House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Minister for Revenue and Assistant Treasurer, the Hon Peter Dutton MP)

Chapter 2 Direct Offshore Foreign Insurers - Insurance Act

Outline of chapter

2.1 Items 3 to 52 in Schedule 2 of this Bill amend the Insurance Act to expand and clarify the existing definition of 'insurance business' to capture DOFIs that carry on insurance business in Australia, either directly or through the actions of another.

2.2 Foreign reinsurers are not captured by the expanded definition and hence not subject to regulation under the Insurance Act unless they choose to establish a branch or subsidiary in Australia. Lloyd's underwriters are not captured under this expanded definition, but they will remain subject to regulation under Part VII of the Insurance Act.

2.3 The Bill includes a mechanism to exempt risks that cannot be adequately insured by authorised insurers.

2.4 To enable APRA to effectively enforce the expanded definition of 'insurance business', this Bill includes powers to allow APRA to investigate the activities of persons it believes are carrying on insurance business in Australia without being authorised or persons aiding, abetting, counselling or procuring these activities.

Context of amendments

2.5 The HIH Royal Commissioner in his comments on DOFIs, noted a possible gap in APRA's regulatory reach. He found that it might be possible for an insurer, for example an insurer who has been refused authorisation by the APRA, to move offshore and issue insurance policies through an agent or broker in Australia in an attempt to avoid the operation of the Insurance Act. In response, the Government commissioned the Potts review in 2004.

2.6 The Potts review found that the current regulatory treatment of foreign insurers operating in Australia lacked consistency. Foreign insurers were treated in different ways depending on whether they were foreign insurers authorised by APRA operating in Australia, Lloyd's underwriters authorised under section 93 of the Insurance Act, or DOFIs. This meant that the degree of protection afforded to Australian policyholders with similar insurance risks would vary depending on the country of origin of the insurer they selected.

2.7 DOFIs are foreign insurers that carry on insurance business in Australia, either directly or via an insurance agent or broker, without establishing a subsidiary or branch. These 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.

2.8 To the extent that they are carrying on a financial services business in Australia as defined under the Corporations Act, DOFIs are subject to consumer protection regulations in Australia. They are required to hold an AFSL and comply with the conditions of that licence, set out in Chapter 7 of the Corporations Act.

2.9 Under the Corporations Regulations, DOFIs must inform purchasers of particular insurance products (generally those aimed at retail clients) through their Product Disclosure Statement (PDS) that they are a foreign insurer and not prudentially regulated in Australia.

2.10 Currently only insurers carrying on insurance business in Australia are subject to FSCODA. However, DOFIs that do not operate through such a structure are not subject to any information collection requirements on their activities in Australia.

Summary of new law

2.11 Schedule 2 expands the definition of 'insurance business' in the Insurance Act to capture anyone that carries on insurance business in Australia, either directly or through the actions of another (for example, an insurance agent or broker).

2.12 As a result, all DOFIs that fit within this expanded definition will have to become authorised under the Insurance Act if they wish to carry on insurance business in Australia. As authorised general insurers, they will be required to comply with Australia's general insurance prudential standards.

2.13 Foreign reinsurers, who do not choose to establish a branch or subsidiary in Australia, will not be caught by this expanded definition. They will be able to continue to operate in Australia without being authorised.

2.14 Lloyd's underwriters will not be caught under the expanded definition but will continue to be regulated under Part VII of the Insurance Act.

2.15 In addition, the Bill provides a framework that enables the creation of limited exemptions in the regulations to allow risks that cannot be placed through an authorised insurer in Australia to be placed with insurers not authorised in Australia.

2.16 Under existing powers in the Insurance Act, APRA will modify its existing general insurance prudential standards to take into account the different risk categories of authorised insurers. APRA will develop a risk-focused prudential framework to apply to all authorised general insurers.

2.17 To ensure that the regime can be effectively enforced, the Bill includes additional enforcement powers to enable APRA to investigate persons it believes are carrying on insurance business without being authorised and those persons aiding, abetting, counselling or procuring this activity. These investigative powers include a power to access the premises of persons and a power to gather information from persons it is investigating.

