Bills Digest No. 140   1997-98 Insurance Laws Amendment Bill 1997


Numerical Index | Alphabetical Index

WARNING:
This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any official legal status. Other sources should be consulted to determine the subsequent official status of the Bill.

CONTENTS

Passage History Purpose Background Main Provisions Concluding Comments Endnotes Contact Officer and Copyright Details

Passage History

Insurance Laws Amendment Bill 1997

Date Introduced: 4 December 1997

House: House of Representatives

Portfolio: Treasury

Commencement: The Act which may be cited as the Insurance Laws Amendment Act 1997, commences on the day it receives Royal Assent. The amendments made to the Acts specified in Schedule 1 commence on a date to be fixed by Proclamation. However, if a Proclamation is not made within 6 months of the Act receiving Royal Assent, Schedule 1 commences on the first day after then end of that period.

The amendments made in Schedule 2 generally commence on a day to be fixed by Proclamation. The conditions that require to be satisfied before Schedule 2 is proclaimed are set out in the paragraph dealing with the main provisions of Schedule 2 in this Bills Digest.

Purpose

The main purpose of the Bill is to improve the security arrangements for Lloyd's of London (Lloyd's) underwriters' Australian policyholders by providing for new prudential supervisory arrangements under the Insurance Act 1973.

There are also amendments to insurance legislation, which include:

  • resolving certain matters arising from the technical operation of the Insurance Act 1973, the Insurance Contracts Act 1984 and the Insurance (Agents and Brokers) Act 1984 which will result in greater consumer protection.
  • removing the regulation of contracts of insurance over non-commercial marine pleasure craft owned by individuals, presently under the ambit of the Marine Insurance Act 1909, and providing for their regulation under the Insurance Contracts Act 1984 which offers greater consumer protection.

Background

Background to amendments relating to Lloyd'

Lloyd's is a major international insurance market, which is based and operated in London. Lloyd's is a society of individuals, known as Names, and corporate members who form syndicates to accept insurance risks. Names are in fact sole traders. The syndicates are run by professionals called managing agents. These agents in turn employ insurance specialists, called underwriters, who deal directly with brokers. The underwriter negotiates with the broker on the acceptance of the risk and the level of premium to be paid. Lloyd's play a major role in the global reinsurance market and is an important participant in the Australian insurance industry. Lloyd's business is to insure a wide range of global insurance risks and it is best known for marine and aviation cover. However, there are syndicates within the market that cover home contents and motor insurance.

The regulation of Lloyd's in the UK is derived from its own Act of Parliament, the Lloyd's Act 1982. This Act consolidated earlier legislation and includes the framework for a system of self regulation at Lloyd's. Lloyd's is exempt from regulation under the Financial Services Act 1986 (UK). However, Lloyd's does have an outside solvency regulator in the form of the Department of Trade and Industry (DTI) which derives its authority from the Insurance Companies Act 1986(UK) (ICA). The full scope of the ICA does not apply to Lloyd's . The supervisory role of DTI is designed primarily to protect the interests of policyholders, and not that of the Names, which is left to the self regulatory regime at Lloyd's. The UK Government announced last week that its new mega supervisory authority for the finance sector, the Financial Services Authority, will be the external regulator of the restructured Lloyd's. The possible impact of the new supervisory arrangements for Lloyd's in the UK, on the measures proposed in this Bill for the protection of Australian policyholders of Lloyd's underwriters, is considered in the Concluding Comments of this Digest.

Lloyd's underwriters incurred large property and liability losses in the late 1980s and early 1990s estimated at over pounds sterling 8 billion. These losses threatened the operation of Lloyd's market and this crisis was averted by a restructuring of its business and the raising of additional finance from companies. The restructuring involved the separation of the losses of 1992 and earlier into a new company called Equitas Limited. In the words of the Insurance and Superannuation Commission, which monitors the operation of Lloyd's underwriters in Australia, this restructuring will "provide Lloyd's with a 'clean' platform from which to plan and manage future business."(1)

In Australia Lloyd's underwriters are subject to the Insurance Act 1973 (the Act) and Part VII of the Act governs the authorisation and conduct of business of Lloyd's underwriters. Under section 93 and the Schedule to the Act the main protection for Lloyd's underwriters' Australian policyholders is the requirement that Lloyd's lodge with the Treasurer:

  • securities of the Commonwealth, the market value of which is at any given time not less than Australian (A)$500 000; and
  • a covenant given by a bank in the way of a guarantee.

