3 of the Bill impose a cap on levies payable, per financial year, for the benefit of the NGF.

4.2                   Schedule 1 in the NGF Bill amends the Corporations (National Guarantee Fund Levies) Act 2001 to impose the cap on levies.  Schedule 3 of the Bill amends the Corporations Act to inform readers of the cap on levies. 

Context of amendments

4.3                   The Corporations Act requires operators of financial markets to have adequate compensation arrangements, generally for the protection of retail clients.  For the ASX, the NGF provides this compensation arrangement.  Claims may be made under the terms of the Corporations Regulations 2001 .

4.4                   The NGF is administered by the Securities Exchanges Guarantee Corporation (SEGC), a subsidiary of the ASX.  The NGF was formed when the state stock exchanges merged 20 years ago and was funded by pooling part of the assets of those exchanges.  As at 30 June 2006, the NGF holds $96.8 million with the major source of funding being investment income.  The NGF is not government-funded.

4.5                   Section 889J of the Corporations Act allows the SEGC to levy participants and the market operator, the ASX, in the event that the amount of the NGF falls below the minimum amount set under section 889I of the Corporations Act (the minimum amount is currently set at $76 million).  These levying abilities are uncapped.

4.6                   Section 889K of the Corporations Act allows the ASX, as market operator, to pass on a contributory levy to participants where the operator has been levied under section 889J but only to the extent of the levy imposed on the ASX. 

4.7                   The NGF Act deals with the imposition and amount of levies imposed by sections 889J and 889K of the Corporations Act.  It is a separate enactment for constitutional reasons.

4.8                   While levies have not been imposed since the inception of the NGF currently the ASX and market participants have uncapped liabilities to refill the NGF. 

4.9                   The amendment provides greater certainty about the global liability of the ASX and participants to refill the NGF and removes this potential for unlimited liability to refill the NGF. 

Summary of new law

4.10               Schedule 1 in the NGF Bill amends section 5 of the Corporations (National Guarantee Fund Levies) Act 2001 to cap the amount of levies that could become payable in a financial year.  The Schedule 3 amendments to the Corporations Act, in the Bill, direct readers to the cap on levies.



Comparison of key features of new law and current law

New law

Current law

There will be a cap on the amount of levies that could become payable in a financial year.

However if the imposed levy was insufficient to meet claims or refill the NGF, the SEGC could impose further levies in succeeding years provided the levy did not exceed the minimum amount each year.

The existing SEGC discretion to decide who and how levies are calculated will not change except for the maximum cap on levies.

SEGC has the discretion to decide who is levied (the ASX and/or market participants) and how the amount of a levy is calculated.

There is no cap on the amount of levies payable for the benefit of the NGF.

 

 

 

Detailed explanation of new law

4.11               The measure imposes a cap on levies payable in a financial year.  The cap on levies per financial year is determined by the minimum amount that is in force at the date a levy determination is made by SEGC.  It is possible that more than one levy determination can be made in a financial year but the total of the levies, in a financial year, cannot exceed the minimum amount that is in force at the date a levy determination is made by SEGC.  This is a limit on the ability of SEGC to determine a levy under section 5 of the Corporations (National Guarantee Fund Levies) Act 2001. 

4.12               The cap applies to levies imposed under subsection 889(J)(1) of the Corporations Act.  It does not apply to levies imposed under subsection 889(K)(1) of the Corporations Act as any levy the market operator imposes on participants is already limited to the amount imposed on the market operator under subsection 889(J)(1).  This means any levy by the market operator, the ASX, on market participants cannot exceed the primary levy imposed on the ASX under section 889(J).

4.13               The cap on levies payable is linked to the minimum amount of the NGF.  The minimum amount is set under section 889I of the Corporations Act at $80 million or another amount set by SEGC.  However any amount set by SEGC must be approved by the Minister and notified in the Gazette.

4.14               SEGC determined the current minimum amount ($76 million) in March 2005.  The link to the minimum amount is appropriate as this amount reflects the needs of the NGF in light of prevailing circumstances. 

4.15               As is currently the case, levies may only be imposed if the NGF falls below the minimum amount.  The existing SEGC discretion to decide who is levied (that is, the market operator, the ASX and/or market participants) and how the amount of a levy is calculated has not changed, except for the cap on levies.

4.16               However if the imposed levy was insufficient to meet claims or refill the NGF, the SEGC could impose further levies in succeeding years provided the levy did not exceed the minimum amount each financial year.

 



C hapter 5  

Regulation impact statement: Discretionary Mutual Funds

Background

5.1                   The issue of the regulation of DMFs and DOFIs arose within the context of the collapse of HIH Insurance Limited.  The HIH Royal Commissioner recommended that the Australian Government amend the Insurance Act to extend prudential regulation to all discretionary insurance-like products - to the extent possible within constitutional limits. 

5.2                   In response to the HIH Royal Commission report, the Government commissioned the Potts review to examine the extent and nature of DMFs and DOFIs operating in Australia and their contribution to overall risk capacity. 

5.3                   As their name suggests, DMFs offer ‘discretionary cover’, that is, an insurance-like product that does not involve a contractual obligation to meet the costs if a risk eventuates.  At its discretion, the provider will consider meeting the costs.  DMFs provide a means of risk management that is an alternative to insurance.  DMFs sometimes meet risks for which commercial insurance may not be available or affordable.  DMFs benefit from cost advantages, compared to authorised insurers, due to their exemption from state taxes and, to a lesser degree, prudential regulation.  It is not clear whether their recent growth (although still a small proportion of the market) is due to their lower costs or demand for tailored products that commercial insurers do not provide. 

5.4                   The Potts review recommended that the APRA regulate all DMFs with contingent risk and all DOFIs that did not come from a regime with prudential regulation that APRA considered comparable to the Australian prudential regime.  In May 2004, the Government accepted the Potts review recommendations.

5.5                   Since then there have been a number of structural and cyclical changes to the Australian general insurance market, including a fuller understanding of the impact of the Financial Services Reform Act 2001 , tort law reforms and a softening of the insurance market, altering the impetus for regulation. 

5.6                   In December 2005, Treasury released a discussion paper seeking public input on proposals to implement the Potts review recommendations.  Treasury received submissions from Australian general insurers, DOFIs, DMFs, captives, reinsurers, brokers and agents, state governments and regulators.

5.7                   As a result of these submissions and the release of the Banks Taskforce report Rethinking Regulation: Report of the Taskforce on Reducing Regulatory Burdens on Busines s on 7 April 2006, the Government is seeking to depart from the Potts review recommendations.  This regulation impact statement (RIS) seeks policy approval for that departure.

5.8                   The Potts review noted there was no comprehensive industry or Government information available on DMFs.  However, based on the limited information that was available, the Potts review estimated that DMFs were unlikely to represent more than half of one percent of the insurance market.  The Potts review found that during the 1980s, DMFs were generally restricted to legal mutuals established under state legislation for solicitors, medical indemnity organisations, some local government pools operating as unincorporated mutuals and a university mutual.  In the 1990s the number of DMFs steadily increased in response to market opportunities.  This trend was accelerated by the hardening of the insurance market in 2001, especially in long-tail public liability lines.

Problem identification

5.9                   DMFs provide discretionary cover.  This means that there is no legal obligation by the provider to meet the costs of an ‘insured’ event.  The DMF merely accepts that it will, at its discretion, consider meeting such costs.  An insurer, on the other hand, assumes an obligation to pay the insured on the happening of an event covered by the terms and conditions of the insurance contract.

5.10               Membership subscriptions form a pool of funds to meet claims by DMF members.  Some DMFs buy insurance top up and drop down cover to supplement the pool funds, to meet large or numerous claims.  Some DMFs may make a call on their members if there is insufficient funds to cover the liabilities incurred by the members.

5.11               DMFs do not pay state insurance taxes on the DMF fund because they are not offering insurance products.  However, they do pay state insurance taxes on any insurance cover they take out to cover the risk products they offer.  Insurance taxes can add up to more than a third of the cost of the insurance product.

5.12               Both the HIH Royal Commissioner’s report and anecdotal evidence suggest that purchasers of DMFs’ products may not be aware that they are not purchasing insurance.  Anecdotal evidence suggests that in some cases the purchaser of a DMF product, the DMF member, is driven more by consideration of price.  The DMF member may not fully understand the discretion that the DMF may exercise, nor the mutual rights and obligations that flow from pooling funds to cover a member’s particular risk (including the possibility of a call on members if there are insufficient funds in the pool).  They may expect that the DMF will cover any claims and may not understand that the DMF has discretion to accept or refuse to pay a claim.

5.13               In addition, as DMF products are not insurance, DMFs are not subject to the prudential requirements in the Insurance Act.  As a result, some argue that DMFs have a greater risk of collapsing or of being forced to exercise their discretion against paying claims because they have insufficient funds.  This would leave the DMF member to meet the cost of any claim, potentially creating hardship in funding the claim and leaving a third party beneficiary without compensation (albeit only where the member has insufficient funds and the risk insured has a third party beneficiary).

5.14               Because DMFs are not subject to the prudential standards in the Insurance Act (particularly the capital requirements) and state insurance taxes (to the extent of the DMF fund), there is a concern that they may have a competitive advantage over insurers.  Insurers have argued that in some lines this competitive advantage has led to the withdrawal of domestic insurers and that in other lines it is very difficult for insurers to compete with a DMF.  However, DMFs have argued that they cover risks that Australian insurers choose not to insure, or not to insure at an affordable price.

5.15               To address these problems, Government action is required to ensure that Australians have information regarding the characteristics of the product they are contemplating purchasing, so that they are making an informed risk management choice.  Those characteristics include the discretion the DMF may exercise and the mutual rights and obligations of belonging to a DMF, in some cases this may include the ability of the DMF to place a call on its members.

5.16               In addition, Government action is required to ascertain whether or not DMFs pose a greater prudential risk because they are not subject to prudential standards. 

Objectives

5.17               The objective of Government action is to ensure that Australians have a range of risk management tools available to them and information about the characteristics of the options they are considering, so that they are in a position to make an informed decision on how to best manage their own risks. 

5.18               At the same time, the Government is seeking to maintain not only contestability, competitiveness and innovation in the insurance sector and community confidence in the Australian general insurance market, but also Australia’s reputation as a sound, well-regulated insurance market.

5.19               Currently, DMFs are generally subject to the financial services provisions within the Corporations Act and are regulated by the Australian Securities and Investment Commission (ASIC).  As they carry on a financial services business (that is, they deal in a financial product, they manage financial risk), they are required to hold an Australian Financial Services Licence (AFSL) and comply with the disclosure requirements for retail clients.  For example, they are required to disclose key characteristics of their product in the Product Disclosure Statement (PDS) they are required to provide to retail clients. 

5.20               Neither the Corporations Act, nor the Corporations Regulations, specifically identify what the key characteristics of a DMF product are and, therefore, what DMFs must disclose to a potential client.  As a result, it is possible that DMFs may not inform potential retail clients about the DMF’s discretion to pay claims and the mutual rights and obligations that flow from being a DMF member, including, in some cases, the DMF’s ability to place a call on its members.

5.21               The requirement to disclose the key characteristics of a DMF product to clients is limited to retail clients.  A business that does not manufacture products and that employs more than 20 people is not a retail client.  This means that, under the Corporations Act, the DMF does not need to disclose the characteristics of its product to potential wholesale members.  Small businesses which may be just above the retail test (for example, they employ 22 people instead of 20) may not understand the characteristics of the DMF product.  Anecdotal evidence suggests that a large number of many DMFs’ wholesale clients may fit this example.  In practice many DMFs, particularly those with retail and wholesale clients, will provide both classes of client with the same information.  However, this is unlikely to occur where the DMF has no retail clients.

5.22               In addition, most DMFs are considered managed investment schemes (MIS) and as such are required to be registered as one under Chapter 5C of the Corporations Act with ASIC.

5.23               The conduct in relation to DMF products is also subject to the consumer protection provisions of the Australian Securities and Investments Commission Act 2001 (for example, DMFs are prohibited from engaging in misleading or deceptive conduct, misleading representation or unconscionable conduct in dealing with their clients). 