2.18 APRA will be able to seek an injunction from the Federal Court restricting this unauthorised activity.

2.19 To complement these changes, the Bill includes a Corporations Act prohibition on AFSL holders and authorised representatives from dealing in a general insurance product unless it is from an authorised insurer, Lloyd's underwriter or an exemption applies (as mentioned above).

2.20 Information will be collected from AFSL holders and authorised representatives under proposed amendments to the Corporations Regulations, on business they place with insurers that are not authorised in Australia, where an exemption applies.

2.21 Once DOFIs become authorised, they will be required, as authorised insurers, to provide information to APRA under FSCODA.

Comparison of key features of new law and current law

Detailed explanation of new law

Amending the definition of 'insurance business'

2.22 This measure expands and clarifies the definition of 'insurance business' so as to ensure that any person carrying on insurance business in Australia, either directly or through brokers or others acting on their behalf (such as agents), are required to be authorised under the Insurance Act and as a result are subject to prudential regulation in this jurisdiction, including the requirement to have a presence in Australia and to hold sufficient assets in Australia to meet their liabilities here. This is designed to protect policyholders from DOFIs that are not subject to robust prudential regulation, and therefore pose a greater risk of not paying out a claim.

2.23 The entities to be covered by this expanded and clarified definition of 'insurance business' are domestic insurers, foreign insurers and foreign reinsurers currently operating under the Insurance Act via a branch or subsidiary, domestic reinsurers and any other insurer that engages in conduct caught by this measure, including insurers currently referred to as DOFIs and offshore 'captives.'

2.24 The activities to be targeted are those leading up to and including undertaking liability under an insurance contract. These include: undertaking liability; business incidental to undertaking liability; and the actions of intermediaries.

2.25 This measure will expand and clarify the definition of 'insurance business' in two ways:

•

by expressly including a set of activities that are to be considered incidental to 'insurance business'; and [ Schedule 2, item 6, subsections 3(5) and 3(7 )]

•

by deeming 'insurance business' carried on outside Australia to be insurance business in Australia if another person in Australia acts on behalf of that first-mentioned person, or acts as a broker of insurance provided by the first-mentioned person, in relation to that business [ Schedule 2, item 6, subsection 3(6 )]

2.26 Incidental activities include: inducing others to enter into contracts of insurance with the person as an insurer, publishing or distributing a statement relating to the person's willingness to enter into a contract of insurance as an insurer and procuring the publication or distribution of such a statement. This is not intended to be an exhaustive list.[ Schedule 2, item 6, subsection (5 )]

2.27 Incidental activities that take place after the insurer has undertaken the liability (that is, entered into the contract of insurance with the insured) will not be captured under the expanded and clarified definition of 'insurance business' in the Insurance Act. It is not intended that the expanded and clarified definition of 'insurance business' capture the activities of merely handling claims, operating accounts, making payments or holding records on behalf of an overseas foreign insurer. [ Schedule 2, item 6 ]

2.28 For example, if an incorporated DOFI uses an Australian based agent or broker, or an agent or broker operating from outside the jurisdiction, to advertise or encourage Australians to enter into an insurance contract with the DOFI, the DOFI is taken for the purposes of the Insurance Act to be carrying on insurance business in Australia and is in breach of subsection 10(1) of the Insurance Act unless it is: authorised; a determination is in force under subsection 7(1) of the Insurance Act; or an exemption under section 3A applies.

2.29 The agent or broker in this example is not himself or herself carrying on insurance business in Australia as he or she is not the entity 'undertaking liability.' That is, he or she is not the entity providing the insurance to the Australia consumer or business under the insurance contract.

2.30 An example of activity that is expressly included as being incidental to insurance business is an overseas insurer that buys an Australian distribution list and targets these people via telephone, e-mail or the Internet suggesting that they take out their insurance with the insurer. In this example, the insurer would be deemed to be carrying on insurance business in Australia, even if the activity of sending the letter took place in the overseas country, because of the effect of the letters or emails in Australia.