The amount of the guarantee varies with the level of premiums underwritten by Lloyd's underwriters in Australia. The notional balance at 30 June 1997 of Lloyd's Deposit was A$562 153.(2) These amounts are available to satisfy a final judgment obtained in Australia against a Lloyd's underwriter

This is not a satisfactory security as the sum of A$500 000 and the amounts payable to the Treasurer under the covenant which is intended to support outstanding claims liabilities in Australia, may generally not have any relationship with the amount of outstanding claims liabilities. The monetary value of the deposit has remained unchanged since 1973 when the Insurance Act 1973 commenced. There is always the potential for underwriting losses to exceed by far the amounts held by the Treasurer to meet the liabilities of Lloyd's underwriters. Thus a notable feature of the general insurance business in Australia is that the overall underwriting result for the private sector is a deficit. The Insurance and Superannuation Commission records that in 1996, the private sector general insurance industry showed an underwriting deficit of $807 million compared with a loss of $890 million in 1995. Nevertheless, the private sector general insurers reported an after tax profit of $811 million in 1996 compared with $795 million in 1996. Contributing to the profit was investment income of $2.3 billion in 1996 compared with $2.1 billion in 1995.(3) These figures are indicative of the extent to which reliance is placed on investment income, by general insurers, to achieve a profit.

As to as Lloyds, there was concern that the losses incurred in 1992 and earlier, which financially ruined many Names, may have adversely impacted on its capacity to operate its market. It is relevant to note that in addition to the security provided under the Insurance Act 1973, Australian policyholders are protected by the society's member trust funds in the UK and the personal wealth of individual members. The value of this additional security was questionable with the losses incurred at Lloyd's.

Further, in the event that Lloyd's underwriters ceased business in Australia, Lloyd's would no longer receive premiums and the value of the covenant will diminish. It is relevant to note that Lloyd's underwriters wrote total premium income in Australia of A$128 million in 1996 compared with A$258 million in 1995.(4)

The amendments proposed in the Bill will change the regulatory requirements in recognition of the restructured framework for the operation of Lloyd's underwriters. It is anticipated that the measures in the Bill will at the same time substantially enhance the protection in the Act for the Australian policyholders of Lloyd's underwriters.

Main Provisions

Amendments relating to Lloyd's

Schedule 2 of the Bill sets out the amendments to the Insurance Act 1973 relating to Lloyd's. The main changes relate to the requirement to establish security trust funds to replace the current requirement of a bank covenant and the requirement that Lloyd's lodge with the Treasurer securities of the Commonwealth to the value of A$2 million in place
of lodging Commonwealth securities to the value of A$500 000 under the existing provisions.

Proposed section 65 provides a simplified outline of Part VII, which is set out below as it succinctly summarises the amendments relating to Lloyd's.

The following is a simplified outline of this Part:

Lloyd's will be required to ensure that there are in existence security trust fund arrangements under which final judgments obtained in Australia against Lloyd's underwriters in respect of certain insurance liabilities may be satisfied out of trust property.

Security trust funds in existence in fulfilment of such a requirement are called designated security trust funds.

The Commissioner may make rules that are applicable to designated security trust funds.

Lloyd's underwriters are authorised to carry on insurance business. However, that authorisation may be suspended or cancelled if there has been a contravention of this Part.

The Commissioner may require the appointment of an actuary to carry out an investigation of the extent to which a designated security trust fund constitutes an adequate security for the class of insurance liabilities secured by the fund.

The Commissioner has powers of inquiry, direction and investigation in relation to designated security trust funds that correspond to the powers conferred by Part V in relation to authorised corporate insurers.

The Federal Court may make an order placing a designated security trust fund under judicial trusteeship.

Lloyd's, or a company nominated by Lloyd's, is required to lodge with the

Treasurer a security deposit valued at $2 million. The deposit is available to meet the costs of judicial trusteeship of designated security trust funds.