5.24               DMFs are also subject to the broader regulatory environment.  That is, DMFs are generally established as either a corporation limited by guarantee or trust fund.  In both cases, they are subject to the broader regulatory requirements contained in legislation and under the common law.  For example, corporations limited by guarantee are regulated by the Corporations Act as a corporation. 

Identification of options

5.25               There are four options to address the issues raised in relation to the regulation of DMFs.

Option 1: Full prudential regulation

5.26               Under this option, DMFs would be required to become Australian authorised general insurers under the Insurance Act in order to continue operating.  As an Australian authorised general insurer, they would be subject to the consumer protection provisions that apply to general insurers under the Corporations Act and Insurance Contracts Act 1984 and APRA would collect information from them under FSCODA.

5.27               DMFs would be required to apply to APRA to become authorised Australian general insurers.  They would be required to provide information on their ownership, board and management, a three-year business plan, the structure of their business, their financial projections and a risk management and reinsurance management strategy.  They would have an ongoing obligation to comply with Australian prudential standards, that is, they would be required to hold capital equal to the minimum capital requirement and have assets in Australia equal to their liabilities.  The DMF would also need to satisfy APRA that the directors and senior managers were eligible to hold key positions within their organisation.  They would also need to appoint an auditor, and possibly an actuary, approved by APRA.  They would also need to satisfy APRA that their proposed risk management and control systems were adequate and appropriate for monitoring and limiting the risk exposures in relation to their operations (including balance sheet and market risks, reinsurance risks, liability risks and capital management risks).  APRA has indicated that it believes that imposing solvency requirements on a discretionary vehicle could be difficult so DMFs would have to restructure so as to offer contractual insurance coverage.

5.28               Under the Corporations Act DMFs, as insurers, would be required to provide PDSs to their retail clients.  For general insurers, retail clients are individuals or small business seeking a motor vehicle, home building, home content, consumer credit, sickness and accident, travel or personal or domestic insurance product.   

5.29               Under the FSCODA, DMFs, as insurers, would be APRA-regulated entities and as such they would be required to provide information on a quarterly basis to APRA.

Option 2: Potts review recommendation — no contingent risk

5.30               Under this option, the Government would implement the Potts review recommendations that required discretionary mutual cover to be offered only as a contract of insurance under the Insurance Act, except where APRA considered that the DMF had no contingent risk that would need to be met by additional undefined member contributions.  (Such risks would fall on a general insurer providing top up or drop down cover.) APRA would also be required to collect information on business written by DMFs under the exemption.

5.31               Under this option, all DMFs would have to submit information to APRA on an ongoing basis, at least annually, so that APRA could assess whether or not the DMF retained any contingent risk.  This information is likely to include information on the structure of the DMF, the amount of money the DMF retained in its fund, information on the products it provided to members and copies of the insurance policies it had taken out to cover any claims in excess of its fund. 

5.32               APRA would decide whether or not the DMF retained any contingent risk.  If it found that the DMF did retain contingent risk, APRA would require the DMF to either cease providing the product or to set up as an insurer and comply with all the requirements detailed above in option 1, including the consumer protection and information collection requirements and the potential for a restructure of the DMF and its product offerings.  APRA would have responsibility for ensuring that the DMF complied with its assessment.  If, however, APRA determined that the DMF did not retain any contingent risk, then it would not prudentially regulate the DMF.  DMFs would still be required to have an AFSL and comply with the consumer protect provisions in the Corporations Act that currently apply to them.

5.33               DMFs would also, depending on how they were structured, still be required to comply with the general Corporations Act provisions that apply to corporations or trust law obligations that apply to trusts.

5.34               In addition, if the DMF was not APRA-regulated it would still be required to submit information to APRA on an ongoing basis under the FSCODA APRA would enforce the provisions of the FSCODA.  APRA would be likely to require information on the number of members, premium income, lines of business, insurers and additional information on its financial statements. 

Option 3: No prudential regulation at this stage but collect information and strengthen consumer protection and commence a review within three years after implementation

5.35               Under this option, DMFs would not be prudentially regulated at this stage.  However, DMFs would continue to be subject to the consumer protection provisions of the Corporations Act and the provisions that apply to DMFs’ clients would be strengthened and extended to DMFs’ wholesale clients.  DMFs would also become subject to the FSCODA.  The Government would review within three years after implementation these provisions to determine whether or not to prudentially regulate DMFs.

5.36               DMFs would also, depending on how they were structured, still be required to comply with the general Corporations Act provisions that apply to corporations or trust law obligations that apply to trusts.

5.37               The FSCODA would be amended so that it applies to DMFs.  APRA would collect information on the risks DMFs cover, the volume of business and any additional information (for example, information on their structure) that would assist the Government in determining whether or not DMFs need to be prudentially regulated, including information on the DMF’s financial statements. 

5.38               Information would also be collected from Australian financial service licence holders who promote or develop DMFs through an amendment to the Corporations Regulations.

5.39               Consumer protection provisions would be strengthened by inserting a regulation into the Corporations Regulations to specify information a DMF must provide to its members before they join the fund.  This would include information on the mutual rights and obligations that flow from becoming a member of a DMF, whether and to what extent they would be subject to a call, the discretionary nature of the product they are purchasing and how the rules governing their membership could be altered. 

Option 4: Status quo — no prudential regulation

5.40               Under this option, the current arrangements regarding DMFs would continue.  DMFs would not be prudentially regulated.  ASIC would continue to regulate DMFs under the Corporations Act as an AFSL holder and they would be required to comply with the Corporations Act disclosure requirements for retail clients.  For example, they are required to disclose key characteristics in their PDSs to retail clients.

5.41               DMFs would also, depending on how they were structured, still be required to comply with the general Corporations Act provisions that apply to corporations or trust law obligations that apply to trusts.

Analysis of the impact of the options

5.42               The groups most affected by the regulation of DMFs are: DMFs, DMF members, insurers and the regulators, APRA and ASIC.

5.43               In accordance with Government requirements, attached to this RIS is a Business Cost Calculator Quickscan Report outlining the costs to DMFs of adopting the various options detailed in this RIS.  A full cost report was not undertaken due to the lack of information available on the number of DMFs operating in the Australian risk market and their role. 



Option 1

Option 1:   Full prudential regulation

 

Benefits

Costs

DMFs

Moderate - increased financial stability and implied endorsement by the regulators

Large - costs of becoming an Australian authorised insurer

DMF members

Moderate - to the extent that the DMF members can obtain insurance not subject to a DMFs discretion or additional calls

Large - significant increases in the contributions of DMF members

Insurers

Small to moderate - insurers could increase their market share if they insure former DMF members

Small - should an insurer choose to offer cover to former DMF members it may incur the increased administrative costs for a large number of small claims currently borne by the DMF

Regulators

Nil

Small to Moderate - the exact costs will depend on the number of DMFs that become insurers and their asset levels.  There will be the cost of authorising DMFs and collecting information from them.

 

Benefits

DMFs

5.44               DMFs would benefit from prudential regulation through their increased financial stability and implied endorsement by APRA.  DMFs would be APRA regulated as general insurers and this implies that the regulator assesses the entity as solvent and that the claims of policyholders will be honoured in all normal circumstances. 

5.45               In addition, to the extent that they were APRA-regulated entities providing their financial services to wholesale clients only they would be exempt from the requirement to hold an AFSL.  DMFs who meet the above criteria would have cost savings because they would not have to obtain an AFSL or meet the ongoing compliance obligations imposed on AFS licensees, for example the requirement to provide a PDS to their clients.  The number of DMFs that may only have wholesale clients and so benefit from this exemption is not known.

DMF members

5.46               Potential and existing DMF members would benefit from the prudential regulation of DMFs as they would not need to understand the unique rights and obligations associated with being a member of a DMF or the discretionary nature of the DMF product they were purchasing.  Under this option, DMFs would become insurers and offer insurance policies. 

5.47               DMF members would be assured that if an event covered by the DMF occurred, they would be covered for that loss according to the terms of the insurance contract.  The DMF would not have any discretion to reject a claim meeting the policy’s terms and conditions.

5.48               Furthermore, DMF members would not be subject to any additional calls, as there are no calls on the holder of a insurance policy.  As a result, there would be more certainty for the DMF members about the price they pay for their cover.  (However, most DMFs that can call on their members explicitly outline the percentage of total premiums they can seek in a call when the DMF member purchases the DMF product.)

5.49               The increased certainty that a claim that met the terms and conditions of the policy would be paid out would flow on to third party beneficiaries.  If a third party beneficiary suffered a loss as a result of the action of a DMF member that was within the terms of that member’s insurance cover, they would be compensated by the insurer.  They would not have to rely on a fund, with a discretion, deciding whether or not to pay their claim or, if it did not, on the capital of the DMF member.  (However, this benefit is limited by the fact that generally there is no requirement to take out insurance.)

5.50               DMF members and third party beneficiaries would also benefit from the protections in the Insurance Act, the Insurance Contracts Act and the Corporations Act that apply to general insurers.  For example, under the Insurance Act, DMF members and third party beneficiaries benefit from the prudential requirement that insurers must keep sufficient assets in Australia to cover their liabilities.  In the event of a failure of a fully regulated DMF, the assets maintained in Australia are to be used to pay claims to Australian creditors before being available to other creditors.

5.51               Third party beneficiaries would also have the benefit under the Insurance Contracts Act that certain insurance policies provide the right to have their claim paid out even if the insured disappears.  Again, this is a benefit only to the extent that a DMF member takes out insurance to cover the risk previously covered by the DMF.

Insurers

5.52               Insurers would benefit from a requirement for DMFs to become authorised insurers as some DMFs that cannot or would not comply with APRA prudential standards would exit the market.  DMF members currently using DMFs to manage their risks would have to either self insure or seek replacement cover from an insurer.  A number of these DMF members are likely to seek insurance cover to replace the risk cover they obtained from the DMF.  This would increase the market share for insurers.  The exact benefit to insurers would depend on the number of DMFs that cease operations.  This may lead to reduced competition in particular lines of insurance business. 

5.53               Brokers, too, would also be likely to benefit.  Former DMF members or people requiring cover for difficult to place risks may approach brokers for assistance in finding replacement cover from insurers.  Again, the exact scope of the benefit to brokers would depend on which, and how many, DMFs cease operating.  It would depend on the risk products these DMFs provide and the ease with which a DMF member can access an insurance product to cover the risk previously covered by the DMF.  DMFs argue that they cover risks that Australian insurers choose not to insure.

Regulators — APRA/ASIC

5.54               There would be no direct benefit to APRA or ASIC under this option.

Costs

DMFs

5.55               Under this option, DMFs would be subject to the same prudential, reporting and licensing requirements as Australian general insurers.  This would eliminate the significant benefits that DMFs obtained from not having to comply with these requirements, in particular the minimum capital requirements, and from not incurring state insurance taxes on products they sold (although DMFs do incur taxes on the top up and drop down insurance products they buy). 

5.56               This option would impose significant costs on DMFs doing business.  In particular, DMFs would be required to comply with the APRA’s minimum capital requirements for insurers (currently $5 million).  DMFs unable to produce a fund of $5 million or to restructure so as to be able to offer contractual cover would cease operating. 

5.57               In addition, DMFs would have to apply to APRA to become Australian authorised general insurers.  The APRA application fee for a licence for general insurers is currently $68,200 (including GST). 

5.58               There would also be the cost to the DMF of ongoing supervision.  The current levy arrangements provide the best estimate of ongoing levies.  The following excerpt from the Financial Sector Levies Discussion Paper provides a basis for the estimate. 

Table 15: Levy Amounts On General Insurers ($’000)

Asset Base

$5m

$25m

$250m

$750m

$3b

$9b

2006-07

5.1

6.9

69.2

207.5

830.0

1,364.0

 

5.59               For those DMFs that provide professional indemnity and public liability cover there would also be the additional NCPD levy.  The levy is a function of an institution’s premium income in those classes as detailed in the following excerpt from the Financial Sector Levies Discussion Paper:

Table 9: Levy parameters for NCPD Levy

Approximate levy parameters based on recouping 1 year’s costs

 

Professional Indemnity

Public and Product Liability

Minimum ($)

5,000

5,000

Maximum ($)

32,000

50,000

Rate (% of premiums)

0.086

0.085

 

DMF members

5.60               As a result of the capital requirements alone, it is likely that a number of DMFs would be unable to become authorised Australian general insurers and would instead exit the market.  This would reduce the number of risk management tools available for Australians to choose between.  The impact on DMF members would depend on how difficult it is for them to obtain replacement cover from the insurance market and how readily they can afford the additional premiums likely to be charged by the insurer.  For many DMF members the cost is likely to be significant, as they have found it difficult to obtain insurance from traditional insurers, either because the risks they seek to insure do not fit neatly within the standard insurance products offered by insurers or because the cost of coverage is beyond what they can afford to pay. 