2.31 Where an Australian initiates contact with a DOFI (for example, through the Internet or by calling or visiting the DOFI directly), the DOFI will not be carrying on insurance business in Australia and will not be required to become APRA authorised. This is because, even under the strengthened and clarified definition of 'insurance business' the DOFI has not been deemed to carry on insurance business in Australia.

2.32 To allow the greatest flexibility to foreign insurers who wish to continue carrying on insurance business in Australia once the definition of 'insurance business' is expanded and clarified, section 118 of the Insurance Act will be expanded to allow a foreign insurer to appoint a range of different legal entities as their agent in Australia. Currently, foreign insurers, who must appoint an agent to comply with Australia's prudential regime, can only appoint an 'individual resident' as their agent. Section 118 will be expanded to allow foreign insurers to appoint an individual resident, body corporate incorporated in Australia, or any other entity specified in Insurance Regulations.[ Schedule 2, items 39 to 52 ]

Foreign reinsurers

2.33 Currently, foreign reinsurers who choose to establish a branch or subsidiary in Australia are required to seek an authorisation to 'carry on insurance business in Australia' under the Insurance Act. It is not proposed that this Bill alter this current state.

2.34 This Bill exempts offshore foreign reinsurers from the requirement to be authorised if they carry on insurance business in Australia. This will allow Australian insurers to continue to access the global reinsurance market.

2.35 Foreign reinsurers writing direct business in Australia would be classified as direct insurers and are required to be authorised under the Insurance Act.

2.36 This exemption applies to reinsurance business carried on by a body corporate incorporated in a foreign country and to an unincorporated body established under the law of a foreign country that may sue or be sued, or may hold property in the name of its secretary or of an office holder of the body duly appointed for that purpose. [ Schedule 2, items 4 and 5 ]

2.37 Incorporated bodies are included because, for example, there are some trust or trust-like structures (which may be unincorporated bodies) issuing fully collateralised reinsurance contracts. Collateralisation comes from the sale of securities. These arrangements are developing as capital markets become more interested in being involved in reinsurance and the securitisation of insurance liabilities. The exemption covers these contracts. [ Schedule 2, items 4 and 5 ]

2.38 If a foreign reinsurer elects to set up a branch or subsidiary in Australia so as to, for example, improve its access to the Australian market, then it will be required to be authorised under the Insurance Act. It will be required to become authorised and comply with Australia's prudential regime.

2.39 Similarly, and consistent with the international treatment of reinsurers, an Australian reinsurer would be required to be authorised by APRA if it sought to commence operations in Australia.

2.40 Foreign reinsurers who currently have a branch or subsidiary in Australia will continue to be regulated by APRA under the Insurance Act and have to comply with Australia's prudential regime. However, these foreign reinsurers can choose to cease writing business through the Australian branch or subsidiary, place that business in run-off in accordance with prudential requirements, and become offshore foreign reinsurers. If they do this, they would no longer be required to be authorised in Australia for the new reinsurance business they write.

2.41 Although offshore foreign reinsurers are exempt, they may be indirectly subject to the Australian regulatory regime through the prudential standards applied to direct insurers in respect of reinsurance obtained from those offshore foreign reinsurers.

Lloyds Underwriters

2.42 Lloyd's underwriters are currently regulated under Part VII of the Insurance Act.

2.43 This Bill does not change how Lloyd's underwriters are regulated under the Insurance Act.

Exemptions made through regulations

2.44 This Bill inserts a provision into the Insurance Act that provides for a mechanism to exempt particular kinds of contracts of insurance or particular contracts of insurance from being insurance business under the Act.[ Schedule 2, item 8, section 3A ]

2.45 As a result, a DOFI providing a contract of insurance or kind of contract of insurance specified in the regulations or in a determination made under the regulations will not be taken to be carrying on insurance business in Australia because the contract or contracts do not meet the definition of 'insurance business' under the Insurance Act.

2.46 A DOFI that supplies contracts of insurance subject to an exemption will not be required to be authorised under the Insurance Act.

