Upcoming Mallesons seminarsGeneral insurers and eligible general insurance policyholders.
What do you need to do?Consider how the FCS reforms will impact on you if a general insurer goes into liquidation.
Ann Newbrun
Special Counsel
Philip Ward
Partner
T +61 2 9296 2213
Ann Newbrun
Special Counsel
T +61 2 9296 2195
Sydney
Peter Stockdale
The Financial System Legislation Amendment (Financial Claims Scheme and Other Measures) Act 2008 (FCS Act) and the Financial Claims Scheme (General Insurers) Levy Act 2008 (GI Levy Act) have commenced, bringing into force the Financial Claims Scheme as it affects general insurers and certain policyholders in the event a general insurer falls into financial difficulty. The Act establishes the Policyholder Compensation Facility (PCF) and provides a framework for the judicial management of general insurers and Australian branches of foreign incorporated locally authorised insurers.
Policyholder Compensation Facility
The FCS Act inserts a new Part VC into the Insurance Act 1973 to establish the PCF, which will be administered by APRA. Regulations have not yet been released.
What is the PCF?
Where an insurer fails, the PCF can be activated whereby APRA will pay insurance claims to eligible policyholders before they would receive any payment in a liquidation of the general insurer. In return, APRA will take those persons’ places as creditors in the liquidation. This facility, which was first raised as a recommendation following the HIH Royal Commission, brings the Australian framework for insurer insolvency into line with international standards of policyholder protection.
How will the PCF be funded?
The PCF adopts a retrospective funding model under the GI Levy Act. In the first instance, APRA’s costs of meeting claims (up to $20 billion) and administering the scheme (up to $100 million) will be met by the Commonwealth. APRA will then seek to recover these costs through the liquidation of the general insurer. If the assets of the general insurer are insufficient, remaining costs may be recovered by way of levy of up to 5 per cent of the gross premiums of general insurers. The levy may be imposed on a class of general insurers and this may be expected where a specialised insurer fails.
While the PCF is described as tax payer neutral, insurers need to be aware of the cost of this subsidisation to their bottom line when the levy is based on gross premiums.
Who will benefit?
The PCF will provide individuals, small businesses, family trusts and not-for-profit organisations with compensation for claims on policies issued by a general insurer, including the Australian branch of an authorised foreign general insurer, where that general insurer fails. Generally, corporate policyholders with an annual aggregate turnover of more than $2 million will not be able to access the PCF and must recover any funds owing in the normal course of the liquidation.
Claims under the following products are excluded from the PCF:
- statutory insurances, such as workers compensation and compulsory third party motor vehicle insurances
- reinsurance
- insurance provided by unauthorised foreign insurers (UFIs or DOFIs), and
- “insurance-like” products, such as discretionary mutual funds.
It would seem that policyholders who would otherwise be able to access the PCF, but cannot because their insurer is a UFI, are placed in a difficult position because they are not covered by the PCF. With the recently introduced restrictions on insuring with a UFI, these policyholders are likely to only have obtained the UFI insurance because it was an atypical line of insurance or could not be reasonably obtained from a domestic insurer.
Directors and officers of the failed general insurer may be precluded from recovering under the PCF for any claims on policies issued by that insurer.
Certain other policies and policyholders will also be ineligible. This will be determined by regulations, to ensure that the PCF is targeting policyholders least able to assess risk, and to promote market discipline of those excluded from the scheme. The Minister also retains a broad discretion to exclude certain classes of policyholders and insureds from the PCF.
How will the PCF operate?
The PCF is activated by Ministerial declaration where:
- The general insurer is placed under judicial management, and
- APRA advises the Minister that it believes the general insurer to be insolvent or, in the case of a foreign incorporated insurer operating locally through a branch, APRA believes that it is unable to pay all its Australian debts and liabilities from its Australian assets.
Once the PCF is established, claimants must apply for assistance in the prescribed form and provide sufficient information to enable APRA to assess their claim. Claims for less than $5,000 will be fast tracked to limit the likelihood that the cost of determining eligibility under the PCF will exceed the value of the claim in question.
