Copyright © All Rights Reserved. Charles Pratten 2008
C/- INTERNATIONAL ASSOCIATION OF INSURANCE SUPERVISORS
CH-4002 BASEL
SWITZERLAND
RE: OPINION CONCERNING THE EFFECT ON INSURANCE ARRANGEMENTS BTW’ INSURANCE BROKERS -&- DIRECT OFFSHORE FOREIGN INSURERS
in relation to:-
‘THE FINANCIAL SECTOR LEGISLATION AMENDMENT [DISCRETIONARY
MUTUAL FUNDS AND DIRECT OFFSHORE FOREIGN INSURERS] ACT 2007’
- and the - ‘INSURANCE AMENDMENT REGULATIONS 2008’
Thank you for requesting my opinion as to what effect the above mentioned Legislation and Regulations will likely have upon insurance arrangements between Australian insurance brokers [and similar authorised intermediaries] and Direct Offshore Foreign Insurers.
For convenience I have abbreviated the following terms:-
- FSLA Legislation’ will mean ‘The Financial Sector Legislation Amendment [Discretionary Mutual Funds and] Act 2007’ which received Royal Assent on 24 September 2007, and came into force on 1 July 2008;
- ‘Regulations’ will mean the Insurance Amendment Regulations 2008;
- ‘DOFI’ will mean Direct Offshore Foreign Insurer [formerly Unauthorised Foreign Insurer] - Not an authorised insurer under the Australian Insurance Act [1973];
- ‘Insurance Broker’ will mean an Australian authorised insurance broker [or similar authorised intermediary] under the Australian Financial Services Reform Act 2001;
- ‘APRA’ will mean the Australian Prudential Regulation Authority which is the primary regulator of Australian Insurance companies authorised to carry on the business of a general insurer under the Insurance Act [1973];
- ‘Australian Insurer’ will mean an Australian insurance company authorised to carry on the business of a general insurer under the Insurance Act [1973].
- The primary effect of the FSLA Legislation and Regulations is to regulate what, if any, insurance business can be arranged between insurance brokers and DOFI’s and if so, upon what terms.
- Regulator Of Insurance Arrangements Concerning DOFI’s
A ‘DOFI’ while authorised to conduct insurance business from and/or within its home jurisdiction, is not an authorised insurer under the Australian Insurance Act [1973].
The primary regulator concerning insurance arrangements between insurance brokers and DOFI’s is the Australian Securities and Investments Commission ‘ASIC’.
While APRA is the primary regulator of Australian insurers, APRA is not the primary regulator concerning insurance arrangements between insurance brokers and DOFI’s.
- The Development of the FSLA Legislation:
In 2001, the disastrous collapse of one of Australia’s largest insurers ‘HIH’ occurred leaving stakeholders some AUD$5.5 Billion in deficit.
A Royal Commission was established soon after to determine the reason[s] for the collapse, during which APRA was criticised for having what the Royal Commissioner described as a generally complacent attitude in its regulatory approach and style.
As a result APRA implemented a range of measures to independently gauge and verify the financial state of each Australian insurer, and the Australian insurance industry in general.
Leading up to the time of HIH’s collapse, APRA were in the initial stages of drafting a significant number of proposed amendments and additions for application to the Insurance Act [1973] intended to strengthen the regulatory and solvency aspects of Australian insurers.
In addition to APRA’s focus on Australian insurers, APRA was also concerned DOFI’s providing insurance on Australian risks were not subject to regulation under the Insurance Act [1973] and thus, planned to introduce amendments and additions into the legislation that would bring DOFI’s under APRA’s authority through the Act’.
However, in addition to the criticism levelled at APRA concerning the collapse of HIH, the Federal Government also came under intense pressure to “do something”, thus APRA was invited to submit the draft proposed amendments and additions for immediate legislative consideration.
However, the proposed amendments and additions were still in the initial draft stage and did not contain any reference to the proposed regulation of DOFI’s but, despite that omission the draft proposed amendments and additions were rushed through both houses of Parliament resulting in the amendments and additions being incorporated into Insurance Act [1973] - with effect from 1 July 2002.