2.47 The new section provides for contracts of insurance to be specified in regulations or in a determination made under regulations. The regulations or determination may specify the contract or contracts of insurance in terms of product (that is, the line of insurance business) or the person who is seeking the insurance. [ Schedule 2, item 8, subsection 3A(2 )]

2.48 Determinations made under the regulations that specify a particular contract of insurance are reviewable in accordance with Part VI of the Insurance Act. Part VI will be expanded to allow a person who has applied for a determination to have that determination reviewed by decision-maker.[ Schedule 2, item 8, subsection 3A(3) and items 13 to 33 ]

2.49 Other determinations made under regulations are legislative instruments for the purposes of the Legislative Instruments Act 2003 . [ Schedule 2, item 8, subsection 3A(4 )]

2.50 The details of the exemption to be included in the regulations will be finalised after consultation with stakeholders.

2.51 The purpose of the exemption is to ensure that, while all insurers who meet the expanded and clarified definition of carrying on insurance business in Australia will be required to be authorised, this approach does not unduly restrict Australian insureds access to the global insurance market, where it can be clearly demonstrated that they require continued access to this market.

2.52 Both the HIH Royal Commissioner's report and the Potts review noted that there were many international commercial insurance arrangements that had worked satisfactorily to date. These reports indicated that Australian insureds in these arrangements did not need additional protection from unauthorised DOFIs as they were generally sophisticated entities, like large corporationsk, who adequately assess their own risks and the risks of the insurance products they purchased.

2.53 In addition, the Australian insurance market, although robust and competitive, is widely acknowledged to be small compared to the major insurance markets in Europe and the United States of America. Some large Australian corporations may not be able to access sufficient insurance to cover their risks in the Australian market.

2.54 Alternatively, there may be Australian businesses and individuals who cannot obtain appropriate insurance from authorised insurers or Lloyd's underwriters in Australia. This may include circumstances where an insurance product is not available at all or where the product is not available with the specific terms and conditions that the Australian insured requires.

2.55 In these cases, without access to offshore foreign insurers, the Australian insured may be faced with bearing the insurance risk themselves.

2.56 To prevent this, regulations will be enacted to exempt specific lines of insurance or insurance for a particular client where these lines of insurance are not available from authorised insurers or Lloyd's underwriters.

2.57 However in developing these exemptions, the balance will need to be maintained between ensuring capacity and access to insurance and allowing the DOFI regime outlined in this Bill to be effective in protecting Australian insureds from less robust offshore foreign insurers.

Enforcement Powers

2.58 The enforcement powers in this Bill expand the existing enforcement powers under the Insurance Act to enable APRA to investigate and take action against suspected breaches of sections 9 and 10 of the Insurance Act, that is the carrying on of insurance business in Australia without being authorised.[ Schedule 2, items 9, 12 and 36 ]

2.59 Most of the enforcement powers in this Bill will be contained within a new Part, Part VA in the Insurance Act, and allow APRA to investigate any person or body corporate it believes on reasonable grounds has engaged in, is engaging in or will be engaging in conduct in contravention of sections 9 or 10 of the Insurance Act.[ Schedule 2, item 12 ]

2.60 APRA will also have the power, under Part VA, to investigate any person or body corporate that it believes on reasonable grounds has engaged in, is engaging in or will be engaging in conduct that constitutes aiding, abetting, counselling or procuring a contravention of sections 9 or 10 of the Insurance Act. [ Schedule 2, item 12, section 62A ]

2.61 Once APRA has launched an investigation, an authorised person (defined under new section 2A) or an inspector appointed by APRA will have the power under this new Part to access the premises of the entity with either the consent of the occupier of the premises or to apply to a Magistrate for a search warrant to search for, inspect, take extracts from and make copies of any books (as defined under the Insurance Act) containing relevant information to the investigation.[ Schedule 2, item 12, section 62B ]

2.62 APRA or an inspector appointed by APRA may, by written notice, require a person they believe on reasonable grounds has or may have information in their control or custody relevant to the investigation, to produce all or any of the books containing information relevant to the investigation or provide APRA or the inspector with all reasonable assistance in connection with the investigation. [ Schedule 2, item 12, subsection 62C ]