Proposed section 67 requires that a security trust fund be established by deed with the trustee being a qualified corporation. A contract of insurance is covered by a security trust fund if insurance liabilities under the contract are secured by the fund. The trust property will be available to satisfy final judgments obtained in Australia against Lloyd's underwriters in respect of a class of insurance policies specified in the deed. Proposed section 68 provides that the Insurance and Superannuation Commissioner (the Commissioner) may by written instrument, after a consultative process, require Lloyd's to ensure that there are in existence trust fund arrangements and other ancillary or incidental arrangements. The Explanatory Memorandum states that the use of instruments and the consultative process is to provide flexibility to meet future changes to Lloyd's corporate structure.(5) Before Schedule 2 is proclaimed , the Treasurer must certify in writing that, in the Treasurer's opinion an instrument will be in force under subclause 68(1) and that one or more security funds will be in existence in fulfilment of an obligation imposed by that instrument.

Proposed section 69 defines a designated security trust for the purposes of Part VII as a fund that complies with rules made by the Commissioner by written instrument under proposed clause 68. The Commissioner may by written instrument make rules governing the operation of designated security trust funds, disclosure of information to the Commissioner, making available to the public copies of trust deeds, the keeping and retention of records and inspection by the Commissioner, the auditing of accounts, the preparation and lodgment of returns to the Commissioner and the valuation of assets of funds. A written instrument for the purposes of proposed section 70 is a disallowable instrument.

The security trust funds are to be funded on behalf of underwriters from syndicate funds held by Lloyd's intermediaries or reinsurers. As the identity of these intermediaries will change with the passage of time, it may turn out that not all the intermediaries at any given time have signed the trust deed. The Explanatory Memorandum expresses the view that there is some legal risk that an intermediary who has not signed the trust deed but who has made payments to the trust may claim that the terms and conditions in the trust deed do not bind that intermediary. Proposed section 71 attempts to limit this risk by introducing a 'presumption of regularity' in respect of money or property transferred to trustees of security trust funds maintained for the purpose of providing security to Lloyd's underwriters' Australian policyholders. Proposed section 71 states that any money or property transferred to a trust is to be taken as held on trust in accordance with the fund's trust deed, irrespective of the intention of the transferor or the authority or capacity of the transferor. It is arguable that the reach of the proposed section 71 may not be wide enough to override grounds for challenging in a court in the United Kingdom the validity of payments made from UK syndicate funds, which are trust funds, to a designated security trust fund in Australia. This may give rise to a conflict of laws question. In addition, as Australia is a signatory to the Convention on the Law Applicable to Trusts and on their Recognition.(6)

Without reservations, the measures in proposed section 71 may raise questions on the law applicable to syndicate funds of intermediaries. The Explanatory Memorandum appears to reflect the legal uncertainties in a cautious approach to the effectiveness of the proposed measures.

The security trust funds are to be funded on behalf of underwriters from syndicate funds held by Lloyd's intermediaries or reinsurers. The identity of these intermediaries will change from time to time and it will be impractical for them to sign up to the trust deed. This will mean that there is some legal risk that payments made by an intermediary to a trust could be challenged on the basis that the intermediary has not signed and is therefore not bound by the trust deed. To limit the risk to the security of Australian policy owners, it should be presumed that all payments made to the trust become part of the trust regardless of any legal irregularity in the funding arrangements in the United Kingdom.(7) (emphasis added)

There are therefore doubts whether the proposed 'presumption of regularity' could overcome any legal irregularity of the UK syndicate funding arrangements of the proposed Australian designated security trust funds. At stake is the attempt at offering protection to Lloyd's underwriters Australian policyholders.

However, there are measures in the Bill to enable the Commissioner to monitor closely the adequacy of the security provided by designated trust funds including the power to requisition actuarial reports (proposed section 75), which may provide advance notice of any threat to policyholders. In addition proposed section 74 gives the Commissioner the authority to direct, with the approval of the Treasurer, that Lloyd's underwriters must not issue or renew policies. These measures may be safeguards that may meet any deficiency arising from the presumption of regularity.

That the attempt to offer greater protection to policyholders of Lloyd's is a major problem is evidenced by the findings of the Treasury and Civil Service Committee of the House of Commons which inquired into the adequacy of self-regulation at Lloyd's in 1995. The salient findings of this Committee are set out below.