Third party claims
Third parties will also be able to claim on a “cut-through” basis where they meet the requirements of section 51 “Right of third party to recover against insurer” of the Insurance Contracts Act 1984. However, the FCS Act does not refer to other legislation which gives similar cut-through rights to third parties, eg section 6 of the Law Reform (Miscellaneous) Provisions Act 1946 (NSW) and section 601AG of the Corporations Act 2001.
Notionally extended cover
To provide protection where a failed insurer cancels or does not renew a policy, the PCF provides for notionally extended cover with the result that cover will continue, under the terms of the policy, for 28 days after the Ministerial declaration activating the PCF.
Amendments to PDSs
There is an 18 month transitional period in which general insurers must update their PDSs to include information about the PCF. Care will need to be taken in the drafting because policyholders eligible to participate in the PCF are not defined by reference to what is a “retail client” for the purpose of Chapter 7 of the Corporations Act.
Judicial management of general insurers
The FCS Act inserts a new Part VB into the Insurance Act providing a framework that enables general insurers and Australian branches of foreign incorporated locally authorised insurers to be judicially managed in the interests of policyholders and the stability of the financial system.
In what circumstances can a judicial manager be appointed?
APRA or the general insurer may apply to the Federal Court for an order for the appointment of a judicial manager. The Court may make an order if it is satisfied that:
- Following an investigation, it is in the interests of policyholders that a judicial manager be appointed, or
- The time required to conduct or complete an investigation would be detrimental to policyholders’ interests and additional prescribed circumstances exist, eg the general insurer is likely to become unable to pay its policy or other liabilities as they become due, the general insurer has failed to comply with any prudential standard, or there are reasonable grounds for believing that the financial position or management of the general insurer may be unsatisfactory.
The Act lists broad bases on which to appoint a judicial manager, though it would be expected that APRA would approach a Court only where circumstances demand it.
A judicial manager appointed by the Court will take precedence over other forms of company external administration. It is an offence for a person to apply for the appointment of an external administrator without first notifying APRA. This regime applies to a branch of a foreign incorporated locally authorised insurer regardless of whether that insurer is already under external administration outside Australia.
Whenever the interests of individuals and small businesses are threatened by a failing insurer, it is likely that APRA will act to have a judicial manager appointed to enable the PCF to be activated if necessary. Therefore it is most likely that a faltering retail insurer would be treated in this way.
What happens when a general insurer is placed in judicial management?
When a general insurer is placed in judicial management:
- Management vests in the judicial manager
- The general insurer may not issue policies without the leave of the Court
- Proceedings in a court against the general insurer cannot be commenced or proceeded with, except with the judicial manager’s consent or leave of the Court
- The judicial manager must prepare and file a report with the Court which recommends a possible course of action that is the most advantageous to the general interests of the policyholders while promoting financial system stability in Australia. Possible courses of action include transfer of business, recapitalisation or winding up of the general insurer.
What are the powers of the judicial manager?
Section 62Y of the Insurance Act sets out the general powers of a judicial manager. The judicial manager has additional powers under section 62Z to facilitate recapitalisation of the general insurer, including by issuing, cancelling and selling shares in the general insurer. Recapitalisation does not have to reflect the shareholdings at the commencement of the appointment. These actions may be done despite any Corporations Act requirements, listing rules, contractual arrangements or provision in the insurer’s constitution. Additionally, any acquisition of business or shares is exempt from competition assessment under the Trade Practices Act 1974.
Prior to undertaking an action to recapitalise the general insurer, the judicial manager is required to prepare an independent report including a fair valuation of each of the shares and rights in the insurer. However, this requirement can be dispensed with before a recapitalisation action if it is in the interests of policyholders and financial system stability to act quickly.
What are the implications for parties contracting with a general insurer that is subsequently placed under judicial management?
Service providers and other contracting parties (eg financiers) cannot terminate their contracts because the general insurer has been placed in judicial management, despite any provision in the contract to the contrary. Contracting parties cannot terminate or otherwise enforce a change of control clause if a recapitalisation or transfer triggers the clause.
Contracting parties should be aware of this when contracting with a general insurer or branch because protections common in contracts dealing with termination upon the appointment of some form of external administration will not be available if a judicial manager is appointed. Nor will change of control clauses be able to be activated in the context of a judicial management.