2.63 The information gathering power listed above also includes a power enabling APRA to require a person to appear before APRA or an inspector and answer questions put to them. [ Schedule 2, item 12, section 62C ]

2.64 A person is not excused from complying with the notice issued under section 62C on the grounds that complying with that notice might tend to incriminate them. However, if the person is an individual and before answering the questions the person informs APRA or the inspector that the evidence might incriminate them, the questions or answers cannot be used in evidence against them in any criminal proceeding other than an offence of failing to comply with the notice or an offence under section 137.1 or 137.2 of the Criminal Code.[ Schedule 2, item 12, section 62D ]

2.65 Where a person is being examined they may be represented by a legal practitioner and notes may be made of the examination. The person being questioned will have a right, free of charge, to a copy of those notes if they request a copy in writing from APRA. [ Schedule 2, item 12, sections 62E and 62F ]

2.66 APRA has the power to delegate the powers contained in Part VA in accordance with section 15 of the APRA Act. An inspector may delegate their powers to an APRA member, an APRA staff member or a person included in a class of persons approved by APRA. [ Schedule 2, item 12, section 62G ]

2.67 APRA is also required under Part VA to complete the investigation within a reasonable time and to provide written notice to the person who was the subject of the investigation that the investigation is complete and whether or not APRA proposes to take further action. [ Schedule 2, item 12, section 62H ]

2.68 What is a reasonable time will be interpreted within the circumstances of the investigation. For example, in a straightforward case, it will be possible to quickly assess whether or not there has been a contravention of sections 9 or 10 of the Insurance Act. APRA will obtain clear evidence from the agent of the DOFI that the DOFI has written insurance policies for Australian insureds, in contravention of the section 10 of the Insurance Act.

2.69 In a more complex case where, for example, the DOFI does not have an agent in Australia and does not operate through brokers, but rather directly advertises their products over the Internet, it may be more difficult to obtain sufficient evidence for APRA to satisfy itself as to whether or not there has been a contravention of section 10 of the Insurance Act. In those situations, APRA may need to seek information from a wider range of sources and this will take more time.

2.70 This may be necessary to enable APRA to form a reasonable belief that an entity was, is, or will be carrying on insurance business without being authorised or aiding, abetting, counselling or procuring that conduct.

2.71 An inspector, if appointed to conduct an investigation under Part VA, must on completion of the investigation provide APRA with a written report as to the result of that investigation.[ Schedule 2, item 12, section 62I ]

2.72 In some situations, APRA may need to gather preliminary information from persons who may or may not be engaged in the unlawful conduct but who may have information on whether another entity was, is, or will be engaging in that conduct before it can commence an investigation under the new Part VA. [ Schedule 2, item 36 ]

2.73 For example, an accountant dealing with the financial records of an entity suspected of carrying on insurance business in Australia without being authorised is likely to have information on the activities of that entity which may assist APRA in forming a reasonable belief that the entity is engaged in unlawful conduct.

2.74 An insurance agent representing a DOFI who is carrying on insurance business in Australia without being authorised and where no exemption applies may have information on the policies, if any, that the DOFI has entered into. That information is likely to assist APRA to form the reasonable belief necessary to launch an investigation.

2.75 To enable effective enforcement action to be taken in these situations, the Bill contains a power that allows APRA, where it believes on reasonable grounds that a person has or may have in their custody or control information or documents relating to conduct that constitutes or may constitutes a contravention of section 9 or 10 of the Insurance Act or aiding, abetting, procuring or counselling a contravention of those sections, to send a written notice to that person requiring that person to give the information in writing signed by the person or produce the documents within a time and in a manner specified in the notice.[ Schedule 2, item 36, section 115AA ]

2.76 This measure is not to be taken to include a right to examine the person, rather it is limited to the person being required to provide either written answers to written questions set out in the notice (similar to an interrogatory) or documents that are relevant to whether or not there has been a contravention of sections 9 or 10 of the Act or aiding, abetting, procuring or counselling a contravention of those sections. [ Schedule 2, item 36, section 115AA ]