Effectively, each Australian insurer’s existing authorisation to carry on insurance business was revoked on 30 June 2002, thus requiring each insurer to make a new application for authorisation under the amended legislation if they wanted to carry on insurance business after that date.
Insurance arrangements concerning DOFI’s were not mentioned in the amended legislation. Indeed, the original amendments and additions were poorly drafted and quite confusing for both the insurance industry and regulators which is evident by the number of further amendments made to the legislation since 1 July 2002.
From 1984 until 2002/2004, the primary legislation and Regulations governing the conduct of insurance arrangements between insurance brokers and DOFI’s was the ‘Insurance [Agents & Brokers] Act 1984’ [now repealed] – the primary regulator concerning the Act’ being the Australian Securities and Investments Commission ‘ASIC’.
Until the repeal of the ‘Insurance [Agents & Brokers] Act 1984’, insurance brokers were required to provide their clients a prescribed ‘Disclosure & Acknowledgment Notice’ setting out information to be related to the client in respect of their insurance arrangements with a DOFI. [formerly ‘Unauthorised Foreign Insurer’]
In 2002, new legislation titled the ‘Financial Services Reform Act 2001’ ‘FSRA 2001’ took effect which replaced the ‘Insurance [Agents & Brokers] Act 1984’ however, the FSRA 2001 included a two [2] year transition period for insurance brokers to apply for an Australian Financial Service Licence in order to carry on insurance broking business after the transition period expired in 2004.
During the transition period the prescribed disclosure provisions of the ‘Insurance [Agents & Brokers] Act 1984’ remained in force, however FSRA 2001 was also silent on the issue of DOFI’s, there being nothing in the FSRA 2001 legislation concerning the conduct of insurance brokers arranging insurance with DOFI’s nor was there any prescribed disclosure requirements included. Most insurance brokers maintained the disclosure provisions of the Insurance [Agents & Brokers] Act 1984’ in any event.
Both ASIC and APRA were relatively silent on the topic of DOFI’s until early 2007 when the draft FSLA Legislation concerning the Insurance Act [1973] and the Corporations Act 2001, was circulated for stakeholder comment.
In essence, the draft FSLA Legislation sought to outlaw the practice of insurance brokers arranging insurance with DOFI’s except for in extreme circumstances such as, for example, there being no other available insurance market in Australia for a particular risk or, where the client was a very large corporation.
Other than in such circumstances the draft FSLA Legislation sought to require DOFI’s wanting to insure Australian risks, to have to obtain authorisation under new provisions of the Insurance Act [1973] requiring they meet certain regulatory and solvency requirements of the Act, and be APRA’s regulatory authority.
During the stakeholder consultation process a number of amendments to the draft FSLA Legislation were circulated for further comment however, the variations offered little respite for DOFI’s not willing to seek authorisation under the Insurance Act [1973].
Despite protestations from leading industry representative groups such as the National Insurance Brokers Association ‘NIBA’ and other significant industry bodies, the FSLA Legislation received Royal Assent on 24 September 2007, with an effective commencement date of 1 July 2008.
Shortly after the FSLA Legislation was passed, the Australian Treasury Department ‘Treasury’ issued draft proposed Regulations titled the ‘Insurance Amendment Regulations’ concerning a process of ‘Exemptions’ from certain provisions of the FSLA Legislation.
As part of the stakeholder consultation process I was invited to make two [2] separate submissions with regards to the proposed exemption provisions, one confidential and the other publicly available. [copy annexed with this report]
During the course of the consultation process I met with senior Treasury officials who raised their concerns that the FSLA Legislation as it stood, could effectively cause the Australian insurance market to become a ‘closed shop’ with the potential to drive up insurance premiums.
In particular, the Australian Competition & Consumer Commission ‘ACCC’ were concerned that the FSLA Legislation was so restrictive that it had the potential to create a collusive regime where Australian insurers might cooperate on price fixing.
Treasury were of the view all Australian insurance consumers were entitled to access other insurance markets -DOFI’s- where Australian insurers could not provide the products and services required and at competitive terms and prices to those otherwise available from DOFI’s.
