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Mallesons Stephen Jaques
Who does this affect?

Lenders mortgage insurers and their insureds. Professional indemnity insurers.

What do you need to do?

Consider responding to the exposure draft.

Authors
Philip Ward  
Partner

Ann Newbrun  
Special Counsel

James Moore  
Special Counsel

Mandy Tsang  
Solicitor
Philip Ward  
Partner
T +61 2 9296 2213
Ann Newbrun  
Special Counsel
T +61 2 9296 2195

Sydney
James Moore  

Melbourne
Katherine Forrest  

Changes to consumer credit regulation - implications for insurance - 19 May 2009

A package including the exposure draft of the National Consumer Credit Protection Bill 2009 (Bill) and associated draft regulations was released on 27 April 2009 with a four week consultation period. The Bill introduces a new Australian credit licensing regime, sets out the requirements under that regime, establishes new “Responsible Lending Conduct” obligations and attaches the National Credit Code as Schedule 1. There are also exposure draft regulations which supplement the Bill.

General information on the Bill is included in our alert of 27 April 2009. In this alert, we consider issues that involve general insurance.

Overview

We have identified some potential issues involving lenders mortgage insurance:

  • changes potentially affecting the scope of cover under a Lenders Mortgage Insurance Policy (LMI Policy)
  • changes that potentially affect other rights and obligations of the parties to an LMI Policy, and
  • the requirement to obtain an Australian Credit Licence (ACL).

For other insurers, there may be greater opportunities to provide professional indemnity insurance for credit providers.

Lenders Mortgage Insurance

Changes to underlying risks - insured or uninsured?

The National Credit Code (Code) is proposed to replace the current Uniform Consumer Credit Code (UCCC). Its application is extended so that regulated credit will include loans to individuals for the purchase of a residential property for investment purposes. Residential property includes vacant land on which a residence will be built.

Further, the threshold under which a debtor can request changes to terms of their credit contract on grounds of hardship and postponement of enforcement proceedings is increased to $500,000.

According to the exposure draft of Regulations dealing with Transitional and Consequential Provisions of the Code and the accompanying commentary, provisions dealing with the application of the Code to existing credit contracts will be finalised after the consultation period. However the initial view is that existing credit contracts will be subject to the Code after the commencement date.

Current LMI Policies

Parties to existing LMI Policies will need to consider the impact of these changes on the cover provided and their rights and obligations generally under those policies. The impact on lenders mortgage insurers and credit providers will depend on the threshold question: whether references in a current LMI Policy to the UCCC are to be taken to include references to the Code. This can only be determined by careful consideration of the definition and interpretation provisions in each particular policy.

If references to the UCCC do include references to the Code, then the extended scope of the Code may extend the obligations of the insurer.

For these LMI Policies, replacement of the UCCC with the Code may result in additional cover being provided even though the insurer may not have been adequately compensated for the additional cover because it was not anticipated at the time of entering into the policy. Further, an insured may have additional obligations that were not envisaged as applying to the insured loan at the time of inception of cover. For example, under some LMI Policies the insured is required to obtain the lenders mortgage insurer’s consent before exercising a remedy in relation to the insured loan if the UCCC applies to the insured loan. If the Code applies to the insured loan whereas the UCCC didn’t, the insured will be required to obtain the lender mortgage insurer’s consent moving forward.

Conversely, if an LMI Policy does not define and refer to the UCCC in a manner which includes the Code in its ambit, provisions in the policy which exclude or circumscribe the insurer’s liability may not achieve their intended commercial effect. If references to the UCCC do not include the Code, then actions under the UCCC that would trigger rights under the policy may not trigger those rights when the equivalent action is taken under the Code.

More specifically:

  • Investment mortgages: if the definition of the UCCC in a policy is wide enough to include the Code in its ambit, provisions of an LMI Policy may be enlivened to provide additional cover (and reciprocally additional obligations upon the insured) in respect of a mortgage of an investment residential property because some standard cover provisions in LMI Policies are prefaced with the words “if the UCCC applies”. Currently such provisions have no work to do as the UCCC does not apply to this category of mortgages.
  • Increased thresholds: lenders mortgage insurers will also need to consider the effect of the increased “hardship” thresholds on existing LMI Policies. Some policies may include cover for loss as a result of changes to terms of the insured mortgage on grounds of hardship and postponement of enforcement proceedings. If the thresholds increase, the scope of cover will increase.