2.77 A person will commit an offence where they fail to comply with a notice under section 115AA. The offence has a maximum penalty of 50 penalty units. [ Schedule 2, item 36, subsection 115AB(1 )]

2.78 It will not be an excuse to fail to comply with the notice issued under section 115AA because complying with that notice might tend to incriminate the person. [ Schedule 2, item 36, subsection 115AB(2 )]

2.79 However, the power contains a protection against self-incrimination. Where a person is an individual and informs APRA prior to giving the information in the form of written answers to written questions that the information might tend to incriminate them, that information will not be admissible in evidence against the person in a criminal proceeding, other than a prosecution under this section or under sections 137.1 or 137.2 of the Criminal Code. [ Schedule 2, item 36, subsection 115AB(3 )]

2.80 This is designed to protect the agent in the example above who may be required to provide information to APRA under this measure even though that information could be used against the agent to prosecute them for aiding and abetting the DOFI in contravention of the law.

2.81 APRA is provided with the power to seek restraining, consent and interim injunctions from the Federal Court of Australia with respect to unauthorised insurers and persons involved in the activities of unauthorised insurers.[ Schedule 2, item 9, section 11A ]

2.82 This power will enable APRA to act quickly in situations where unauthorised insurers are carrying on insurance business in Australia. The provision permits APRA or any person whose interests are affected by the conduct of the entity to seek an injunction.[ Schedule 2, item 9, section 11A ]

Minor technical amendment

2.83 A grammatical correction is made to the power to investigate a general insurer, authorised non-operating holding company (NOHC) or subsidiary.[ Schedule 2, item 11 ]

2.84 The power to enable APRA to access premises under section 115A is amended to require a warrant to be sought from a magistrate rather than a justice of the peace.[ Schedule 2, items 37 and 38 ]

Application and transitional provisions

2.85 These measures will commence on 1 July 2008.[ Clause 2 ]

2.86 The Bill includes a transitional measure to allow regulations to be made to specify particular entities or classes of entities to which the expanded and clarified definition of 'insurance business' in item 6 does not apply for a period to be specified in the regulations, not exceeding two years.[ Schedule 2, subitems 7(1) and 7(3 )]

2.87 To address the Corporations Act prohibition outlined in Chapter 3, entities that are set out in the transitional regulations to this Bill will be deemed for the purposes of the Corporations Act prohibition to be authorised insurers under the Insurance Act. [ Schedule 2, subitem 7(2 )]

2.88 As a result, AFSL holders and authorised representatives (who would otherwise be in breach of the Corporations Act prohibition if they deal in a general insurance product that is not from an authorised insurer or a Lloyd's underwriter or to which an exemption applies), will not be in breach of the prohibition when they deal in general insurance products from entities specified in regulations that are not yet required to be authorised under the Insurance Act. [ Schedule 2, subitem 7(2 )]

2.89 This transition measure will provide the flexibility to exempt particular entities or classes of entities that may require more time to seek authorisation under the Act.

Consequential amendments

2.90 To enable APRA to use a technical expert to access information when APRA access the premises under section 62B, section 2A will be inserted into the Insurance Act to define 'authorised person' for the purposes of Part VA to be APRA or a person authorised by APRA, in writing, for the purposes of Part VA.[ Schedule 2, item 3 ]

2.91 Part V will be renamed 'Investigations of general insurers etc' so as to clearly distinguish between investigations into the activity of authorised general insurers (Part V) and investigations into the activities of entities suspected of carrying on insurance business in Australia without being authorised under the Insurance Act or aiding, abetting, counselling or procuring that unauthorised activity.[ Schedule 2, item 10 ]

2.92 Section 103 of the Insurance Act is also amended to ensure that Part VA does not apply to the exclusion of certain other laws of the Commonwealth, State or Territory that make provision for an investigation into the affairs of the body corporate or other person.[ Schedule 2, items 34 and 35 ]