Treasury were also of the view insurance consumers were entitled to have the benefit of professional advice from insurance brokers concerning their insurance arrangements but that the FSLA Legislation as it stood, effectively prohibited insurance brokers arranging insurance with DOFI’s where in certain circumstances it could be in the consumers best interests to do so.
In the weeks leading up to 1 July 2008, the proposed Insurance Amendment Regulations were passed ‘The Insurance Amendment Regulations 2008’ with the result that a workable process of exemptions have been developed which, in certain circumstances, allow insurance brokers to continue arranging insurance with DOFI’s but, subject to a more restrictive regime than existed prior to 1 July 2008.
- Key Legislative Restrictions Concerning Insurance Arrangements With DOFI’s
Please note, the following excerpt is from the FSLA Legislation.
[The complete version is annexed with this report]
|
“Financial Sector Legislation Amendment [Discretionary Mutual Funds and
Direct Offshore Foreign Insurers] Act 2007
Corporations Act 2001
1 At the end of Division 4 of Part 7.8 Add:-
985D Financial services licensees etc. not to deal in general insurance products from unauthorised insurers etc.
[1] A financial services licensee, or an authorised representative of a financial services licensee, must not deal in a general insurance product if the insurer for the product, or [if there is more than one insurer for the product] each insurer for the product, is not at least one of the following:
- a general insurer within the meaning of the Insurance Act1973;
- a Lloyd’s underwriter within the meaning of that Act;
- a person in respect of whom a determination is in force, under subsection 7[1] of that Act, that subsection 9[1] or 10[1] or [2] of that Act does not apply [the effect of which is the effect referred to in paragraph 9[1][c], 10[1][c] or 10[2][c] of that Act [as the case requires]].
[2] Subsection [1] does not apply in relation to a general insurance product if, because of section 3A of the Insurance Act 1973, undertaking liability under the contract of insurance concerned is not, or would not be, insurance business for the purposes of that Act”.
|
- Key Exemption Provisions of the Regulations
There are four [4] key points to the Exemption provisions of the Insurance Amendment Regulations 2008, all of which are subject to self assessment by an insurance broker when considering whether or not certain insurance business is exempt from the FSLA legislation. [Refer to Section 4. to 4[E] of the Insurance Amendment Regulations 2008 - attached herewith]
In short the Exemption provisions relate to;
- Insurance contracts for high-value insured - Where the policyholder is a high- value insured with an operating revenue derived in Australia during one financial year of at least $200 million and/or has at least 500 employees; or,
- Insurance contracts for atypical risks - Where the risk is atypical, particularised as insurance relating to such things as hazardous properties including radioactive, toxic or explosive properties - nuclear fuel, nuclear material or nuclear waste - biological material or biological waste - war or warlike activities and/or terrorist acts – and so forth. It also includes liability arising from the ownership or operation of an aircraft or from owning, chartering, managing, operating or being in possession of a vessel other than a pleasure craft; or,
- Insurance contracts for other risks that cannot reasonably be placed in Australia - If after reasonable enquiry and effort an Australian insurance broker is satisfied on reasonable grounds that a particular risk cannot reasonably be placed with an Australian insurer, in circumstances where no Australian insurer will insure against the risk or where the terms [including price] on which any Australian insurer will insure against the risk is substantially less favorable to the insured than the terms on which a DOFI will insure against the risk; and, provided the insurance broker keeps written records of its inquiries into the matters mentioned above, the insurance can be placed with a DOFI; or,
- Insurance contracts required by foreign laws - Where laws of a foreign country require a contract of insurance to be issued by an insurer, or a kind of insurer, authorised or permitted under the laws of that country.
Sections [1.2.& 4.] are relatively straightforward, so long as the client and/or the insurance risk meets prescribed exemption criteria I can see no impediment to an insurance broker arranging the insurance with a DOFI subject to the requirements of Section 4D of the Insurance Amendment Regulations 2008.