5.61               DMF members may be unable to get insurance for some risks and may have to pay more to insure other risks, obtaining a less tailored product in the process. 

5.62               For other DMF members the costs may be minimal, although there is likely to be an increase in the premiums that they are charged, due to taxes being levied on the entire risk and not just on the top up or drop down insurance policies that a DMF may take out to cover its risk products.  Some DMF members may have risks for which it is relatively easy to find replacement cover from an insurer.  For example, cover for a large business seeking property cover for an ordinary building is likely to be readily available in the Australian insurance market.

5.63               DMF members, if they become insureds, are also likely to be more greatly impacted by the Australian general insurance market cycle.  At the moment, with a softening insurance market, they may be able to obtain insurance cover.  As the cycle moves and the market hardens, they may find it more expensive or more difficult to obtain or renew cover.  Anecdotal evidence suggests that a number of DMFs were set up after the collapse of HIH and UMP, at a time when the insurance market had hardened, precisely because their members could not obtain coverage from insurers either at all or at a price they were willing to pay. 

Insurers

5.64               Insurers would also be under some pressure to provide cover at affordable prices for former DMF members whose DMF no longer covers their risk.  This is particularly the case with community groups that had great difficulty in obtaining public liability cover when the insurance market hardened in 2001.  Although a moderate cost for insurers, there could be reputational damage to the industry if former DMF members are unable to obtain replacement risk cover.

5.65               In addition, DMF members would have less incentive to minimise or take responsibility for their risks where they transfer that risk to an insurer.  DMFs are funded by members who often have a common association and thus are likely to exert pressure on other members to minimise their risk.  In contrast, there is little or no ‘peer pressure’ or risk management skill transfer between the different policyholders of an insurer (although, the number and amount of claims may affect the insurance premiums that a DMF member will pay in the future).

Regulators — APRA/ASIC

5.66               For APRA there would be the additional costs of granting more insurance licences.  For APRA and ASIC there would be additional monitoring and enforcement costs associated with extending prudential regulation to these entities. 

5.67               However, APRA is mainly funded through industry levies and licence fees, therefore any increased costs for APRA are likely to flow through to DMFs through levies.  The exact estimate of these costs would depend on the number of DMFs that become insurers.

5.68               ASIC would have a minor cost saving because it would not have to issue licences to DMFs that were APRA-regulated and had only wholesale clients or monitor compliance with licensing requirements for these DMFs.

Option 2

Option 2:   Potts review — no contingent risk

 

Benefits

Costs

DMFs

Large - most DMFs have no contingent risk and could continue to operate and offer an alternative to insurance for Australians

Moderate - some DMFs will cease operating, resulting in members needing to find replacement cover

DMF members

Moderate - to the extent that DMF members can still obtain cover not subject to a discretion or additional calls

Moderate - increases in premiums to the extent that the DMF members can obtain replacement cover where DMFs exit the market

Insurers

Small - DMFs will need to take out insurance to cover their risk products and some DMFs may cease operating, with members needing replacement cover

Small - reputational damage if former DMF members cannot access replacement cover and perhaps some additional administration costs

Regulators

Nil

Moderate - estimate cost of establishing separate regime $500,000-$1 million plus ongoing enforcement and monitoring

 

Benefits

DMFs

5.69               Anecdotal evidence suggests that a large number of DMFs would have no contingent risk and would be able to continue to operate in Australia.  This option would provide a substantial benefit to DMF members and the Australian community, as DMFs would continue to provide an alternative risk management tool for DMF members.  This option would also allow DMF members, who have been unable to obtain traditional insurance, to continue to transfer their risk to another entity, in this case the DMF. 

DMF members

5.70               DMF members and third party beneficiaries would also have the significant benefit that there would be no contingent risk to them.  If the DMF had insufficient funds to cover a claim, the DMF’s top up or drop down insurance policies would cover the claim. 

5.71               In addition, DMF members would have certainty as to the premium payable to cover their risk.  The DMF would not be able to place a call on its DMF members.

Insurers

5.72               A number of DMFs may be unable to restructure or obtain insurance policies to cover some or all of their risks.  As a result, these DMFs would have to cease operations.  This could result in a moderate benefit to insurers in that they could potentially obtain more business from DMF members whose DMF ceased operation. 

5.73               Finally, insurers would also have the substantial benefit that all DMFs remaining would need to insure the risks they cover for their members, so as to satisfy the no contingent risk condition.

5.74               Brokers, too, would obtain a moderate benefit under this option.  A number of the DMFs, particularly those with difficult to place risks, may seek assistance in finding insurance to cover the risk above the DMF fund. 

5.75               In addition, former DMF members, whose DMF has ceased operations, may also seek assistance from brokers in placing their risks and in obtaining the best insurance cover. 

Regulators — APRA/ASIC

5.76               There would be no additional benefits to APRA or ASIC from this option.

Costs

DMFs

5.77               This option would impose significant costs on some DMFs.  Some DMFs would not be able to obtain insurance cover for some or all of the risk products they offer their members.  As these DMFs would retain some contingent risk, these DMFs would have to become insurers, cease operating or sever the lines of business for which they cannot obtain insurance cover. 

DMF members

5.78               This option would result in a significant cost to some DMFs members, who may not be able to obtain insurance cover for their risks and will have to self insure.  As a result, in the event that there is a claim for that risk they would have to bear that claim themselves.  Depending on the size of the claim and how they are organised, this would see them potentially being liable for the claim or their business ceasing operations because the business has insufficient assets to meet the claim. 

5.79               In addition, DMF members have the substantial cost of also losing an alternative risk management tool, potentially making them even more reliant on insurance and insurers and more susceptible to the insurance cycle.  They would also have to pay in most cases a higher premium for their risk cover, as insurance taxes will be added to the pure risk insurance premiums. 

5.80               The exact impact of applying this sort of regulation is not known as it is not clear exactly how many DMFs operate in Australia, the precise covers they offer, how many members they have or what is the scope of their activities.  The decision to cease operating or to cease providing a particular risk cover would be made by the individual DMF based on its financial situation, the views of its members and the difficulty it had in obtaining insurance to cover its risk product.  As a result, it is not possible at this stage to predict with any certainty what a particular DMFs would do or what would happen to the availability of particular lines of business.

5.81               Even those DMF members who remain part of an operating DMF are likely to have somewhat higher contributions.  DMFs would have the additional administrative costs of providing financial statements and coverage details to APRA (so that APRA can determine they retain no contingent risk) and pass on the additional costs of obtaining top up and drop down insurance to cover the risks in the DMF fund.  While, it is not anticipated that these administration costs would be significant, the cost of the additional insurance could be moderate.  The exact costs to each DMF member would vary depending on how many members there are in the DMF, its lines of business and the complexity of its financial affairs. 

5.82               It is not anticipated that the DMF’s provision of information to APRA is likely to add significant costs to most DMF members.

5.83               Finally, this option does not strengthen the consumer protection provisions that would apply to potential DMF members determining whether or not to cover their risk through a DMF.  The current arrangements outlined above under the policy objective would continue to apply.  As noted, there are a number of DMF members who, although they are wholesale clients and therefore are not required to be given a PDS, nonetheless may not have the expertise to obtain information about the characteristics of the product they are considering purchasing. 

Insurers

5.84               Insurers would be under some pressure to provide insurance policies to cover the DMF risk cover, given that the consequence of the DMF being unable to obtain cover is that it must cease to write that line of business. 

5.85               The insurers would also face the same costs as outlined under option 1 where a DMF stops covering a member’s risk and the member seeks to replace their DMF risk cover with insurance cover. 

5.86               Although these are a minor cost for insurers, there could be reputational damage to the industry if former DMF members are unable to obtain replacement risk cover.

Regulators — APRA/ASIC

5.87               This approach is likely to result in significant costs for APRA, in the form of greater complexity and uncertainty, as APRA would have to establish, monitor and enforce a separate prudential regulatory regime applying only to DMFs.  In particular, APRA is concerned that it is likely to be held responsible if a DMF collapses, as it developed the regime.  This has significant reputational costs for APRA and significant costs for Australia’s reputation as a well regulated insurance market. 

5.88               APRA has estimated the costs of establishing a separate prudential regulatory regime at $500,000 to $1 million.  This is, as noted earlier, a high level estimate.

5.89               APRA has no basis for estimating the cost of authorisation without considering in more detail the separate prudential regulation regime.  It is suggested that the current general insurance licence fees provide an estimate of these costs in the absence of better information.

5.90               Similarly, APRA has no basis for estimating the on-going costs of monitoring, supervising and enforcing this new prudential regime without determining what monitoring, supervising and enforcing may entail.  The current general insurance levies detailed above provide an estimate of these costs in the absence of better information. 

5.91               The Government too is concerned with how it would define contingent risk and apply the test in a meaningful way to allow at least some DMFs to continue to operate in the Australian market.  It would take time to determine what constituted no contingent risk. 

5.92               In addition, it is unlikely that any concept developed will fully cover the range of activities that the Government is seeking to capture.  This would require the Government to review the initial interpretation of contingent risk and to modify that definition.  These changes would create uncertainty in the risk management market. 

5.93               Moreover, given that the Potts review found that DMFs only account for 0.5 per cent of the Australian general insurance market, the Government may be seen to be overregulating DMFs, particularly in light of the Banks Taskforce report and the ‘regulate first, ask questions later’ culture identified in that report. 

Option 3

Option 3: No prudential regulation but collect information and strengthen consumer protection and review in three years time the need for prudential regulation

 

Benefits

Costs

DMFs

Moderate - improved understanding of their market and role

Very small - very small increase in administration costs from strengthened consumer protection and providing APRA with information, but this will be passed on to members

DMF members

Large - continue to have access to an alternative risk management tool, but with strengthened disclosure to ensure they have the information to make an informed decision about the risk management product they use

Very small - very small increase in costs flowing from strengthened consumer protection and information provision

Insurers

Nil

Nil

Regulators

Large - APRA obtains the information required for Government to determine whether or not to prudentially regulate DMFs and for the Government it will assist in determining whether there are any market gaps in the Australian insurance market.

Small - $200,000 - $400,000 to establish and then $1,500 - $2,000 ongoing costs per entity per receipt of information

 

Benefits

DMFs

5.94               This option would have the significant advantage of being proportionate, in that it seeks to address the critical concern of consumer protection in a targeted way, addressed specially at the provisions most directly created to enhance consumer protection, that is the disclosure requirements in the Corporations Act, while at the same time not imposing a form of prudential regulation on a group of entities, where there is insufficient information currently available to understand the extent and nature of their presence in the market and the risks they pose. 

DMF members

5.95               This approach ensures substantial benefit to DMF members as they continue to have a range of risk management tools available to them, so that they can determine how to manage their risks.  However, it also allows DMF members to make these risk management decisions based on disclosed information of the costs and benefits of using a DMF product over insurance to cover their risks. 

Insurers

5.96               There would be no direct benefit for insurers from this option, although insurers may benefit from consumers being more well informed about the DMF product and as a result, choosing to have their risk covered by an insurance policy, rather than a DMF product.

Regulators — APRA/ASIC

5.97               APRA would collect information on DMF activities under this approach.  For APRA, this is a significant benefit, in that it will be able to use this information to determine clearly the size, structure and lines of business of DMFs.  They would also have the information necessary to assist Government in determining whether or not there is a need to prudentially regulate DMFs.

5.98               ASIC, too, would benefit.  Requiring all DMF members to be given information on the key characteristics of the DMF product before they decide to cover their risks using the DMF product may reduce complaints from DMF members who did not fully understand the product they were obtaining.  Because of the way complaints are made to ASIC and then recorded by ASIC, it is not clear how many complaints ASIC has received against DMFs.  As a result, it is unclear how significant this benefit would be to ASIC.

