WARNING:
This Digest was prepared for debate. It reflects the legislation as
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Bill.
CONTENTS
Passage History Purpose Background
Main Provisions Concluding Comments Endnotes Contact Officer and
Copyright Details
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.
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 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.
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.
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.
- Insurance and Superannuation Commission - Annual Report
1996-97, 36.
- 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.
- Insurance and Superannuation Commission - Annual Report
1996-97, 37 and 38.
- ibid., 37.
- Explanatory Memorandum to the Insurance Laws Amendment Bill
1997; paragraph 142, 36.
- 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.
- Explanatory Memorandum to the Bill; paragraph 145, 37.
- 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.
- ibid., paragraph 70, xxviii
- ibid., paragraph 76, xxix.
- ibid., paragraph 79, xxix.
- 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.
- ibid., 2-6
Bernard Pulle
2 March 1998
Bills Digest Service
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ISSN 1328-8091
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