Please note, the following excerpt is from the Insurance Amendment Regulations 2008
[The complete version is annexed with this report]
Insurance Amendment Regulations 2008
4D Insurance contracts for other risks that cannot reasonably be placed in Australia
[1] For subsection 3A [1] of the Act, a contract of insurance is specified if an Australian insurance broker certifies in writing that the risk insured under that contract cannot reasonably be placed with an Australian insurer.
[2] In deciding whether the risk insured under that contract cannot reasonably be placed with an Australian insurer, the Australian insurance broker must be satisfied, on reasonable grounds, that:
- there is no Australian insurer that will insure against the risk; or
- the terms [including price] on which any Australian insurer will insure against the risk are substantially less favourable to the insured than the terms on which the unauthorised foreign insurer will insure against the risk; or
- insurance with an Australian insurer would be substantially less favourable to the insured than with an unauthorised foreign insurer because of other circumstances.
Example for paragraph [c]
The insured and the unauthorised foreign insurer have a pre-existing relationship, and the maintenance of that relationship will have significant benefits for the insured.
[3] The Australian insurance broker must make reasonable inquiries about the matters mentioned in subregulation [2].
[4] The Australian insurance broker must keep written records of:
- its inquiries into the matters mentioned in subregulation [2]; and
- its reasons for being satisfied of those matters.
[5] If requested by the insured, the Australian insurance broker must give a copy of the certificate under subregulation [1] to the insured. |
Section 4D[2][a][b][c] of the exemption Regulations offer the widest range of opportunities for insurance brokers considering arranging insurance with DOFI’s however, there are a series of key fundamental comparative factors which need to be considered before being able to do so.
- Key Fundamental Comparative Factors to be Considered For Exemption
Client:-
Does the client meet the criteria of High Valued Insured?
[$200m Annual t/o and/or 500 employees]
Yes – The Exemption would apply.
No - The Exemption would not apply.
Atypical Risk:-
Is the risk ‘atypical’?
Yes – The Exemption would most likely apply, subject to consideration of Section 4D of the Regulations.
No - The Exemption would not apply.
Placement of Risk in Australia:-
Can the Risk reasonably be placed with an Australian insurer in similar comparative terms available from a DOFI, including - Product Availability; 'Policy Wording’ – ‘Premium’?
Yes – The Exemption would not apply.
No – The Exemption would most likely apply, subject to consideration of Section 4D[2][a][b][c] of the Regulations such as;
Premium:- Is the premium quoted by a DOFI substantially less than the premium quoted by an Australian insurer for the same product; ie, ‘apples with apples test’
Yes - Exemption 4D[2][b] would apply.
No - Exemption 4D[2][b] would not apply.
Policy:- Is the DOFI’s policy wording [the contract] substantially more restrictive than what would be considered ‘standard’ wording for the same product generally available from Australian insurers?
Yes – Exemption 4D[2][b] would not apply.
No – Exemption 4D[2][b] would apply.
Satisfied on Reasonable Grounds:-
On balance, after taking into consideration the key fundamental comparative factors mentioned above, if the client’s insurance is arranged with a DOFI would the client’s insurance arrangements from the perspective of policy terms and premium combined, be on substantially less favourable terms to the client then if otherwise arranged with an Australian insurer?
Yes – The Exemption would not apply.
No – The Exemption would apply.
Sections 4D[4][a][b] requires an insurance broker arranging insurance with a DOFI to document by way of written record, the assessment process leading to their decision that on reasonable grounds they were satisfied an exemption and/or exemptions applied, thus allowing them to arrange insurance with a DOFI.
My analysis of the exemption provisions establishes the issue of ‘reasonableness’ to be a primary factor in respect of an insurance broker’s decision to arrange insurance with a DOFI. The Regulations prescribe strict requirements upon the insurance broker in this respect.
In my opinion the word ‘reasonable’, and its variations ‘ness’, ‘...’ly’ ought to be considered in its ordinary meaning:- [e.g. from the Collins Dictionary]
‘Reasonable’ means:-
- ‘using or showing reason’;
- ‘sensible’;
- ‘not extreme or excessive’;
- ‘not expensive’;
- ‘fair average’.