5.99               The Government would also be seen to be taking a targeted approach and obtaining the necessary information to determine where or not there are prudential reasons to impose significant and costly regulatory requirements on business.  This approach would have a significant benefit to the Government, in that it is in keeping with the Government’s response to the Banks Taskforce.  Moreover, by collecting information on DMFs, Government may also benefit by getting an early indication of gaps in the insurance market and signs when the insurance market is beginning to harden.

Costs

DMFs

5.100           DMFs would have slightly higher administration costs from this option as the DMF would have to provide APRA with information on its activities and its members with information on the key characteristics of the DMF product they are purchasing.  At the moment they only need to provide this information to their retail clients. 

5.101           It is not possible to calculate exactly what these additional costs will be because the costs will vary depending on the number of its members, whether these members are wholesale clients not currently receiving this information, the lines of business of the DMF and the complexity of its financial situation.  It is likely that this amount will be very small as it would be spread across all the DMF members.  In fact, anecdotal evidence suggests that those DMFs with both retail and wholesale clients will face no additional cost as they already provide wholesale clients with PDSs.

5.102           The DMFs that experience the highest administration costs are those DMFs that have only wholesale clients and presumably are not providing these clients with a PDS.  However anecdotal evidence suggests that there are very few DMFs that fit into this category and as noted above the cost of printing and providing a information on the key characteristics of the product to members is likely to be very small, when spread across all of a DMFs’ members.

5.103           Anecdotal evidence also suggests that the cost to DMFs of collecting the information APRA would require is likely to be comparatively small.  A number of DMFs are already collecting information on the lines of business they write, the premiums they receive, the claims they pay out and the insurance premiums they pay for their own risk management purposes.  As a result, it is unlikely to impose a significant cost on DMFs to pass this information to APRA.  There is unlikely to be a significant increase in the administration cost on members. 

5.104           DMFs are also required to provide annually to ASIC copies of their financial statements as a condition of their AFSL.  Passing that information to APRA is unlikely to result in significant costs to the DMF and hence to its members.

DMF members

5.105           As noted above, it is not possible to calculate exactly what the costs of this option would be, but it is likely to be very small, as it would be spread across all DMF members.

Insurers

5.106           There would be no direct costs to insurers from this option.

Government regulators — APRA/ASIC

5.107           APRA would require additional resources to undertake the collection of information on DMFs.  They estimate they would require $200,000 to $400,000 to establish the collection of information.  Again, this is a high level estimate. 

5.108           The ongoing cost per entity per receipt of information is likely to be $1,500 to $2,000.  APRA developed these figures based on some work done in relation to superannuation licensing and so is reasonably confident with their robustness. 

5.109           For those DMFs that provide professional indemnity and public liability cover there would also be the NCPD levy as detailed under Option 1 above.

Option 4

Option 4:   No regulation

 

Benefits

Costs

DMFs

No additional compliance costs

Nil

DMF members

No additional costs and members continue to have access to a wide range of risk management tools

Moderate to large - DMFs members may not have information on the characteristics of the product that would then enable them to make an informed decision on whether to become a member

Insurers

Nil

Moderate - DMFs will continue to compete with insurers in the risk management market, but will not be subject to the prudential requirements and their products will not have insurance taxes applied to proportion of the members’ contribution that remains in the DMF fund

Regulators

Nil

Moderate - APRA will not be able to provide information to Government so that Government can decide whether or not to prudentially regulate DMFs

 

Benefits

DMFs

5.110           This approach has the benefit of not creating any additional compliance costs or paperwork for the DMF.  Moreover, it also ensures that DMFs would continue to offer alternative risk cover.  DMFs would continue to have the benefit of not being prudentially regulated or subject to state insurance taxes, to the extent that they do not pay insurance taxes on the proportion of the members’ premiums that is pooled in the DMFs’ fund.  They would not have to retain a minimum level of capital and will not be subject to the risk management, reinsurance, or assets in Australia prudential standards outlined above, which insurers argue allows DMFs to provide their products at lower prices and gives them a significant competitive advantage.  In addition, DMFs would not be required to provide information to APRA and will not face that additional cost.

DMF members

5.111           This option has the benefit that DMF members would have DMF products as an alternative risk management tool.  In addition, DMF members would not be faced with the costs of the DMF providing information to APRA.

Insurers

5.112           There would be no direct benefit for insurers from this option.

Regulators — APRA/ASIC

5.113           This approach would not create additional compliance costs or paperwork on the regulators. 

Costs

DMFs

5.114           This option has no cost for DMFs. 

DMF members

5.115           This approach potentially imposes a cost on DMF members.  Consumer protection provisions that protect potential DMF members are not strengthened, so it is not certain how well informed these potential members are and whether they understand the consequences that flow from choosing a DMF product over an insurance product.  As a result, they may not have considered the financial implications to themselves if they are required to meet a claim and the DMF exercises its discretion to refuse the claim or there is a call on members. 

Insurers

5.116           Insurers would also have the significant costs of having to compete with DMFs.

Regulators — APRA/ASIC

5.117           This approach also imposes a potentially significant cost on APRA, APRA may be concerned about leaving DMFs unregulated, particularly in the event that one of the DMFs collapses.  In particular, APRA has made the point that Australian policyholders are unlikely to understand the distinction between a DMF product and an insurance product, in the event that a DMF does not pay out on a claim where the member expects it to or where the DMF collapses.

5.118           Under the current approach, there is a limited understanding of what DMFs must disclose to their retail members and there is less information required to be disclosed to wholesale members before they agree to purchase the product.  As a result, ASIC cannot be certain that the members have fully understood the characteristics of the product they are purchasing.  This may result in complaints to ASIC against the DMF which they will have to spend resources investigating. 

5.119           In addition, without gathering information to understand the DMFs’ role in the market, the Government also has the significant cost, under this approach, that it can not determine whether it should be concerned about the possible long term impacts of DMFs on the viability of the general insurance market in Australia.  In particular, it cannot measure their effects on lines of business where Australian insureds have traditionally had difficulty obtaining insurance or determine whether any market gaps may be developing.

Consultation

5.120           The Government has undertaken a public inquiry into the regulation of DMFs and their role in the general insurance industry.  It has also released a Treasury discussion paper and had continual consultation with key stakeholders over the last three years. 

5.121           In 2003, the Government undertook the Potts review.  The Potts review sought submission from the public on the extent and nature of DMF operations in Australia and their contributions to overall risk capacity.  The Potts review received 19 submissions from a range of stakeholders including DMFs, Australian authorised general insurers, brokers and agents, industry associations, state governments and the regulators, ASIC and APRA.  In response to comments in these submissions, the Potts review developed its key recommendations, which were accepted by the Government in May 2004. 

5.122           In December 2005, Treasury released its public discussion paper seeking comments from all interested stakeholders on the implementation of the Potts review recommendations.  It received 28 submissions from a range of stakeholders, including Australian insurers, DMFs, brokers, industry associations, the regulators, ASIC and APRA and a number of state governments.

5.123           Throughout this period, Treasury has also consulted with interested stakeholders.  It has held a number of meetings with DMFs, insurers, brokers and both regulators to better understand DMFs and their role and regulation, and also to determine how to implement the Potts review recommendations. 

5.124           From the various submissions and discussion held with key stakeholders varying views emerged, although most stakeholders have held largely consistent views throughout the consultations to date. 

5.125           Insurers believe that DMFs should either be required to become authorised general insurers or be required to abide by the same regulatory requirements as insurers; that is, they should be required to comply with APRA prudential standards, the Insurance Act, Corporations Act and the Insurance Contracts Act.  They want to ensure a level playing field and protect Australian policyholders and third party beneficiaries.

5.126           Brokers believe that DMFs should either be captured under the ‘carrying on insurance business in Australia’ definition in the Insurance Act and have to comply with that Act, or that their activity should be regulated through the financial intermediaries that provide their products and that they should be subject to increased disclosure requirements but not prudentially regulated.

5.127           DMFs do not believe that they should be regulated by APRA, either because of the structure of their business (that is they are a corporation limited by guarantee and as such they should be regulated by ASIC) or because they do not have any contingent risk because they have insurance policies to cover their risk cover beyond the money in the fund. 

5.128           All stakeholders however do agree that it would be helpful to collect information on the activities of DMFs and their role in risk management market in Australia.

5.129           The views of these stakeholders have been taken into consideration in determining the options contained in this RIS.  In essence, the options in this RIS were developed from the range of options suggested by stakeholders.  These options were examined taking into consideration the key concerns raised by these stakeholders — competitive neutrality, the protection of DMF members and third party beneficiaries, the range of risk management tools available to provide capacity in the Australian risk management market and the potential broader systemic risk that DMFs pose to the risk management market, the financial system and other key markets in Australia.

Conclusion and recommended option

5.130           At the moment there is insufficient information to determine the role and size of DMFs operating in the market nor the type of prudential regulation that would be appropriate if they were to be licensed.  There is no evidence that the collapse of a DMF would result in any broader systemic risk to the financial system and other markets in Australia.  As a result, there is insufficient evidence to justify the prudential regulation of DMFs (either full prudential regulation [option 1] or partial regulation, by only allowing DMFs with no contingent risk to continue to operate [option 2]). 

5.131           However, it is important to collect information on DMFs so that the Government can determine whether DMFs pose any greater risk to their members or the broader risk management market, financial system and other key markets in Australia.  In the meantime, it is also prudent to ensure that those who use a DMF product to cover their risks have information available to them to allow them to weigh up the costs and benefits of using a DMF product over self insuring or taking out an insurance policy.  As a result, the preferred approach is option 3.  This does not involve prudential regulation at this stage, but would instead strengthen consumer protection, collect information on DMFs and review these arrangements and the need for prudential regulation within three years after the commencement of these arrangements.

5.132           This option rests on the assumption that full prudential regulation of DMFs is likely to result in DMFs exiting the market, reducing the risk management tools available to Australians and increasing the costs of risk transfer for those Australians that cannot get insurance to cover their risks. 

5.133           Finally, it also rests on the assumption that, while DMFs account for a very small percentage of the Australian risk management market, they fill market gaps or provide products that may be more suitable for their clients than conventional insurance contracts.

5.134           This option balances the need to ensure that Australians can access a range of risk management products, while at the same time protecting DMF members, by ensuring that they have information about the product they are purchasing.  In addition, it also provides for a review of the need for prudential regulation within three years after the commencement of the provisions and once the regulators have sufficient information to identify the role and markets of DMFs.

Implementation and review

5.135           It is proposed that option 3 will be implemented through legislative amendments to the FSCODA, Corporations Act and the Corporations Regulations.

5.136           The FSCODA will be amended so that it applies to DMFs.  APRA, using its powers under the Act, will collect information on the risks DMFs are covering, the volume of business and any other information (for example, information on their structure) that the Government will require in order to determine whether there is a need to prudentially regulate DMFs.  APRA will collate this information and it may be published, subject to confidentiality considerations.  Limiting the information collected and collecting it only twice a year will reduce the compliance costs and paper burden on DMFs.

5.137           Information will also be collected from Australian financial service licence holders who promote or develop DMFs through an amendment to the Corporations Regulations.

5.138           Consumer protection provisions will be strengthened by inserting a regulation into the Corporations Regulations that specifies the information that a DMF must provide to its members before they join the fund, namely the mutual rights and obligations that flow from becoming a member of a DMF, including whether and to what extent they will be subject to a call, the discretionary nature of the product they are purchasing and how the rules governing their membership can be altered.  This protection will cover both retail and wholesale clients of a DMF.  The exact form that this regulation will take will be developed by ASIC and Treasury in consultation with industry.  The intention is not to prescribe a set of words that must be used in the regulation, but rather to specify what the key characteristics of the DMFs’ product are.

5.139           This approach is flexible, in that these items represent the minimum information that DMFs must disclose.  The individual DMF and ASIC can determine whether there any other items that a particular DMF should disclose.

