The Commonwealth Treasury


Regulation of discretionary mutual funds and direct offshore foreign insurers

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Direct offshore foreign insurers

Background on DOFIs

26. Foreign insurers wishing to conduct authorised insurance business in Australia must establish a subsidiary or branch in Australia and apply to APRA for licensing under the provisions of the Insurance Act. However, foreign insurers can still sell insurance to Australians via an insurance agent or broker licensed in Australia without establishing a subsidiary or branch. These foreign insurers, known as DOFIs, are not subject to the provisions of the Insurance Act because they are not considered to be carrying on ‘insurance business in Australia’ under sections 9 and 10 of the Insurance Act. However, these DOFIs may be subject to prudential and consumer regulation in their home jurisdiction.

27. The review found that the ‘carrying on insurance business in Australia’ test lacks clarity, is unnecessarily restrictive and does not reflect the implications of the internationalisation of insurance services.

28. The review concluded that DOFIs comprise approximately 2.5 per cent of the Australian insurance market overall, but provide significant capacity in specialised lines. The review also noted that DOFIs largely operate out of comparable regulatory jurisdictions and write much of their business for large corporate entities.

Review recommendations

29. The key findings of the review in relation to DOFIs are as follows:

Objectives of the recommendations

30. The review noted that the profile of DOFIs and the insurance capacity they provide in the Australian market underline the importance of not implementing regulatory changes of a magnitude or a time frame that could prove disruptive.

31. The recommendations are intended to improve current prudential regulatory arrangements. They seek to avoid prohibiting commercial arrangements that have worked satisfactorily to date and to target areas of the highest risks such as foreign insurance companies operating out of less stringent regulatory jurisdictions.

32. In considering the regulation of DOFIs, the Government would be seeking to balance an appropriate level of stability and policyholder protection against any significant adverse impact on the availability and affordability of insurance. The recommendations recognise the need for a competitive, freely-contestable insurance market, with appropriate prudential and consumer protection.

33. The recommendations do not seek to place insurance provided by DOFIs on an identical footing with insurance written by authorised insurers. When the recommendations are implemented, Australian creditors could be placed at a disadvantage compared to creditors in the insurer’s home jurisdiction in the event of a wind-up.

Question 1

Treasury invites comments on whether the objectives of the review recommendations are appropriate.

Question 2

If the objectives are appropriate, are the review recommendations the best means of achieving the objectives?

Question 3

What will be the implications for the supply of insurance in Australia of implementing the recommendations?

Issues for clarification

34. Implementing the review recommendations for DOFIs raises a number of issues in terms of interpreting each of the criteria involved. Issues for resolution include:

Marketing insurance in Australia

35. The existing Insurance Act would require a number of changes to capture all insurers marketing insurance in Australia and to clarify the activities captured by the definition of ‘insurance business in Australia’.

36. Implementation of the recommendations would require that insurers ‘marketing insurance’ in Australia, as opposed to the current ‘carrying on insurance business’ in Australia, be subject to the Insurance Act. This implies a broadening of the scope of the Act.

37. The review did not propose extending the regime to situations where Australian consumers sought out and bought insurance directly from foreign insurers (over the internet, for example) where those insurers did not seek to market their products in Australia, directly or through agents or brokers.

38. That is, the regime would not apply if an Australian decided to seek out insurance overseas (either in person, by telephone or over the internet), but would apply if a DOFI targeted insurance business in Australia by, for example, offering (either directly, through agents or brokers, or via the internet) insurance to Australians. The e-mailing of an offer of insurance to Australian sports car owners would be considered marketing insurance in Australia.

39. There are a number of possible ways of broadening the scope of the Insurance Act to capture all insurers marketing insurance in Australia and clarifying what activities constitute ‘carrying on insurance business in Australia’ for the purposes of prudential regulation.

Insurance business

40. It is proposed that the definition of insurance business be broadened to capture entities or individuals engaged by domestic and foreign insurers to:

41. It is proposed to amend the definition of ‘insurance business’ to clarify that an insurer is carrying on such business whether the acts are performed directly by the insurer or through a representative of the insurer (for example, an agent or broker). An entity that falls within this broader scope would need to be either an authorised insurer or acting on behalf of an authorised insurer.

42. This broadening of the scope of the definition of insurance business would capture any insurer (including a DOFI) that uses persons in Australia to procure, market or administer insurance business, whether or not these activities occur as stand-alone activities or in conjunction with undertaking the insurance liabilities.

In Australia

43. To clarify the description of ‘in Australia’, it is proposed that a provision similar to section 911D of the Corporations Act 2001 (the Corporations Act) be introduced, defining when insurance business is taken to be carried on in Australia.