In reference to Exemption 4D[2][b] it is imperative that premium quoted by a DOFI be substantially less than premium quoted by an Australian insurer, for substantially the same policy cover and terms.
Likewise it is imperative the terms of policy cover available from a DOFI are not substantially less favourable or substantially more restrictive than otherwise available from an Australian insurer.
However, there is no specific definition in the Regulations of what ‘substantially less favourable’ means or what the test/measure is, rather it is intended that the insurance broker consider the particular circumstances and make an assessment thereon.
Without a specific definition in the Regulations, a test, for instance, an insurance broker ought to adopt a very strict view of what is reasonable in regard to the particular circumstances however, where premium comparison is concerned a substantial difference alone can be a determining factor on its own.
There is no measure on what ‘substantial’ is to be based. For example a 5% premium variance on $10,000.00 is $500.00, this would be considered a substantial difference by most clients and certainly enough difference for most clients to choose to insure with a DOFI over an Australian insurer. Whereas, a 5% premium variance on $500.00 is ‘$25.00 and would not be considered substantial.
An insurance broker considering arranging a client’s insurance with a DOFI on premium issues alone, ought to include in the quotation submission to their client an explanation of the ‘substantial’ provisions of the Regulations and include price comparisons from both DOFI’s and Australian insurers and, where practicable have the client acknowledge the premium available from the DOFI is substantial in their view and enough to instruct their insurance broker to arrange insurance with the DOFI.
In this respect, an insurance broker contemplating arranging insurance with a DOFI should also consider their client’s financial circumstances when considering what advice or recommendations they might make to the client and what, if any, exemptions apply.
The insurance broker must be able to prove their decision to arrange insurance with a DOFI, was a reasonable decision based on reasonable consideration of the key fundamental factors concerning the insurance.
Good practice in my opinion would require an insurance broker to request insurance terms from both Australian insurers and DOFI’s where reasonable and practicable.
An insurance broker must have made a reasonable attempt to identify those Australian insurers actively engaged in providing the particular line or class of insurance being sought. There is no point requesting terms from insurers not actively engaged in providing the type of insurance cover required.
The process of assessing whether or not an exemption or exemptions apply is relatively straightforward – so long as the insurance broker arranging insurance with a DOFI considers all the key fundamental comparative factors in reference to Insurance Amendment Regulations 2008, and the insurance broker is satisfied on reasonable grounds that an exemption and/or exemptions apply, I can see no impediment to the insurance broker arranging insurance with a DOFI, subject to the client agreeing to have their insurance risk placed with a DOFI upon being presented with appropriate explanation and disclosure.
- An Example of the Process of Consideration - Professional Indemnity Insurance
An insurance broker is not prohibited from requesting insurance terms from a DOFI’ otherwise, there could be no mechanism for comparability between terms offered from both Australian insurers and DOFI’s.
- an insurance broker considering arranging their client’s professional indemnity insurance with a DOFI, would have to consider what is also comparatively available from Australian insurers;
- it would not be good enough for the insurance broker to have considered only one comparative offer from one Australian insurer if there were more than one Australian insurer offering terms for that class of insurance;
- the insurance broker must have made a reasonable attempt to identify those Australian insurers actively engaged in offering a particular line or class of insurance, in this example ‘professional indemnity’, and approach those insurers to obtain terms on each and every occasion unless, there is good reason not to approach one or more of those particular insurers;
- the terms offered from responding Australian insurers would then have to be considered comparatively to those offered from responding DOFI’s with particular regard to key fundamental factors, ie; ‘The Client’ – ‘Product Availability’ – ‘Policy Wording’ – ‘Premium’ before making any assessment whether or not the insurance is capable, under the exemption Regulations, of being arranged with a DOFI; and,
- in further consideration, the insurance broker is required to assess whether or not by arranging their client’s insurance with a DOFI, if their client would be placed in a situation ‘substantially less favourable’ then if the client’s insurance was arranged with an Australian insurer - with regard to the aforementioned key fundamental factors.