5.140           Finally, under this option the Government will undertake a review within three years of implementing these arrangements to determine whether or not DMFs should be prudentially regulated and, if so, how.  Moreover, information will provide Government with information on the place DMFs occupy in the Australian risk management market in particular lines of business, to help it make this decision.

Discretionary Mutual Funds Quickscan report

What is the problem you wish to address?

Anecdotal evidence suggests that purchasers of DMFs products may not be aware that they are not purchasing insurance.  In addition, as DMF products are not insurance, DMFs are not subject to the prudential requirements in the Insurance Act.  As a result, some argue that DMFs have a greater risk of collapsing or of being forced to exercise their discretion against paying claims because they have insufficient funds.  However, Government does not have sufficient information to determine what role DMFs play in the Australian risk market and whether they pose a greater risk of collapsing because they are not prudentially regulated.

What is the objective of the policy?

The objective of Government action is to ensure that Australians have a range of risk management tools available to them and information about the characteristics of the options they are considering, so that they are in a position to make an informed decision on how to best manage their own risks. 

At the same time, the Government is seeking to maintain not only contestability, competitiveness and innovation in the insurance sector and community confidence in the Australian general insurance market, but also Australia’s reputation as a sound, well-regulated insurance market.  To do this, Government must obtain more information on DMFs.

Businesses Affected:

unknown due to the lack of information.  Anecdotal evidence suggests between 50-100.

Supporting evidence for the following options:

Information is not currently available on the number of DMFs operating in the Australian market.  As a result, it is not possible at this time to accurately calculate the costs to DMFs or the DMF industry of the various options outlined below.  However, classes of costs to DMFs are described below and in the RIS. 

Level of certainty for the following options:

Low

Option 1: Full prudential regulation

Under this option, DMFs would be required to become Australian authorised general insurers under the Insurance Act in order to continue operating.  As an Australian authorised general insurer, they would be subject to the consumer protection provisions that apply to general insurers under the Corporations Act and Insurance Contracts Act 1984 and APRA would collect information from them under FSCODA.

Option 2: Potts Review — no contingent risk

Under this option, the Government would implement the Potts review recommendations that required discretionary mutual cover to be offered only as a contract of insurance under the Insurance Act, except where APRA considered that the DMF had no contingent risk that would need to be met by additional undefined member contributions.  (Such risks would fall on a general insurer providing top up and drop down cover.) APRA would also be required to collect information on business written by DMFs under the exemption.

Option 3: No Prudential Regulation, but collect information, strengthen consumer protection and review within three years

Under this option, DMFs would not be prudentially regulated at this stage.  However, DMFs would continue to be subject to the consumer protection provisions of the Corporations Act and the provisions that apply to DMFs’ retail clients would be strengthened and extended to DMFs’ wholesale clients.  DMFs would also become subject to FSCODA.  Information would also be collected from AFSL holders who promote or develop DMFs through an amendment to the Corporations Act.  The Government would review these arrangements within three years of their implementation to determine whether or not to prudentially regulate DMFs.

Option 4: Status quo — no prudential regulation

Under this option, the current arrangements regarding DMFs would continue.  DMFs would not be prudentially regulated.  ASIC would continue to regulate DMFs under the Corporations Act as an AFSL holder and they would be required to comply with the Corporations Act disclosure requirements for retail clients.  For example, they are required to disclose key characteristics in their PDS to retail clients.

 



 

Notification

Education

Permission

Purchase Cost

Record Keeping

Enforcement

Publication/

Documentation

Procedural

Other

Option 1: Full prudential regulation

Nil

DMFs would be required to tell their clients that they were required to become insurers.  DMFs would also have to educate their officers about the prudential standards and reporting requirements they must comply with as an APRA authorised general insurer.

DMFs would be required to become APRA authorised general insurers and comply with the Australian prudential standards.

Nil

DMFs would be required to comply with the annual reporting requirements that APRA requires from general insurers.

DMFs would be required to comply with the same APRA enforcement and inspection requirements that apply to general insurers.

Nil

Nil

NIl

 

 

Notification

Education

Permission

Purchase Cost

Record Keeping

Enforcement

Publication/

Documentation

Procedural

Other

Option 2: Potts review recommendation

DMFs would have to notify APRA if they retained a contingent risk and then have to become an APRA authorised insurer.

DMFs would be required to tell their clients that either they were required to become insurers or that they were required to take out insurance to cover the risks of the fund, so as to ensure no contingent risk was retained in the fund.  They would also have to educate their officers regarding the obligation to report the retention of contingent risk to APRA.

DMFs would have to satisfy APRA that they retained no contingent risk or they would have to become APRA authorised general insurers.

DMFs that sought to continue to operate as DMFs would have to purchase insurance to cover the risks of the fund so that the fund retained no contingent risk.

DMFs that became authorised insurers would be required to comply with the annual reporting requirements that APRA requires from general insurers.  DMFs that continued to operate as DMFs would be required to report on their business and satisfy APRA that they retained no contingent risk in the fund.  These DMFs would also have to provide information to APRA on the business they wrote.

DMFs would be required to comply with any APRA enforcement and inspections requirements that were put in place to ensure that the DMF retained no contingent risk and to ensure information was collected from DMFs.

DMFs would be required to disclose the fact that they retained no contingent risk in the fund and had insurance to cover the risks of the fund to their members and prospective members.

Nil

Nil

 

 

Notification

Education

Permission

Purchase Cost

Record Keeping

Enforcement

Publication/

Documentation

Procedural

Other

Option 3: No prudential regulation now, review, information collection, strengthen consumer protection

Nil

DMFs would have to educate their officers about information about the DMF product they must disclose to their clients.

Nil

Nil

DMFs would have to provide information to APRA on the business they wrote. 

Financial intermediaries would have to provide information to ASIC on the DMF business they were placing.

DMFs would be subject to APRA’s enforcement powers with regard to the information collection requirements.

Financial intermediaries will be subject to ASIC enforcement provisions if they breach the reporting requirements.

DMFs would be required to provide all their clients with a document outlining the key characteristic of their product.

Nil

Nil

 

 

Notification

Education

Permission

Purchase Cost

Record Keeping

Enforcement

Publication/

Documentation

Procedural

Other

Option 4: Status quo

Nil

Nil

Nil

Nil

Nil

Nil

Nil

Nil

Nil

 

 



Background

6.1                   The issue of the regulation of DMFs and DOFIs arose within the context of the collapse of HIH Insurance Limited.  The HIH Royal Commissioner recommended that the Australian Government amend the Insurance Act to extend prudential regulation to all discretionary insurance-like products - to the extent possible within constitutional limits.  He also made some comments regarding DOFIs. 

6.2                   In response to the HIH Royal Commission report, the Government commissioned the Potts review to examine the extent and nature of DMFs and DOFIs operating in Australia and their contribution to overall risk capacity. 

6.3                   DOFIs are foreign insurers that sell insurance to Australians, either directly or via an insurance agent or broker licensed in Australia under the Corporations Act, without establishing a subsidiary or branch.  These foreign insurers are not subject to the provisions of the Insurance Act because they are not considered to be ‘carrying on insurance business in Australia’ under sections 9 and 10 of the Insurance Act.  However, these DOFIs may be subject to prudential and consumer regulation in their home jurisdiction.

6.4                   The Potts review recommended that the APRA regulate all DMFs with contingent risk and all DOFIs that did not come from a regime with prudential regulation that APRA considered comparable to the Australian prudential regime.  In May 2004, the Government accepted the Potts review recommendations.

6.5                   Since then there have been a number of structural and cyclical changes to the Australian general insurance market, including a fuller understanding of the impact of the Financial Services Reform Act 2001 , tort law reforms and a softening of the insurance market, altering the impetus for regulation. 

6.6                   In December 2005, Treasury released a discussion paper seeking public input on proposals to implement the Potts review recommendations.  Treasury received submissions from Australian general insurers, DOFIs, DMFs, captives, reinsurers, brokers and agents, state governments and regulators.

6.7                   As a result of these submissions and the release of the Banks Taskforce report Rethinking Regulation: Report of the Taskforce on Reducing Regulatory Burdens on Business on 7 April 2006, the Government is seeking to depart from the Potts review recommendations.  This regulation impact statement (RIS) seeks policy approval for that departure.

6.8                   The Potts review found that DOFIs accounted for approximately 2.5 per cent of the general insurance market and that their number was growing steadily.  DOFIs appeared to often fill market niches, either by way of specialised insurance (such as insuring classic cars) or policies that authorised insurers were not prepared to offer (for example, public liability cover for waterslides and theme parks).  However, the Potts review also found that there was a significant amount of property insurance for wholesale clients being written by DOFIs.  In recent years there has been an increasing trend for offshore insurers to move into the longer tail classes of insurance, such as professional indemnity and public liability insurance.  Anecdotal evidence also indicated that the type of public liability risk being insured overseas was primarily tourism and recreation related cover, for activities such as waterslides and theme parks, horse riding schools and motor racing.

Problem identification

6.9                   The HIH Royal Commission report noted that Australian entities may insure risks in Australia with offshore foreign insurers that are not authorised under the Insurance Act.  Australian policyholders can purchase such insurance directly or through an Australian agent or broker.  The report noted that in some cases it might be unnecessary to regulate insurance written offshore.  Much of this business is likely to involve large commercial insurance contracts where a purchaser would normally be considered able to judge for itself the risks involved in the transaction.  However, there were suggestions that such arrangements constituted a gap in APRA’s current regulatory reach.  This could have implications for Australians unaware that they were purchasing an overseas insurance product.

6.10               The Potts review found that the current regulatory treatment of foreign insurers operating in Australia lacked consistency.  Foreign insurers were treated in different ways depending on whether they were foreign insurers authorised by APRA operating in Australia; Lloyd’s underwriters authorised under special provisions of the Insurance Act; or unauthorised foreign insurers conducting business in Australia directly or through agents or brokers.  Foreign insurers not authorised in Australia were domiciled in jurisdictions with different regulatory regimes.  This meant that the degree of protection afforded to policyholders with similar insurance risks would vary depending on the country of origin of the insurer they selected.

6.11               At the same time, however, the Potts review was concerned to avoid prohibiting commercial arrangements that have worked satisfactorily to date.  It considered that the Government should target its regulation at areas of highest risk, such as foreign insurance companies operating out of low status regulatory jurisdictions with minimal prudential requirements. 

6.12               ASIC media releases outlined actions and orders that ASIC obtained against overseas insurers and their local agents within Australia.  A number of investigations have followed complaints that foreign insurers were not paying claims, or trading while insolvent.  One example related to International Unity Insurance (General) Limited and its Australian agent, International Unity Insurance Pty Ltd, a Solomon Island insurer providing motor vehicle insurance products to Australians.

Objectives

6.13               The policy objective is to ensure that policyholders with similar risks are afforded a similar degree of protection regardless of the origin of their insurer, while ensuring that commercial arrangements that have worked satisfactorily to date are not prohibited.  It is also to ensure that no higher standard is imposed on foreign insurers than domestic general insurers.

6.14               As noted above, foreign insurers are treated in different ways.  Foreign insurers authorised by APRA and Lloyd’s underwriters are regulated through the Insurance Act, administered by APRA.  However DOFIs (those foreign insurers conducting business in Australia through brokers and agents and those who market their product directly to Australians through the internet for example) are not required to be prudentially regulated in Australia under the Insurance Act. 

6.15               DOFIs, like any other Australian general insurer carrying on a financial services business in Australia are required to hold an AFSL and comply with the conditions of that licence.  These conditions are set out in Chapter 7 of the Corporations Act. 

6.16               DOFIs must also alert purchasers of particular insurance products (generally those aimed at retail clients) through their Product Disclosure Statement (PDS) that they are a foreign insurer and not authorised in Australia.

6.17               In addition, the conduct in relation to DOFI products is also subject to the consumer protection provisions of the Australian Securities and Investments Commission Act 2001 (ASIC Act) (for example, DOFIs are prohibited from engaging in misleading or deceptive conduct, misleading representation or unconscionable conduct in dealing with their clients).

6.18               Foreign insurers operating through a branch or subsidiary in Australia as authorised Australian general insurers are required to provide information on their activities under FSCODA.  However, DOFIs that do not operate through such a structure are not subject to any information collection requirements on their activities in Australia.