44. For the purpose of implementing the review recommendations, the provision would state that conducting insurance business in Australia would include:

45. Such conduct would include targeting Australian consumers via the internet or telephone.

46. These arrangements would not apply to the provision of ongoing services in relation to a product acquired while the policyholder was outside Australia. For example, they would not apply to an insurance contract purchased by an Australian while living in Scotland.

Question 4

Are the proposed amendments to the Insurance Act to capture DOFIs marketing insurance in Australia the most effective means of implementing the recommendation?

Question 5

Will the proposed extension of ‘insurance business’ capture all DOFIs?

Question 6

Will the proposed extension capture activities or entities that should not be caught?

Question 7

Is the definition of what is taken to occur ‘in Australia’ enforceable?

Question 8

Would these proposed amendments have unintended implications for currently authorised insurers, including subsidiaries and branches?

Question 9

Are there alternative means of extending prudential regulation to DOFIs marketing insurance in Australia?

Exemptions when operating from a comparable regime

47. DOFIs marketing insurance in Australia without APRA authorisation would need to apply to APRA for an exemption.

48. In order for the exemption to be implemented, it is necessary to determine:

Conditions to be met for exemption

49. To obtain and maintain an exemption from prudential requirements in Australia, a DOFI would need to:

50. The second condition is intended to facilitate the collection of information about DOFIs operating in Australia. An amendment to the Financial Sector (Collection of Data) Act would enable APRA to collect relevant data from DOFIs as a condition for any exemption.

51. The third condition for eligibility establishes that it is the DOFI’s responsibility to inform APRA of any change in its circumstances that may affect its eligibility for the exemption, both in terms of its home regime and its own circumstances. APRA would be given the power to vary or revoke an exemption to reflect conditions placed on the insurer in their home jurisdiction, such as it being suspended or placed in run-off.

52. The obligation for the DOFI to report to APRA any relevant changes in circumstance will be supported by ensuring APRA has sufficient monitoring, investigation and enforcement powers in relation to the exemption from the Insurance Act.

53. In the event that a DOFI breaches a condition of the exemption, section 14 of the Insurance Act would apply to impose a penalty for a strict liability offence.

Question 10

Are these conditions appropriate for DOFIs seeking to obtain an exemption from the Insurance Act?

Question 11

Are any further conditions necessary to effectively implement the review’s recommendations?

Assessment of comparable regulatory regimes

54. In order to conduct an assessment of an insurer’s home regime, APRA would be required to compare broad objectives and outcomes rather than conduct a line-by-line comparison of the requirements in each regime. Outlined below are broad principles that could be used to assess a regime. They are in line with principles used by APRA to consider lenders’ mortgage insurance in its guidance note on risk-weighted on-balance sheet credit exposure (AGN112.1).

Characteristics of the overseas regulator

55. In making its assessment, APRA would consider the appropriateness and sufficiency of the:

Characteristics of the overseas general insurance prudential regulatory regime

56. APRA would assess the extent and nature of mandatory requirements and the standards that the overseas regime places on the general insurers including that the insurer is:

Additional criteria

57. APRA would also be able to take into account any other significant factors in its assessment of the comparability of a foreign regime, such as ensuring active supervision of a general insurer in its home jurisdiction. For example, an insurer may be domiciled in a regime where the prudential regulation is comparable with that of Australia, but the insurer itself may have had its licence suspended in that regime, or have been placed in run-off.

58. As such, an additional criterion would require the DOFI to satisfy APRA that it is actively operating and writing business in its home jurisdiction, and being regulated for that business. APRA could be satisfied by a variety of means, including a letter from the home regulator or evidence that the DOFI was undertaking a material amount of business in the home jurisdiction, or some alternative measure.

Question 12

Do the proposed criteria to determine the eligibility of an overseas regime provide sufficient certainty that the DOFI is appropriately regulated without requiring APRA to conduct an exhaustive examination of the DOFI, its home regime and its prudential stability?

Question 13

Are there other criteria that ought to be considered when determining a ‘comparable regime’?

Mechanism for obtaining an exemption

59. One approach for the granting of exemption would be to amend section 7 of the Insurance Act to allow APRA to make a determination to exempt a DOFI from some or all parts of the Insurance Act where APRA considers the overseas regime to be comparable, based on the broad principles outlined above.

60. A DOFI would apply to APRA in writing for an exemption from the requirement to be authorised under the Insurance Act to market insurance business in Australia.