  • Our main concern is that regulation at Lloyd's should give assurance that the regulatory failures of the past will not recur. It is evident that no form of regulatory regime can give a 100% guarantee of efficacy but there is much evidence to suggest that the performance of regulation at Lloyd's in the recent past has fallen well below acceptable standards.(8)
  • We accordingly recommend that legislation should be introduced to transfer to an independent body responsibility for the regulation of Lloyd's according to the principles established under the Financial Services Act and refined in practice by the SIB (Securities and Investment Board).(9)
  • The lack of professional indemnity insurance in Lloyd's (E&O cover) is a matter of considerable concern. It is inequitable for Names to trade forward with unlimited liability where even a simple clerical error could result in a major loss for the Name without the availability of some form of cover. It would be preferable for this cover to be placed outside the market but Lloyd's should also consider the central provision of such cover. This matter should be addressed as a matter of priority as it means that a major commercial pressure to ensure proper underwriting standards, proper reserving and proper capital adequacy is absent.(10)
  • The evidence suggests that there is a need for a wider investigation of events at Lloyd's which go beyond the order of reference of this Committee.(11)

The UK Government's response in 1995 was in the main to review the progress made by Lloyd's to put its house in order after at least two years. It stated:

Accordingly the Government will undertake in due course a longer-term review of the statutory framework of Lloyd's regulation. It would not begin until it is clear that the current reforms (including the authorisation of the Equitas company and the settlement) are coming into effect, and the launch would wait until the shape of the future market (particularly the balance between Names and corporate capital) is clearer. This points to delaying the start of the review for at least two years.(12)

In May 1997, the Regulatory Review Group set up by Lloyd's recommended that both the UK Department of Trade and Industry (DTI) and the Securities and Investment Board (SIB) oversee the regulation of Lloyd's market. It was argued by the Board that external accountability is essential to reinforce confidence and to assure all members of the society that their interests would be taken into account.

The UK Government last week decided that Lloyd's of London will be overseen by an independent watchdog, ending its 300-year old tradition of self-regulation. The Financial Services Authority, the new regulator created to oversee the UK's financial services sector, will be given wide powers over disciplinary and solvency measures at the market. The proposals include the authorisation of managing agents and the direct authorisation and supervision of Lloyd's names. The decision was confirmed last week in the House of Commons by the Economic Secretary to the Treasury.

Financial Impact

Lloyd's or a company nominated by Lloyd's will be required to make a security deposit of A$2 million with the Treasurer under proposed section 92Q. The deposit is intended to meet administrative costs in administering the judicial trusteeship of security trust funds. Under the proposed amendment both legal and equitable ownership of the security will be transferred to the Commonwealth. The amendment also requires the Treasurer to return any interest on the A$2 million security deposit on application by Lloyd's. This requirement to pay interest is intended to maintain equality of treatment between Lloyd's and other corporate insurers who under the Insurance Act 1973 are free to invest the solvency margin amount and take the benefits from the investment.

Proposed section 92Q provides that the Consolidated Revenue Fund is to be appropriated for payment of interest to Lloyd's. However, as the interest derived on the securities will be paid into the Consolidated Revenue Fund prior to its payment to Lloyd's, the actual financial impact on the Commonwealth will be nil.

Schedule 1 - General Amendments

As indicated in the Regulation Impact Statement(13) the amendments to the Insurance Act 1973, the Insurance Contracts Act 1984 and the Insurance (Agents and Brokers) Act 1984 will improve information flows between contracting parties. These amendments as well as the amendments to the Marine Insurance Act 1909 will improve the protection offered to marine pleasure craft owners.

The amendments in proposed paragraphs 44(1)(a) and (b) will streamline the reporting requirements for authorised insurers and give greater flexibility to the Insurance and Superannuation Commission (ISC) in responding to changing information needs. The form and contents of the statutory accounts and statements could with the proposed changes be subject to ongoing review to improve the prudential reporting requirements and to repeal outmoded requirements.

Proposed section 9A will bring marine pleasure craft owned legally and beneficially by one or more individuals within the ambit of the Insurance Contracts Act 1984.

The Explanatory Memorandum clearly indicates how the various other amendments proposed by Schedule 1 will benefit consumers.