Identification of options

6.19               There are three options to address the issues raised in relation to the regulation of DOFIs.

Option 1: Targeted prudential regulation

6.20               Under this option, anyone who is ‘carrying on insurance business in Australia’ either directly or through the actions of another would be required to become an authorised insurer under the Insurance Act and would be subject to Australian prudential regulation.  The activities to be caught under this expanded definition are the activities up to and including entry into an insurance contract.  These include: activities currently caught under the definition - undertaking liability and business incidental to undertaking liability — and actions of intermediaries, including inducing an Australian to enter into an insurance contract (for example advertising targeted at Australians).  Australians who physically go overseas to take out insurance or who surf the internet and take out insurance that way will not be caught under the expanded definition. 

6.21               The entities to be caught under this expanded definition of ‘carrying on insurance business in Australia’ are domestic insurers, foreign insurers currently operating via a branch or subsidiary, DOFIs (captives are a subset of any of these categories) and reinsurers authorised by APRA. 

6.22               Foreign reinsurers will be exempt from having to be authorised in Australia, This approach would recognise that reinsurance is a global business.  Australia does not have any domestic reinsurers at this time.  Requiring offshore reinsurers to be authorised by APRA would severely limit the ability of Australian insurers to place part of their risk with reinsurers.  This approach is in keeping with the international treatment of reinsurers, where they are regulated in their home jurisdiction.  However, as noted above, APRA would regulate a domestic reinsurer established in Australia under the Insurance Act and any foreign reinsurer, who chooses to establish a branch or subsidiary in Australia.  Foreign reinsurers who do not establish a branch or subsidiary in Australia would continue to be indirectly subject to the regulatory regime through the prudential standards applied to insurers.

6.23               Once captured under the regulatory regime, APRA will, in applying Australian prudential standards, use its current powers to tailor the application of those standards according to the insurer’s risk profile, regardless of whether the insurer is a domestic or foreign insurer.  These targeted prudential standards will take into account the insurer’s customer base, home regulatory environment, ownership structure and type of business offered.

6.24               APRA would also make modifications to the existing prudential standards for insurers already authorised in Australia, depending on their client base and the type of entity providing the product.  The exact modifications that would be made to the prudential standards will be developed in consultation with industry during the transition period.

6.25               Another key concern is to ensure that the regulation of DOFIs does not reduce the capacity for sophisticated policyholders (such as large corporations) to make their own insurance arrangements.  To that end, there would be an exemption to the proposed regulatory regime for insurance business that cannot be placed in the Australian insurance market, either because of the nature of the risk, the capacity of the Australian insurance market or because there is simply insufficient expertise in Australia to assess that risk.  This exemption would allow risks that could not be placed in the Australian market to be placed offshore with foreign insurers that are not APRA authorised under the Insurance Act. 

6.26               As insurers authorised by APRA, DOFIs would continue to be subject to the consumer protection provisions in the Corporations Act outlined above and would be required to provide the same information to APRA as Australian domestic insurers under FSCODA.  Information would also be collected from the financial intermediaries on the business they were placing with exempt DOFIs.

6.27               There would also be a prohibition on financial intermediaries that would prevent them from providing an insurance product from all but APRA authorised insurers or exempt insurers and collect information on the business financial intermediaries are placing with DOFIs.

Option 2: Potts review — comparable regime

6.28               Under this option, DOFIs marketing insurance in Australia would be exempt from prudential regulation in Australia if they were domiciled in a country APRA considers to have comparable prudential regulation, subject to a market significance threshold to prevent established authorised insurers moving offshore.  DOFIs not meeting this test would be required to become authorised under the Insurance Act, if they wished to continue to conduct insurance in Australia.

6.29               PRA would also assume a information collection role in relation to DOFIs.

Option 3: No prudential regulation

6.30               Under this option, there would be no prudential regulation of DOFIs.  However, they would still have to obtain an AFSL and comply with the disclosure requirements in the Corporations Act.  They would not have to provide APRA with information on their activities in Australia.  Foreign insurers with a branch or subsidiary in Australia would continue to be APRA-authorised and would be required to comply with the same requirements as all other Australian authorised general insurers.

Analysis of the impact of the options

6.31               The groups most affected by the regulation of DOFIs are: DOFIs; the Australian insureds that use DOFIs; financial intermediaries; Australian authorised insurers; and the regulators, APRA and ASIC.

6.32               In accordance with Government requirements, attached to this RIS is a Business Cost Calculator Quickscan Report outlining the costs to DOFIs of adopting the various options detailed in this RIS.  A full cost report was not undertaken because, even though each option provides a regulatory framework, some of the detail within the framework have yet to be finalised.  For example, if option 1 were to be adopted, APRA will spend a year developing its modified prudential standards in consultation with stakeholders and prepare a RIS at that stage of the process.  Similarly, the collection of information from DOFIs and financial intermediaries would be undertaken after consultation with industry and APRA to determine exactly what information is required and how frequently.

Option 1

Option 1:   Targeted prudential regulation

 

Benefits

Costs

DOFIs

Moderate - APRA would apply modified prudential standards to all insurers, including DOFIs, taking into consideration the DOFI’s profile and home jurisdiction

Moderate to large - DOFIs will be required to become APRA authorised or cease operating in Australia

Australian insureds

Large - DOFI required to have a presence and capital in Australia, so insureds would be able to access assets if the DOFI collapses

Moderate - some DOFIs may choose to cease writing Australian business rather than becoming authorised - this will reduce the Australian insured’s choice (in some cases there may be no insurance product available to cover their risk)

Australia authorised insurers

Large - DOFIs will be subject to the same prudential standards as Australian authorised insurers

Small - Australian authorised insurers will be required to adapt to the modified prudential standards

Financial intermediaries

Large - financial intermediaries will continue to be able to place some large commercial and specialised risks offshore

Moderate - financial intermediaries will be unable to place risks with unauthorised DOFIs unless an exemption applies

Regulators

Large - greater clarity as to who is required to be authorised and facilitates the enforcement of prudential standards against DOFIs

Small to Moderate - APRA estimates that establishing the modified prudential regime will cost $500,000 - $1 million + on-going monitoring and enforcing

 

Benefits

DOFIs

6.33               DOFIs would have the substantial benefit that the regulatory requirements that they must comply with in their home jurisdiction would be taken into consideration by APRA in applying the Australian prudential standards.  This would reduce duplication for the DOFI in complying with more than one prudential regime.  For example, if the DOFI was part of a global corporate group and that group had a good risk management process, the DOFI may be able to satisfy the APRA prudential standard by applying this risk management process to its Australian business.  The extent to which a DOFI’s home jurisdiction is taken into account will depend on the home regulatory regime and the DOFI concerned.  The more comparable a home jurisdiction is with the Australian prudential regulatory regime, the more APRA may be able to use that situation to satisfy Australian prudential standards. 

6.34               In addition, APRA would also consider the clients of the DOFI in determining whether the DOFI has satisfied APRA’s prudential standards.  For example, a DOFI that is part of a global corporate group and that only provides insurance to other companies within the global corporate group may not need to hold as much capital in Australia, or meet other prudential standards to the same degree as a DOFI writing insurance lines for Australian retail insureds. 

Australian insureds that use DOFIs

6.35               APRA will require all DOFIs that wish to operate in Australia to have, at a minimum, a presence in Australia and assets in Australia equal to their liabilities.  This offers a significant benefit to Australian policyholders in that it protects them by ensuring that, in the event of the DOFI’s collapse, they have an increased ability to access the assets of the insurer.

6.36               This option also has the significant benefit of allowing some sophisticated players in the general insurance market (for example, large corporations) to continue to access the global insurance market.  In general, it does not affect commercial arrangements that the Potts review found had worked well to date and where the insureds is able to judge the risks involved in the transaction. 

6.37               At the same time, Australians and most businesses would be dealing with an APRA-authorised insurer unless they had a risk that they could not place with such an insurer.  In this case, they would still have the choice to either place the risk through a Lloyds underwriter or to seek an appropriate exemption in order to place the risk with a DOFI not authorised by APRA. 

6.38               For DOFIs and their clients, this option would achieve the objective of ensuring that Australian policyholders are protected (that is, they are given a similar level of protection if they use a DOFI product or an Australian insurer’s product).  At the same time it recognises that there are some risks that cannot be placed in Australia and allows Australians to access the overseas market.  Targeted prudential regulation will allow DOFIs to gain authorisation using their risk profiles.  This will ensure DOFIs are not overregulated. 

Australian authorised insurers

6.39               This option would require all insurers providing insurance products in Australia to be subject to the same prudential standards (including the capital adequacy requirements) and required to have a presence in Australia.  This approach would have a significant benefit for Australian authorised insurers as they will no longer be at a regulatory disadvantage (that is, forced to comply with more stringent regulation compared with DOFIs).  In addition, it would be much easier to enforce collection from DOFIs of those insurance taxes currently collected from Australian general insurers, because they would have a local presence.  This would eliminate the competitive advantage that Australian insurers argue DOFIs have gained from it being very difficult to enforce the collection of state taxes against these DOFIs.  (State and Commonwealth taxes may not be being collected for many insurance policies they write, resulting in a lower premium price.)

Financial intermediaries

6.40               Financial intermediaries would benefit by being confident that, when they place business with an authorised insurer, APRA is monitoring the insurer’s financial soundness, client’s claims are paid out when they occur and clients are able to access funds in the event that the insurer collapses. 

6.41               However, financial intermediaries also have a significant benefit in that they would continue to be able to access the global insurance market for their large commercial clients and would be able to place risks that could not be insured in Australia offshore. 

Regulators — APRA/ASIC

6.42               For APRA there would be greater clarity about the application of the legislation.  A number of stakeholders consulted expressed frustration with the definition of ‘carrying on insurance business in Australia’ and the difficulty that lay in determining when a DOFI has met the test.  Under this option, a DOFI would be required to be authorised if it is directly, or through the actions of another, ‘carrying on insurance business in Australia’.  In addition, the actions of the financial intermediary, to the extent that they target Australians to enter into contracts with DOFIs, would be brought under the expanded definition of ‘carrying on insurance business in Australia’.

6.43               Given that it would be easier to identify who is regulated under this option, it would be easier to identify where there was a DOFI acting in breach of the Insurance Act and to take action against that entity. 

6.44               Finally, because DOFIs that wish to operate in Australia would require a local presence, it would be easier for APRA to enforce its prudential standards against the DOFI.  This is because there would be a responsible officer subject to the penalties under the Insurance Act.

6.45               This option would mean that information collection under FSCODA would automatically apply.  As Australian authorised general insurers, they would already be captured under the current regime.

Costs

DOFIs

6.46               This option also has a potentially significant cost for DOFIs, as it would require all DOFIs to be authorised by APRA.  That means that all DOFIs who wanted to continue carrying on business in Australia, have to apply for an APRA licence and comply with the reporting and prudential standards APRA sets for them, outlined above.  These costs would be significant for the DOFIs. 

6.47               DOFIs would also be required to apply to become authorised.  The current licence application fee of $68,200 provides an estimate of authorisation costs. 

6.48               DOFIs would also have ongoing APRA reporting costs.  The current general insurance levies provide an estimate of these costs, in the absence of better information.  The following excerpt from the Financial Sector Levies Discussion Paper provides a basis for the estimate. 

Table 15: Levy amounts on general insurers ($’000)

Asset Base

$5m

$25m

$250m

$750m

$3b

$9b

2006-07

5.1

6.9

69.2

207.5

830.0

1,364.0

 

6.49               For those DOFIs that provide professional indemnity and public liability cover there would also be the NCPD levy.  The NCPD levy is a function of an institution’s premium income in those classes, as detailed in the following excerpt from Financial Sector Levies Discussion Paper dated May 2006:

Table 9: Levy parameters for NCPD Levy

Approximate levy parameters based on recouping 1 year’s costs

 

Professional Indemnity

Public and Product Liability

Minimum ($)

5,000

5,000

Maximum ($)

32,000

50,000

Rate (%)

0.086

0.085

 

Australian insureds that use DOFIs

6.50               Anecdotal evidence from brokers suggests that a number of DOFIs may cease operating in the Australian market, as the cost of meeting Australia’s prudential regulations would outweigh the benefits, especially where the DOFI is only writing a small volume of business in Australia.  This may result in lower capacity in the Australian market, particularly in niche markets, and less choice for Australian insureds.  This has potential consequences for some Australian insureds, who may have difficulty obtaining insurance cover. 