61. APRA would consider the application for exemption on a case-by-case basis and assess whether the offshore regime was comparable based on broad principles outlined in law. It would be the insurer’s responsibility to provide APRA with the necessary information although APRA could ask the DOFI to provide any information necessary to determine whether to grant an exemption.

62. If APRA considers that the DOFI operates out of a regime that is not comparable, the entity would be required to meet all requirements of the Insurance Act should it wish to market insurance in Australia.

63. A fee for assessing the application would be charged. Section 51 of the Australian Prudential Regulation Authority Act 1998 would give APRA the ability to charge a DOFI for the work involved in considering a DOFI’s application for exemption.

Question 14

Are there any concerns with this possible mechanism or process for obtaining an exemption?

Question 15

Are there any preferred options?

Data collection

64. As noted above, one condition of the exemption would be the provision of data to APRA, under the Financial Sector (Collection of Data) Act. APRA would establish standards for DOFIs so that they are not subject to all of the data requirements of authorised insurers.

65. Such data would not be collected to assist with prudential regulation (as APRA will not be regulating exempt DOFIs). Instead, the purpose of this data collection will be to develop and maintain a clear understanding of the size and type of business DOFIs write in Australia. For example, details on the lines of insurance and volumes of business written in Australia could be collected.

66. Such data could also be used to determine whether exempt DOFIs continue to satisfy the exemption criteria. However, as noted earlier, the obligation rests with the DOFI to inform APRA should its situation change.

Question 16

What type of data should be collected from exempt DOFIs to inform understanding on their role in the insurance market?

Other exemptions

Captive insurers

67. Domestic captives2 are currently regulated under the Insurance Act. (The Insurance Act does not recognise captives as a separate type of insurer.) Wholesale consumers use captives as an alternative to self-insurance.

68. APRA has been exploring proposals to exempt from prudential regulation domestic captive general insurers whose business is limited to wholly-owned corporate groups. APRA released its discussion paper on exempting captives from prudential regulation on 23 February 2005.

69. In general, the services provided by captives often resemble self-insurance within a corporate group that is itself not subject to regulation. The decision to retain insurance risk within a corporate group, either through a captive insurer or through self-insurance by member companies in that group, is a commercial one.

70. To ensure consistency with APRA’s proposal to exempt domestic captives from prudential regulation, it may be appropriate to extend the proposal to offshore captives.

71. In implementing the review recommendations on DOFIs, the Insurance Act could also be amended to allow for an exemption of captives. Captives meeting appropriate criteria (both domestic and DOFIs) would be exempt from prudential regulation in Australia.

72. However, determining the appropriate criteria for captives to be exempt from regulation exposes a tension between securing appropriate protection for policyholders but defining captives and their service sufficiently broadly to have some practical benefit.

73. Possible criterion already explored by APRA include the captive:

74. Some of these criteria may be appropriate for all captives and others may not.

75. For example, it may be appropriate for jurisdictions that mandate statutory classes of insurance, such as workers’ compensation and some professional indemnity insurance, to consider specifying what type of insurer can provide the statutory insurance.

76. These jurisdictions need to be aware that captives, DMFs and DOFIs that write statutory classes of insurance business, or write insurance business to enable a corporate group to meet statutory obligations, may face a lower level of supervision.

77. However, rather than the Australian Government restricting an exemption from prudential regulation available for those classes of insurance, it is the responsibility of those jurisdictions mandating certain types of insurance to specify what classifies as appropriate insurance in these situations.

78. Some jurisdictions already stipulate the appropriate source of statutory insurance. Other jurisdictions may wish to consider whether they wish to limit who can provide mandated insurance.

Question 17

Should offshore captive insurers be exempt from the requirements of the Insurance Act, in line with current proposals to exempt domestic captives?

Question 18

What would be the appropriate criteria for a captive insurer to qualify for an exemption from prudential regulation?

Question 19

Should criteria for eligibility vary between domestic and offshore captives?

Reinsurers

79. The scope of the Insurance Act captures both insurance and reinsurance arrangements. To that extent, if the scope of the Insurance Act is broadened to capture DOFIs marketing insurance in Australia, unless a specific exemption is made, the business of foreign reinsurers marketing insurance in Australia will also be captured.

Question 20

Is there any reason why foreign reinsurers should be caught by the proposed DOFI regulation regime?

Question 21

What would be the implications for the domestic insurance market if offshore reinsurers (and their brokers and agents) are forbidden to market insurance in Australia unless they are domiciled in a comparable regime?

Question 22

Is this approach consistent with the international treatment of reinsurers?