Future LMI Policies

Lenders mortgage insurers and insured mortgagees should consider the application of the Code to mortgages and consider amendments to the policy wordings to reflect the expanded risks, pricing or premium changes and changes to underwriting criteria.

Master Policies

The implications for existing and future master policies governing the relationship between the insurer and insured should also be examined.

Conduct - Licensing

Requirement - engaging in a credit activity.

Lenders mortgage insurers may need to obtain an ACL to be able to lawfully exercise their rights against a mortgagor, surety or third party (such as a valuer) in the event of a claim. This is because an ACL is required if a business is involved in a “credit activity”. A lenders mortgage insurer could be engaging in a “credit activity” in the ordinary course of claims handling, under the following scenarios:

  • DEF5, Items 1(a), 4(b) and 5(c): a person engages in a credit activity if they perform the obligations, or exercise the rights, of:

 
  • a credit provider in relation to a credit contract…whether the person does so as the credit provider or for or on behalf of the credit provider
  • a mortgagee in relation to a mortgage…whether the person does so as the mortgagee or for or on behalf of the mortgagee, and
  • another person who is a beneficiary of a guarantee in relation to the guarantee…whether the person does so on the person’s own behalf or for or on behalf of the other person.

This may raise issues under rights of subrogation. Where a lenders mortgage insurer “stands in the shoes of” or otherwise acts as the credit provider, mortgagee or beneficiary of a guarantee pursuant to a right of subrogation or an analogous right under an LMI Policy, the lenders mortgage insurer may be engaged in a “credit activity”.

  • under DEF9(a): a person is a credit provider, mortgagee or beneficiary of a guarantee where the person is an assignee of the rights of a credit provider, mortgagee or beneficiary of a guarantee under a credit contract, mortgage or guarantee. A lenders mortgage insurer may become an assignee after payment of a claim and thus require an ACL.

Obligations

Lenders mortgage insurers will need to fulfil a range of obligations under the ACL which are set out in our previous alert. However, being APRA regulated, lenders mortgage insurers will be exempt from certain requirements such as:

  • the obligation to have adequate resources to engage in the credit activities and adequate risk management
  • reporting contraventions of the Bill to ASIC if already reported to APRA, and
  • the requirement to hold professional indemnity insurance (see below).

Further, licensing conditions which conflict with the lenders mortgage insurer’s usual activities which are APRA regulated will require consultation between ASIC and APRA. There are special procedures for cancellation or suspension of an ACL for APRA regulated bodies.

Transition

There will be a two stage transition process where entities will be registered and then licensed for the ACL regime. For further details, please see our previous alert.

Exercising mortgagee’s rights

The Code also sets out new default notice requirements before a credit provider can enforce a credit contract or a mortgage against a defaulting debtor or mortgagee. Lenders mortgage insurers should be aware of these notice requirements when exercising the enforcement rights of a mortgagee.

Professional indemnity insurance

A licensee under the ACL regime must have arrangements for compensating persons for loss or damage suffered because of a contravention of an obligation under the Bill by the licensee or its representatives. The arrangements must satisfy any requirements prescribed by the regulations or approved in writing by ASIC. One such requirement is to hold professional indemnity insurance cover that is adequate. Considerations of what is adequate are set out in the regulations. The requirements are based on regulation 7.6.02AAA of the Corporations Regulations 2001 (Cth) which sets out the requirement for Australian Financial Licensees to have adequate PI cover.

ASIC Regulatory Guide 126 Compensation and insurance arrangements for AFS licensees (RG 126) may therefore be relevant in determining what is “adequate”. Similar problems relating to fulfilling RG 126 may arise in this new licensing regime. These have been identified in a previous insurance alert and include:

  • cover for fraud and dishonesty by directors, employees and other representatives, and
  • cover for external dispute resolution scheme awards.

General insurers should consider how this mandatory requirement may create business opportunities.

What next?

Comments in response to the Bill are sought by Friday, 22 May 2009.

This publication is only a general outline. It is not legal advice. You should seek professional advice before taking any action based on its contents.