6.51               Once DOFIs are authorised by APRA, it would be possible to enforce Australian taxes on DOFIs and they must comply with Australian prudential standards, these costs may result in premium increases for some Australian insureds.  However, there is insufficient information currently available on DOFIs to be able to ascertain the extent of any such increase. 

Australian authorised insurers

6.52               There may also be small costs for local Australian domestic insurers as they adapt to the modified prudential standards that apply to them under this approach.  However, it is envisaged that the standards would be modified to reduce the costs on certain types of insurers to take into account their risk profile.  It is not envisaged that any strengthening of existing standards would occur under this process.  Domestic insurers would be able to choose whether to continue to be bound by the stricter standards or comply with the modified standards.

Financial intermediaries

6.53               It may also create some costs for financial intermediaries, who will be unable to provide insurance products from unauthorised DOFIs to some of their clients.  However, the costs are difficult to estimate, given that there is insufficient information on the amount of insurance business placed with DOFIs and the number of these DOFIs that may cease operating in Australia.

Regulators — APRA/ASIC

6.54               This option would also impose a number of administrative costs on APRA, as it would be required to process applications from DOFIs for Australian licences.  In addition, it would have to monitor these DOFIs and ensure that they comply with Australian prudential standards, or enforce their compliance. 

6.55               APRA estimates the costs of establishing modified prudential regulation standards at $500,000 to $1 million.

6.56               APRA would also require additional resources and expertise to monitor the exemption and collect information on what risks are being placed offshore through that mechanism. 

Option 2

Option 2:   Potts Review

 

Benefits

Costs

DOFI

Moderate to large - target DOFIs from regulatory regimes that APRA does not consider comparable, these DOFIs would have to become authorised.  But DOFIs from comparable regimes would be exempt from APRA authorisation

Large - it would be difficult to determine whether or not a DOFI was from a comparable regime and it creates uncertainty for the DOFI as to how long their regime will remain comparable

Australian insureds

Moderate - Australian insureds would still have access to DOFIs from comparable regimes but this would not be as great as the protection offered by Australian prudential regulation.  They would be protected from DOFIs from less comparable regimes, who would have to become authorised to operate in Australia

Small to moderate - Australian insureds would have no protection in the event that a DOFI from a well regulated regime collapsed and without a presence in Australia, it would be very difficult to get a claim paid out if the DOFI refused to pay

Australian authorised insurers

Small to moderate - Australian authorised insurers will gain the indirect benefit of having less competition as DOFIs from non-comparable regimes will be required to become authorised or exit the Australian insurance market

Moderate to large - exempt DOFIs would continue to be able to charge lower premiums as they would not be subject to Australia’s prudential standards and their premiums would continue to reflect the difficulty of collecting state insurance taxes on their premiums

Financial intermediaries

Large - they could still place risks with DOFIs from comparable regimes

Moderate - financial intermediaries would need to check that the DOFI was from a comparable regime and would have to continually monitor both the DOFI and its home jurisdiction to ensure it continued to be eligible for the exemption

Regulators

Nil

Moderate to Large - $500,000 - $1 million to establish the regime and on going monitoring, enforcing and assessing comparable regimes of  $2 million - $4 million annually

 

Benefits

DOFIs

6.57               This option has a significant benefit for reputable DOFIs and their members in that it would target those DOFIs that pose the greatest risk of collapsing, because they are not subject to comparable prudential regulation in their home jurisdiction.  DOFIs from countries with comparable prudential regulation would be able to rely on their home jurisdiction and not become APRA authorised.  This significantly reduces the compliance costs for well-regulated DOFIs; they do not need to apply to APRA for a licence to carry on insurance business in Australia; they are not required to hold a minimum level of capital in Australia; and they are not subject to Australia’s consumer protection, financial reporting and information collection provisions.

Australian insureds that use DOFIs

6.58               The approach would ensure that well regulated DOFIs would continue to write business in the Australian market and would not create a barrier to these DOFIs continuing to supply their products to Australians.  This would have the substantial benefit of having continuing competition in the Australian market.  In some specialised niche markets, where only overseas insurers operate, Australian insureds would be able to access those lines directly or through a financial intermediary.  While the risk posed by DOFIs from well regulated regimes is lower than for other DOFIs, the well regulated regime will still not provide the same level of protection to Australian insureds as the Australian prudential regulatory regime.  Authorised insurers are required to maintain assets at least equal to Australian liabilities.  On the liquidation of an authorised insurer, Australian liabilities must be settled from those Australian assets before foreign liabilities can be settled from those Australian assets.  This protection will not be available to insureds, who use DOFIs, irrespective of the home regulatory regime.

6.59               In addition, as these DOFIs are exempt from the Australian prudential regulatory regime they may be able to offer their products to Australians at a lower price than Australian insurers, although this is offset against the cost of complying with comparable home jurisdiction regimes.  The extent to which state insurance taxes are being collected on DOFI insurance policies is not clear.  Insurers argue limited state insurance taxes are currently being collected on DOFI insurance policies.  Maintaining competition from DOFIs may result in lower costs to Australians. 

Australian authorised insurers

6.60               There is no direct benefit from this option for Australian authorised insurers, although it would have the indirect benefits of removing competition from DOFIs from non-comparable regimes.

Financial intermediaries

6.61               This option would also allow financial intermediaries to source a range of products from global well-regulated insurers, thereby allowing them to find and negotiate with insurers to provide a targeted solution for their clients.

Regulators — APRA/ASIC

6.62               There would be no direct benefits to APRA and ASIC of this option.

Costs

DOFIs

6.63               Consultations with stakeholders suggested that it was very difficult to determine which countries would have a prudential regulatory regime comparable with that of Australia.  There are significant risks associated with this approach for the DOFI, in that it is unclear what constitutes a comparable regime and how comparability will be measured.  Moreover, it also creates uncertainty because it is not clear what a home jurisdiction must do for APRA to deem its prudential regime to be comparable with that of Australia. 

6.64               DOFIs from regimes that APRA did not consider comparable would have the costs of becoming APRA-authorised and complying with Australian prudential standards (including holding capital here and having a presence in Australia) or alternatively withdrawing from the market.

Australian insureds that use DOFIs

6.65               If DOFIs from well-regulated regimes are not required to have a presence in Australia or to hold capital here, it would be very difficult for Australian insureds to get access to capital in the event that the DOFI collapses or where a claim is not paid.  Even if the DOFI does not collapse, there may be no capital in Australia that the Australian courts can access to pay out a policyholder’s claim.  In this situation, the Australian policyholder would need to take action against the DOFI in a foreign court. 

6.66               This would be a significant risk for the Australian policyholders, particularly small businesses and retail clients who may not understand the significance of the DOFI not being regulated in Australia and having assets here until their claim goes unpaid.  Although the exact number of DOFIs that have collapsed or refused to pay out claims is not known, ASIC has applied to the court to wind up or stop DOFIs from operating in Australia on several occasions in the past couple of years.

Australian authorised insurers

6.67               DOFIs from well-regulated regimes may be able to provide their product at lower prices because they do not need to comply with Australian prudential standards.  The cost of complying with prudential standards in their home jurisdiction may be less than the cost for Australian insurers of complying with the Australian prudential standards.  Also, it may be difficult to enforce the same state insurance taxes faced by Australian insurers.  Australian authorised insurers argue this is a significant cost and that this results in DOFIs obtaining a competitive advantage.  This may result in Australian insurers losing market share to DOFIs and in some cases getting out of particular lines of insurance altogether.  It may also encourage Australian insurers that have overseas subsidiaries to transfer their business offshore, so as to take advantage of the competitive advantage enjoyed by well-regulated DOFIs. 

6.68               Reduced competition in the Australian insurance market would be likely to have a cost to Australians, as they would have fewer products to chose from when placing their risk and the products that remain may offer fewer protections.  In addition, reducing the size of the Australian insurance market may also affect Australia’s reputation overseas for having a well-regulated, robust and competitive general insurance market may be compromised by the proposal.  This may have an impact on Australian insurers with foreign operations.

Financial intermediaries

6.69               Financial intermediaries would have the additional costs of having to determine whether the insurer they were recommending to their clients came from a comparable regime or not.  They would need to determine whether that DOFI needed to be APRA authorised.  In addition, they would need to continue to monitor that DOFI and its home jurisdiction to ensure the DOFI continued to be exempt from having to comply with the Australian prudential regime.  Although not a significant cost for brokers, depending on how the system was set up, it nonetheless would require brokers to devote resources to ongoing monitoring.

Regulators — APRA/ASIC

6.70               If this option is adopted, APRA would have the significant costs of establishing a regulatory regime to cover DOFIs.  Those from a robust prudential regime would be exempt and all other DOFIs would be required to become APRA authorised.  This creates a separate regime that APRA would enforce and monitor, increasing complexity for both the DOFIs and the system of insurance regulation more generally. 

6.71               The costs of Option 1 would be the same as for Option 2 with the additional ongoing costs of assessing and maintaining up to date knowledge of foreign regulatory regimes.  APRA estimates this ongoing cost to be $2 million to $4 million per year. 

6.72               In order to provide a robust regime under this option APRA envisages needing an additional cell of dedicated staff and a considerable amount of international participation in on-site supervision work with offshore regulators.

Option 3

Option 3:   No prudential regulation

 

Benefits

Costs

DOFI

Large — no additional compliance costs

Nil

Australian insureds

Large — broadest range of insurers available and lower premiums

Large — Australian insureds would have no protection in the event that a DOFI collapsed and without a presence in Australia, it would be very difficult to get a claim paid out if the DOFI refused to pay

Australian authorised insurers

Nil

Large — DOFIs would continue to be able to charge lower premiums as they would not be subject to Australia’s prudential standards and their premiums would continue to reflect the difficulty of collecting state insurance taxes on their premiums

Financial intermediaries

Large — broadest range of insurers available for their clients

Nil

Regulators

Nil

Moderate — if a DOFI collapses regulators may face reputational costs.

 

Benefits

DOFIs

6.73               This option is the current position.  It has the advantage that there would be no additional compliance costs on those DOFIs that do not choose to establish a branch or subsidiary in Australia.  It allows all DOFIs to operate in the Australian market, so long as they or their financial intermediary have an AFSL. 

Australian insureds that use DOFIs

6.74               This option provides Australians and financial intermediaries with a major benefit as they would have the broadest range of products from which to choose when placing their risk.  The fact that many of these DOFIs do need to pay state taxes, but those taxes are not enforced, means that they can provide their products at lower prices to Australian consumers. 

Australian authorised insurers

6.75               There would be no direct benefits to Australian insureds from this option.

Regulators — APRA/ASIC

6.76               There would be a lower administration costs on APRA, as APRA would not be required to prudentially regulate DOFIs.  Although, given that APRA does not regulate DOFIs now, it is only a benefit from the perspectives of the two other alternative options being considered.

Costs

DOFIs

6.77               There would be no direct costs to DOFIs from this option.

Australian insureds that use DOFIs

6.78               This approach would have significant costs for Australian policyholders.  It leaves them unprotected in the event that the DOFI collapses.  Australian insureds, especially Australian retail clients, may have difficulty ascertaining the financial soundness of an overseas insurer.  The fact that they are from a comparable regime does not directly indicate the financial soundness of the insurer. 

6.79               Similarly, the fact that a DOFI is from a robust prudential regime does not assist Australian insureds in the event that the insurer collapses.  In that situation, Australian insureds may have difficulty in recovering the money they paid in premiums or having their claims paid.  Depending on the jurisdiction, it may be difficult to have an Australian court judgment enforced against the assets of the insurer.  This would particularly be the case in countries where priority is given to domestic policyholders over foreign policyholders. 

Australian authorised insurers

6.80               For domestic insurers, the ability of DOFIs to access the market and yet not be prudentially regulated or pay the same state insurance taxes creates a significant competitive disadvantage and cost for Australian authorised insurers.  This can lead to a reduction in an Australian domestic insurer’s market share and at the margins of the industry create an incentive for some Australian insurers to move offshore.