Market significance test

Rationale for market significance test

80. Concerns were raised during the review that changes to the regulation of DOFIs could provide an incentive:

81. However, given the comparable regime recommendations, options for regulatory arbitrage appear to be limited. It is not obvious that the proposed changes would introduce significant incentives for Australian insurers or foreign insurers currently authorised under the Insurance Act and operating through subsidiaries or branches to move offshore.

Question 23

What are the incentives for insurers to move offshore once established in Australia should the DOFI recommendations be implemented?

82. To limit situations in which insurers marketing insurance in Australia do so as a DOFI, and to deliver increased policyholder protection, the review recommended a ‘market significance’ test. The market significance test would limit any exemption for DOFIs to those DOFIs that are not considered to be significant players in the market.

Question 24

Is it appropriate to introduce barriers to a DOFI writing insurance business in Australia if APRA is satisfied it is comparably regulated in its home regime?

Mechanisms for market significance test

83. If a market significance test is introduced, market significance could be measured in a number of ways, including:

84. Any test adopted may need to vary depending on the line or lines of insurance being written. For example, premium income for one contract insuring a submarine may be greater than income from thousands of home and contents insurance contracts. Practical difficulties would flow from such an arrangement. Market segmentation in developing the market significance test would reduce simplicity and make assessment against the test far more complex for insurers that write across a number of lines of insurance.

85. One restriction in developing an appropriate market significance test is the current lack of data on DOFIs operating in Australia and their share of the Australian market.

Question 25

What would be an appropriate market significance test?

Question 26

Should a market significance test vary by class of business (to reflect different market shares being ‘significant’ depending on market concentration and average premium size)?

86. Whatever test is adopted, once ‘market significance’ is reached, the DOFI would be required to establish as a branch or subsidiary in Australia.

87. There are significant practical difficulties in implementing and enforcing the market significance test, including how to manage DOFIs that become ‘significant’ and therefore require authorisation, or foreign insurers that, while currently authorised, reduce in significance and seek to become exempt DOFIs.

88. APRA may require discretion to consider other factors to determine whether the DOFI may continue to operate as an exempt DOFI or should set up as a branch or subsidiary in Australia. Such flexibility would be important to cover such situations as where a DOFI unexpectedly exceeds the dollar limits. As an example, if the premium limit is set at $10 million and the DOFI’s business reaches $10,000,001 it would apply to APRA to determine whether it could continue to operate as a DOFI, despite exceeding the limit.

Question 27

How should the business written in Australia by a DOFI that had been exempt but is then required to become authorised be treated? Should such business be APRA-regulated?

Question 28

Alternatively, how should the business of an authorised insurer that reduces its market significance and becomes a DOFI operating from its home regime be treated?

Question 29

Does the complexity of designing and managing the market significance test, both for APRA and the insurer, outweigh any benefits it may have for Australian policyholders?

Transitional issues and revocation of authorisation

89. Once the review recommendations are implemented, new entrants into the Australian market would be required to comply immediately. They would need to be authorised insurers under the Insurance Act or receive an exemption from APRA as a DOFI operating from a comparable prudential jurisdiction.

90. Those DOFIs that have been marketing insurance in Australia without being authorised general insurers or establishing subsidiaries or branches will require a transition period to seek authorisation or receive an exemption from APRA. A transition period of approximately two years would seem appropriate to minimise transition costs both for insurers and Australian policyholders, particularly for short-tail business.

91. Foreign insurers currently authorised by APRA may seek to conduct their business from comparable offshore jurisdictions. Such an insurer would need to seek revocation of its authorisation under the Insurance Act.

92. Arrangements for the revocation of a licence are already in place under the Insurance Act. APRA can only revoke the authorisation if the insurer has no liabilities in Australia. There are two options under existing provisions of the Act.

Option 1: Transfer of business

93. Under this option, the insurer would transfer all of its business to another insurer by way of a court-approved scheme under Part 3 of the Insurance Act. A transfer or amalgamation of the insurance business may also require approval under the Insurance Acquisitions and Takeovers Act 1991. Following a go-ahead under that Act and court approval, APRA could revoke authorisation because the insurer would no longer have liabilities in Australia.

94. Should an authorised insurer be seeking to transfer its business to allow the revocation of its license and to move offshore to become an exempt DOFI, there are three options in terms of the recipients of the insurance business:

95. Currently, the application of Part 3 of the Insurance Act only allows transfer of business to another authorised general insurer. This would require the modification of the meaning of ‘general insurer’, to ensure that it includes overseas insurers that are eligible to carry on insurance business in Australia.