In the above example, I have used the terms ‘responding Australian insurers and ‘responding DOFI’s’ because, from experience an insurance broker could not expect all insurers approached to provide terms on a particular risk would respond on each and every occasion, and/or in the time frame required.
In my opinion it is reasonable for an insurance broker to take into some consideration an insurer’s response, or lack of response when assessing whether or not there is sufficient reasonable grounds on which to arrange insurance with a DOFI.
I would expect from experience and research that there is somewhere between 9 and 14 Australian insurers actively offering professional indemnity insurance products for a range of professions and enterprise.
Using the above example, an insurance broker considering arranging professional indemnity insurance with a DOFI would be expected to approach each of those insurers with a request to provide quotation terms.
This is not difficult nor a particularly time consuming process given the availability of modern computer systems which effectively allow an insurance broker to request terms from numerous insurers with the click of one key stroke.
In my opinion an insurance broker would be wise to regularly contact every Australian insurer, as such that appear on APRA’s website, and request the insurer’s expression of interest to provide terms for the particular lines and classes of insurance they wish to underwrite.
If such practice was conducted every six [6] months for example, it would allow the insurance broker to remain up to date with knowledge of insurance products and services available from each Australian insurer and their appetite for certain particular lines and classes of risks.
Finally, on this point there has been a trend in recent years for insurers to appoint Underwriting Agencies to provide underwriting and administrative services on their behalf – effectively outsourcing their underwriting and administration.
Some Australian insurers have more than one underwriting agency providing the same and/or similar services, some will offer terms directly to the public and others will only deal with insurance intermediaries, and some will do both.
The Regulations concerning the exemption provisions specifically mention ‘Australian insurers’ - there is no mention of a requirement or expectation that an insurance broker would also have to approach underwriting agencies however, if specifically directed to do so by an Australian insurer it would not be unreasonable for the insurance broker to do so.
An example of this type of arrangement is Berkley Insurance Co’ [ W.R. Berkley Lloyds] which has appointed ‘Pro Risk’ Underwriting Agency as the firm’s exclusive underwriting agent servicing professional indemnity and liability type insurance on its behalf.
It would not be unreasonable therefore, if directed by Berkley Insurance Company to request insurance terms from Pro Risk. [Underwriting agencies are not authorised insurers for the purposes of the Insurance Act 1973]
- Disclosure to Clients When Arranging Insurance with a DOFI:
- When arranging insurance with a DOFI, an insurance broker must provide their client a disclosure notice containing the following prescribed information:-
- a statement that the insurer is not authorised under the Insurance Act 1973 to conduct insurance business in Australia; and
- a statement that the insurer is not subject to the provisions of the Insurance Act 1973, which establishes a system of financial supervision of general insurers in Australia; and
- a statement that the wholesale client should consider whether to obtain further information, including:
- the country in which the insurer is incorporated, and whether the country has a system of financial supervision of insurers; and
- the paid up capital of the insurer; and
- which country’s laws will determine disputes in relation to the financial product.
Interestingly, the prescribed disclosure information now required under the Insurance Amendment Regulations 2008 are essentially the same requirements of the Insurance [Agents & Brokers] Act 1984. [repealed]
The Insurance Amendment Regulations 2008 facilitate the opportunity for insurance brokers to continue arranging insurance with DOFI’s subject to the exemption provisions of those Regulations insofar as they apply to the Corporations Act 2001 and the Financial Sector Legislation Amendment [Discretionary Mutual Funds and] Act 2007.
However, not all types and classes of insurance previously capable of being arranged with DOFI’s prior to 1 July 2008 will be exempt from the legislation referred above.
I believe I have exhausted the explanation of the consideration process as to how insurance brokers ought to assess whether or not a particular insurance risk can, or cannot be arranged with a DOFI and if so, on what terms.
Thank you for the opportunity to provide my opinion on this subject.
Yours Sincerely
Charles Pratten
Dip.Fin. Serv Gen.Bkr
Attch: Financial Sector Legislation Amendment [Discretionary Mutual Funds and] Act 2007
Insurance Amendment Regulations 2008
Treasury Submission Nov’ 2007
Copyright © All Rights Reserved. Charles Pratten 2008