6.81               Although the exact number of DOFIs that have collapsed or refused to pay out claims is not known, ASIC has applied to the court to wind up or stop DOFIs from operating in Australia on several occasions in the past couple of years.

Regulators — APRA/ASIC

6.82               Finally, the regulators may also face criticism in the event that a DOFI collapses and are likely to have substantial reputational costs.

Consultation

6.83               The Government has undertaken two public inquiries into the regulation of DOFIs and their role in the general insurance industry, as well as continual consultation with key stakeholders over the last three years. 

6.84               The first public inquiry was the Potts review that took place in 2003.  The Potts review sought submissions from the public on the extent and nature of DOFI operations in Australia and their contributions to overall risk capacity.  The Potts review received 19 submissions from a range of stakeholders including DOFIs, Australian authorised general insurers, captives, reinsurers, brokers and agents, industry associations, state governments and the regulators, ASIC and APRA.

6.85               In response to the comments of these submissions, the Potts review developed its key recommendations, which were accepted by the Government in May 2004.  In December 2005, Treasury released a public discussion paper seeking comments from all interested stakeholders on how to implement the Potts review recommendations.  It received 28 submissions from a range of stakeholders, including Australian insurers, reinsurers, captives, DOFI, brokers, industry association, the regulators ASIC and APRA and a number of state governments.

6.86               Throughout this period, Treasury has also consulted with interested stakeholders.  It has held a number of meetings with DOFIs, insurers, brokers and the regulators both to better understand DOFIs, their role in the Australian general insurance market and how to regulate them but also how to practically implement the Potts Review recommendations. 

6.87               From the various submissions and discussion held with key stakeholders varying views emerged, although most stakeholders have held largely consistent views throughout the consultations to date. 

6.88               Australian authorised insurers believe that DOFIs should be subject to the same prudential and regulatory requirements as domestic insurers.  In particular, they argue that DOFIs should be required to hold capital in Australia and establish a presence here.  Australian authorised insurers are particularly concerned about DOFIs obtaining a competitive advantage by not being required to hold capital here and Governments not being able to enforce the collection of Australian taxes on their insurance policies that cover Australian risks. 

6.89               DOFIs, on the other hand, believe that APRA should not disadvantage overseas insurers from operating in Australia if they are established in a comparable prudential regime.  DOFIs from comparable regimes do not believe that they should be prudentially regulated in Australia as they are already subject to prudential regulation in their home jurisdiction. 

6.90               Financial intermediaries do not believe that foreign insurers should be prudentially regulated in Australia.  Instead, they believe that the disclosure requirements applying to DOFIs should be strengthened.  Australian financial intermediaries suggest they should be required to disclose to all their clients, regardless of whether these clients are retail or wholesale clients, that the DOFI is not APRA authorised and that they may not be able to enforce their claims against the DOFI or access funds to pay their claims if the DOFI collapses.

6.91               In developing the options in this regulation impact statement, the concerns of insurers to have a level playing field and protect consumers, the concerns of brokers to able to continue to access insurance products to meet the needs of their clients and the concerns of DOFIs from robust prudential regulatory regimes not be subject to regulatory duplication were all taken into consideration.

Conclusion and recommended option

6.92               Option 2 was rejected as being unworkable because stakeholders’ submissions during the consultations suggested that it would be very difficult, if not impossible, to determine what constituted a comparable regime; that is, the criteria that would be used to make that assessment.  It would also create added complexity in the regulation of insurers in Australia because it would create another regime to regulate DOFIs.

6.93               Stakeholder comments indicated that some form of regulation for DOFIs was required to protect Australian insureds and third party beneficiaries from a DOFI not paying claims and/or collapsing and not paying claims.  Also, DOFIs enjoy a competitive advantage over Australian insureds, in not maintaining a presence in Australia or being subject to APRA’s prudential standards, particularly the capital requirements.  As a result, option 3 was rejected as it did not address these two concerns.

6.94               Given the above comments and the analysis, option 1, targeted prudential regulation, is recommended.  This option allows APRA to take into consideration the range of unique risk factors associated with each insurer that seeks to operate in the Australian market, while at the same time ensuring that at a minimum there is sufficient capital in Australia to cover Australian insureds liability in the event that an overseas insurer fails.  It also ensures that information is collected on the role of DOFIs in the general insurance market so that APRA can develop increasingly targeted prudential standards.

Implementation and review

6.95               It is proposed that option 1 be implemented through legislative amendments to the Insurance Act, Corporations Act, Corporations Regulations and FSCODA. 

6.96               The definition of insurance business in the Insurance Act would be amended to cover the expanded activities and entities described above.  There may also need to be an exemption from needing to be authorised for foreign reinsurers and an additional exemption for insurance business that cannot be placed in the Australian market.

6.97               In addition, to ensure that APRA can enforce option 1, APRA’s existing powers under the Insurance Act to:

·          require production of information, books, accounts or documents;

·          access premises; and

·          initiate investigations

would be expanded to include persons APRA reasonably believes are carrying on insurance business in Australia without authorisation or aiding, abetting, procuring or counselling a second person to carry on insurance business in Australia without authorisation. 

6.98               In addition, APRA would be given a power to seek restraining, consent and interim injunctions from the Federal Court with respect to unauthorised insurers and persons involved in the activities of unauthorised insurers.  This power would enable APRA to act quickly in situations where unauthorised insurers are carrying on insurance business in Australia.  The injunction power would only permit APRA or any person whose interests are affected by the conduct of the entity to seek an injunction. 

6.99               The administration costs associated with these enforcement measures would be met out of APRA’s existing budget.

6.100           Insurers and financial intermediaries consulted have acknowledged the need to expand APRA powers under the Insurance Act to ensure that APRA has sufficient power to effectively monitor and ensure compliance with the proposed DOFI regime.

6.101           APRA would develop its modified prudential standards in consultation with Treasury and stakeholders, including existing APRA authorised insurers, DOFIs and financial intermediaries. 

6.102           No changes will need to be made to the consumer protection provisions of the Corporations Act.  As an APRA-authorised insurer, DOFIs will be subject to the same consumer protection provisions that currently apply to Australian general insurers under the Act.

6.103           However, it is also proposed that a prohibition would be inserted in the Corporations Act preventing Australian financial service licence holders from providing a general insurance product to their clients that is not from an Insurance Act authorised or exempt insurer.  The enforcement powers that ASIC already has under the ASIC Act will be used to enforce the prohibition. 

6.104           No changes will need to be made to FSCODA to collect information from DOFIs as they will fit within the category of APRA regulated entities already in the Act.  However, it is proposed that the Corporations Act be amended to allow ASIC to collect and provide to APRA information from financial intermediaries on the business they are placing with DOFIs.

6.105           As it will require time for APRA to develop its modified prudential standards and DOFIs currently operating in the Australian market will need time to apply for authorisation, it is proposed that the new regulatory regime commence on 1 July 2008.  This provides APRA with a timer to develop its modified prudential framework in consultation with industry and for DOFIs to apply to become authorised.

Direct Offshore Foreign Insurers Quickscan report

What is the problem you wish to address?

The current regulatory treatment of foreign insurers operating in Australia lacks consistency.  Foreign insurers are treated in different ways depending on whether they are: foreign insurers authorised by APRA operating in Australia; Lloyd’s underwriters authorised under special provisions of the Insurance Act; or unauthorised foreign insurers conducting business in Australia directly or through agents or brokers.  Foreign insurers not authorised in Australia may be domiciled in jurisdictions with different regulatory regimes.  This means that the degree of protection afforded to policyholders with similar insurance risks would vary depending on the country of origin of the insurer selected.

At the same time, however, there is a concern to that commercial arrangements that have worked satisfactorily to date not be prohibited. 

What is the objective of the policy?

The policy objective is to ensure that policyholders with exactly the same risk are afforded the same degree of protection regardless of the origin of their insurer, while ensuring that commercial arrangements that have worked satisfactorily to date are not prohibited. 

Businesses Affected:

exact numbers of DOFIs affected is not known due to the lack of information.  Anecdotal evidence from financial intermediaries suggests between 10-50.

Supporting evidence for the following options:

Information is not currently available on the number of DOFIs operating in the Australian market.  As a result, it is not possible at this time to accurately calculate the costs to DOFIs of the various options outlined below.  However, the classes of costs to DOFIs are described below and in the RIS. 

Level of certainty for the following options:

Low — Medium

 

Option 1 — Targeted prudential regulation

Under this option, all DOFIs would be subject to full Australian prudential regulation, that is they would be required to be licensed under the Insurance Act and meet prudential requirements.  However in applying the prudential standards APRA would use its current powers including discretionary and exemption powers to tailor the application of those standards according to the DOFI’s risk profile.  These tailored prudential standards will take into account the insurer’s customer base, home regulatory environment, ownership structure and type of business offered.

As APRA authorised insurers, DOFIs would continue to be subject to the consumer protection provisions in the Corporations Act and would be required to provide the same information to APRA as Australian domestic insurers under FSCODA Information would also be collected from the financial intermediaries on business placed with DOFIs.

Option 2 — Comparable regime

Under this option DOFIs marketing insurance in Australia would be exempt from prudential regulation in Australia if they are domiciled in a country APRA considers to have comparable prudential regulation, subject to a market significance threshold to prevent established authorised insurers moving offshore.  DOFIs not meeting this test would be able to market insurance in Australia as an authorised insurer through a branch or subsidiary.

APRA would assume an information collection role in relation to offshore insurers.

Option 3 — Status quo

Under this option, there would be no prudential regulation (that is, no requirement for the DOFI to establish a presence or have assets in Australia etc.) of DOFIs.  However, they would continue to have to obtain an Australian financial services licence and comply with the disclosure requirements in the Corporations Act.  They would not have to provide APRA with information on their activities in Australia.  Foreign insurers with a branch or subsidiary in Australia would continue to be APRA authorised and would be required to comply with the same requirements as Australian authorised general insurers.



 

Notification

Education

Permission

Purchase Cost

Record Keeping

Enforcement

Publication/

Documentation

Procedural

Other

Option 1: Targeted prudential regulation

DOFIs will be required to notify their financial intermediaries as to whether they are APRA authorised or not.

DOFIs will have to educate their officers on Australian prudential and reporting requirements.

Financial intermediaries will have to educate their officers on the new prohibition that makes it an offence for financial intermediaries to offer an insurance product from an unauthorised insurer, unless an exemption applies.

DOFIs will be required to apply to APRA to become an authorised insurer, unless exempt.  Australian insureds that cannot have their risks underwritten by an authorised insurer will have to apply to use an unauthorised DOFI.

Nil

DOFIs will be required to comply with APRA’s reporting requirements for authorised general insurers.  Financial intermediaries will be required to provide ASIC with information on the DOFI business they are placing.

DOFIs will be subject to APRA’s enforcement and reporting requirements that apply to general insurers. 

Financial intermediaries will be subject to ASIC enforcement provisions if they breach the prohibition or reporting requirements.

Nil

Nil

Nil



 

Notification

Education

Permission

Purchase Cost

Record Keeping

Enforcement

Publication/

Documentation

Procedural

Other

Option 2: Potts Review — comparable regime

Nil

DOFIs will have to educate their officers on the new Australian regime and whether they are exempt or must become APRA authorised general insurers.  For DOFIs that must become authorised, there will also be the additional education costs outlined in option 1 above.

DOFIs will have to apply to APRA and satisfy APRA that they are from a comparable regime so as to obtain the exemption from having to be APRA authorised.

Nil

Both exempt and authorised DOFIs will be required to provide APRA with the same information that APRA authorised general insurers provide on the business they write in Australia.  Authorised DOFIs will have the additional reporting requirements associated with being authorised.

Exempt DOFIs and authorised DOFIs will be subject to APRA’s information collection enforcement provisions. 

Authorised DOFIs will also be subject to APRA’s enforcement provisions that apply to all APRA authorised general insurers.

Nil

Nil

Nil

 

 

Notification

Education

Permission

Purchase Cost

Record Keeping

Enforcement

Publication/

Documentation

Procedural

Other

Option 3: No prudential regulation

Nil

Nil

Nil

Nil

Nil

Nil

Nil

Nil

Nil