Option 2: Voluntary run-off

96. Another option would be for the insurer to go into voluntary run-off. The insurer would be required to meet all prudential requirements associated with conducting run-off insurance business but would be able to write all renewals from the overseas-incorporated insurer.

97. The benefits of this option for the insurer moving offshore appear questionable, as the insurer would still be required to devote capital and other resources to manage the run-off. Particularly for long-tail liabilities, the run-off could take many years.

Question 30

Are these options sufficient for managing the Australian business of an insurer seeking to move offshore?

Question 31

Is there any reason to restrict to general insurers those insurers to which business is transferred under the first option?

Question 32

Are there particular risks for Australian policyholders that need to be addressed?

If so, what alternative mechanisms would best address these concerns?

Enforcement powers

98. To the extent that DOFIs are marketing insurance in Australia, APRA requires sufficient powers to enforce the recommended regulatory requirements.

Question 34

With the extension of the Insurance Act, will APRA have jurisdiction to monitor and enforce, as required, compliance with the proposed DOFI regulatory requirement?

Question 35

Are further changes to APRA’s powers under the Insurance Act required?

Consumer protection

Application of the Corporations Act

99. The review suggested that it would be desirable to strengthen information disclosure to consumers under the Corporations Act by requiring brokers, agents and other intermediaries marketing DOFI business in Australia to disclose certain information to consumers. This information would include such details as the country of origin of the insurer, the prudential regulator in the country of origin and whether the insurer is authorised to conduct insurance business in that country, its reinsurance arrangements and its solvency rating.

Current licensing regime

100. Generally, a DOFI that sells its products in Australia will require an Australian Financial Services Licence (AFSL).

101. A person requires an AFSL to deal in financial products or provide financial product advice in Australia. A financial product includes a facility through which a person manages a financial risk, such as general insurance products.

102. As a financial services licensee, a DOFI must comply with certain obligations, including maintaining competency, ensuring their financial services are ‘provided efficiently, honestly and fairly’ and taking responsibility for the actions of authorised representatives. Where a licensee provides services to retail clients (consumers), they must also belong to an external dispute resolution scheme.

103. There are exemptions from the need to obtain an AFSL. Some DOFIs may make use of such exemptions and hence will not hold an AFSL. For example, licensing exemptions apply where:

104. Other exemptions include where:

Current disclosure regime

105. When providing financial services to retail clients, a regulated entity must disclose certain information orally and/or through written documents.

106. The FSG and SoA requirements only apply to licensees and authorised representatives. However, the PDS requirements apply to product issuers (including DOFIs) whether they are licensed or not.

107. Under Corporations Regulation 7.9.15, a DOFI must also include the following information in a PDS:

Current treatment of intermediaries

108. Insurance brokers would usually hold their own AFSL. They would be subject to the same licensing, conduct and disclosure requirements as other licensees.

109. There are no additional specific disclosure requirements that apply to intermediaries that recommend or arrange for the sale of DOFI products. However, brokers represent consumers and they may disclose information about DOFIs when providing advice to their clients.

110. The National Insurance Brokers Association of Australia is currently updating its Code of Conduct. A requirement of the Code will be that brokers inform their clients when they are recommending insurance offered by a DOFI.

Question 36

Do the current requirements under the Corporations Act already make relevant information with regard to DOFIs available to retail consumers?

Question 37

Why should the wholesale business of DOFIs be treated differently to the wholesale business of foreign securities, in relation to any additional disclosure requirements?

Application of the Insurance Contracts Act

111. The Insurance Contracts Act 1984 (the Insurance Contracts Act), which regulates the terms included in insurance contracts and insurer conduct in relation to such contracts, applies to actual or proposed contracts of insurance whose proper law is, or would be, the law of a State or the law of a Territory to which the Act applies or to which it extends.

112. Insurance contracts issued by DOFIs may fall within the scope of the Insurance Contracts Act. However determining what the ‘proper law’ of the particular contract is could involve the application of private international law rules.

113. To overcome the ambiguity surrounding the Insurance Contracts Act’s application to DOFIs, a recent review of its terms recommended the Act be amended to clarify that it applies to all contracts of insurance issued by DOFIs to Australian insureds or in respect of Australian risks.

114. That proposal, together with other proposed changes to the Act will be the subject of consultations in the future. There is some concern about whether such a provision would be enforceable in overseas jurisdictions.

Other issues?

Question 38

Are there other matters or issues that should be addressed in the implementation of the review’s recommendations for the regulation of DOFIs?

 


2 Captive insurance involves an arrangement where a separately formed company (the ‘captive’ insurance entity), within a group of related companies or persons, performs the functions of insurer to that group.