Concluding Comments

Transition from Self Regulation to External Regulation of Lloyd's

Impact of Proposed Changes in the UK law

Part VII of the Insurance 1973 was in the first instance included to regulate Lloyd's underwriters in Australia for the protection of Australian policyholders, considering its unique position in the international insurance market. The measures in the Bill are intended to level the playing field between Lloyd's underwriters and other insurers, by bringing Lloyd's underwriters more into line with other authorised insurers under the Insurance Act 1973. These measures take into account the restructuring at Lloyd's which has taken place since 1992 but still accord to Lloyd's underwriters a special regime under Part VII. The announcement by the UK Government last week that Lloyd's will be brought within the supervisory regime of the Financial Services Authority raises the question whether Lloyd's underwriters in Australia should be brought within the same supervisory regime under the Insurance Act 1973, as other insurers operating in the international insurance market. A UK Draft Bill to give effect to the new supervisory regime for Lloyd's is expected later this year and it is anticipated that it may be some time before Lloyd's restructures itself on the lines of other players in the international insurance market. It can therefore be expected that the changes to the law in the UK will have transitional measures in operation until the restructuring is achieved and the losses of past years wiped out with future profits.

In consequence, transitional measures in Australia to deal with the continued restructuring at Lloyd's will be required and proposed paragraph 74(1)(b) will give the Insurance and Superannuation Commissioner the authority to act to meet any contingencies. Proposed paragraph 74(1)(b) provides that if as a result of an enactment of an Act of the United Kingdom, a substantial change is made in the constitution, powers, rights or obligations of Lloyd's or of Lloyd's underwriters, the Commissioner may, with the Treasurer's agreement, by written notice give either or both of the following directions:

  • that Lloyd's underwriters must not issue policies or undertake liability under insurance contracts; and
  • that Lloyd's underwriters must not renew policies.

Any changes in the UK law relating to Lloyd's may only effect the transition from self-regulation to external regulation and therefore enhance the existing supervisory arrangements which will be to the ultimate benefit of all policyholders of Lloyd's underwriters. Therefore, the need to for the Commissioner to have recourse to the drastic provisions of proposed paragraph 74(1)(b) may not arise. Nevertheless, these and other measures in the Bill for the protection of Australian policyholders discussed under the Main Provisions may meet the needs of the period when Lloyd's transforms itself to the status of other major players in the international insurance market.

Endnotes

  1. Insurance and Superannuation Commission - Annual Report 1996-97, 36.
  2. The Auditor-General Audit Report No. 31 197-98, Audit of the Aggregate Financial Statement prepared by the Minister for Finance and Administration - Year ended 30 June 1997, 18.
  3. Insurance and Superannuation Commission - Annual Report 1996-97, 37 and 38.
  4. ibid., 37.
  5. Explanatory Memorandum to the Insurance Laws Amendment Bill 1997; paragraph 142, 36.
  6. Convention on the Law Applicable to Trusts and on their Recognition (The Hague, 1 July 1985); Australian Treaty Series 1992 No. 2; The Convention entered into force for Australia and generally on 1 January 1992.
  7. Explanatory Memorandum to the Bill; paragraph 145, 37.
  8. Financial Services Regulation: Self-Regulation at Lloyd's of London; Treasury and Civil Service Committee; Fifth Report Session 1994-95 (17 May 1995); Volume 1; paragraph 69., xxvii.
  9. ibid., paragraph 70, xxviii
  10. ibid., paragraph 76, xxix.
  11. ibid., paragraph 79, xxix.
  12. Financial Services Regulation: Self-Regulation at Lloyd's of London; Treasury and Civil Service Committee; Fifth Special Report: Session 1994-95 (19July 1995); paragraph 1.25, x.
  13. ibid., 2-6

Contact Officer and Copyright Details

Bernard Pulle
2 March 1998
Bills Digest Service
Information and Research Services

This paper has been prepared for general distribution to Senators and Members of the Australian Parliament. While great care is taken to ensure that the paper is accurate and balanced, the paper is written using information publicly available at the time of production. The views expressed are those of the author and should not be attributed to the Information and Research Services (IRS). Advice on legislation or legal policy issues contained in this paper is provided for use in parliamentary debate and for related parliamentary purposes. This paper is not professional legal opinion. Readers are reminded that the paper is not an official parliamentary or Australian government document.

IRS staff are available to discuss the paper's contents with Senators and Members
and their staff but not with members of the public.

ISSN 1328-8091
© Commonwealth of Australia 1997

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Published by the Department of the Parliamentary Library, 1997.



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