The Commonwealth Treasury


Regulation of discretionary mutual funds and direct offshore foreign insurers

Close Window

Introduction

1. Treasury is seeking comments from interested parties on the implementation of the key findings of the Review of Discretionary Mutual Funds and Direct Offshore Foreign Insurers, headed by Mr Gary Potts (the review).

2. Discretionary mutual funds (DMFs) and direct offshore foreign insurers (DOFIs) currently provide some level of insurance cover or insurance-like risk management in the Australian market. However, these entities are not subject to the same level of prudential regulation by the Australian Prudential Regulation Authority (APRA) as Australian authorised insurers.1

3. The Treasurer released the report of the HIH Royal Commission into the failure of the HIH Insurance Group on 16 April 2003 (www.hihroyalcom.gov.au). Recommendation 42 proposed that the Australian Government amend the Insurance Act 1973 (the Insurance Act) to extend prudential regulation to all discretionary insurance-like products, to the extent that it is possible to do so within constitutional limits.

4. The HIH Royal Commissioner made no recommendation about regulating DOFIs, but noted that in many instances it is unnecessary to regulate insurance written offshore because it involves large commercial insurance contracts.

The review of discretionary mutual funds and direct offshore foreign insurers

5. In response to the HIH Royal Commissioner’s recommendation, the Government commissioned the review of DMFs and DOFIs on 12 September 2003. The purpose of the review was to consider the appropriate level of prudential and consumer regulation for DMFs and DOFIs. The review made a number of recommendations to change the regulation of DMFs and DOFIs.

6. The Treasurer accepted the recommendations of the review and released the key findings on 27 May 2004. These are available from the DMF and DOFI review website at www.dmfreview.treasury.gov.au. The full report of the review has not been publicly released as it contains a significant amount of commercial-in-confidence information.

7. Since the release of the key findings of the review in May 2004 Treasury has undertaken additional consultations with a range of key stakeholders to consider options for implementing the findings of the review.

8. Treasury is now seeking to consult more broadly on options for implementing the review’s recommendations.

Recent general insurance reforms

9. In recent years, several significant improvements to the regulation framework for general insurance have been implemented.

10. Significant prudential reforms have been achieved through the passage of the General Insurance Reform Act 2001 (the General Insurance Reform Act) and the implementation of the recommendations of the HIH Royal Commissioner.

11. The General Insurance Reform Act amended the Insurance Act to increase minimum entry-level capital for general insurers from $2 million to $5 million and to tailor capital adequacy requirements more closely to the risk profile of individual insurers.

12. Risk management standards have also been strengthened to ensure general insurers are well managed. In particular, the ‘fit and proper’ tests have been expanded to apply to both the board and senior management.

13. Reforms were also introduced to enable APRA to make prudential standards, thus building greater flexibility into the legislative framework. Greater flexibility will allow the prudential regime to accommodate market developments more easily over time.

14. Considerable progress has also been made in implementing the HIH Royal Commissioner’s recommendations. APRA’s internal governance arrangements and front-line supervisory capacity have been enhanced. The Government’s Corporate Law Economic Reform Program (CLERP 9) reforms to corporate governance and audit requirements came into force in July 2004. Other agencies, such as the Australian Accounting Standards Board and the Australian Stock Exchange, have also made significant progress in addressing the recommendations for which they are responsible.

15. The Government’s reforms to the prudential regulation of general insurance are complemented by the reforms to enhance consumer protection, introduced by the Financial Services Reform Act 2001. These reforms include implementing a single, harmonised licensing regime for providers of financial services and advice to consumers, a consistent and comparable disclosure regime, as well as uniform arrangements for regulation of financial markets.

16. In combination, these reforms have addressed significant gaps in the regulatory framework and improved the consistency of financial markets regulation. More importantly, they have helped enhance public confidence in the general insurance industry and the financial sector more broadly.

Structure of this paper

17. This discussion paper is in two main sections covering DOFIs and DMFs separately. Each section comprises:


1 Throughout this paper, references to ‘authorised insurers’ or ‘APRA — authorised insurers’ refer to insurers authorised under section 12 of the Insurance Act 1973 to conduct insurance business in Australia. Depending on context, the phrase may also be used to refer to Lloyd’s underwriters authorised under special provisions in the Insurance Act. Implementation of the review recommendations does not entail changing current arrangements for Lloyd’s underwriters.