House of Representatives

Replacement Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Josh Frydenberg MP)

Chapter 1 Implementing Recommendation 4.7 of the Financial Services Royal Commission

Outline of chapter

1.1 This Chapter provides an overview of the amendments in Schedule 1 to the Bill to give effect to recommendation 4.7 of the Financial Services Royal Commission to extend the existing protections of the unfair contract terms regime under the Australian Securities and Investments Commission Act 2001 to insurance contracts governed by the Insurance Contracts Act 1984 .

Context of amendments

1.2 Many businesses use standard form contracts to engage with consumers. These contracts generally set out terms on a 'take it or leave it basis' which means consumers are unlikely to be able to negotiate with the business if they believe elements of their standard form contract are unfair.

1.3 To address this problem the unfair contract terms regime was introduced in 2010 to protect consumers from unfair contractual terms in standard form contracts. A term in a relevant standard form consumer contract is void if it is unfair. The rest of the contract continues to bind the parties if it is capable of operating without the unfair term. A court can declare that a term in a relevant standard form consumer contract is unfair on application by a party to the contract or ASIC. The regime was extended to small business contracts in 2016. Insurance contracts covered by the Insurance Contracts Act 1984 have always been specifically excluded from the unfair contracts terms regime.

1.4 A range of government and independent inquiries since 2010 have recommended that the unfair contract terms regime should be extended to insurance contracts, including:

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Recommendation 4.7 of the Financial Services Royal Commission in 2019; ^[4]

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Recommendation 6 of the Australian Competition and Consumer Commission first interim report in the Northern Australia Insurance inquiry in 2018; ^[5]

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Recommendation 3.1 of the 2018 Parliamentary Joint Committee on Corporations and Financial Services inquiry into the life insurance industry; ^[6]

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Recommendation 11 of the 2017 Senate Economics Committee inquiry into the general insurance industry; ^[7] and

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Proposal 10 of the 2017 Australian Consumer Law Review. ^[8]

1.5 Following the 2017 Senate Economics Committee inquiry into the general insurance industry, the Government announced it would extend the unfair contract terms regime to insurance contracts. ^[9] In June 2018, the Government published a proposals paper outlining a potential model for extending the regime. ^[10]

1.6 In February 2019, the Financial Services Royal Commission recommended applying the unfair contract terms regime in the Australian Securities and Investments Commission Act 2001 to contracts regulated under the Insurance Contracts Act 1984 . The Financial Services Royal Commission also recommended adjusting the regime in its application to insurance contracts by defining the main subject matter for insurance contracts as the terms of the contract which describe what is being insured. ^[11] The Government agreed to implement this recommendation in full. ^[12]

1.7 The Financial Services Royal Commission also noted that over-prescription and excessive detail in legislation can undermine regulation. Such detail can shift responsibility for behaviour away from regulated entities and result in a 'box-ticking' approach, rather than ensuring they comply with the fundamental norms of behaviour that should guide their conduct. Commissioner Hayne considered that a clearer focus on those fundamental norms in the primary legislation and subordinate instruments will improve the regulatory architecture and ensure that the intent of the law is met.

1.8 The Government also agreed to identify the norms of behaviour and principles that underpin legislation as part of the legislative simplification process (recommendation 7.4 of the Financial Services Royal Commission). The norm underlying this Bill is that insurers should not include terms in their standard form contracts that are unfair to the other party.

Summary of new law

1.9 There are two key components in the Bill.

1.10 First, the Bill amends the Insurance Contracts Act 1984 to enable the unfair contract terms regime under the Australian Securities and Investments Commission Act 2001 to apply to insurance contracts covered by the Insurance Contracts Act 1984 .

1.11 Secondly, the Bill amends the Australian Securities and Investments Commission Act 2001 to tailor the existing unfair contract terms regime in its application to insurance contracts. These changes are listed below:

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Main subject matter: The Australian Securities and Investments Commission Act 2001 presently excludes terms that define the main subject matter of a contract from the unfair contract terms regime. The Bill will amend the Australian Securities and Investments Commission Act 2001 to provide that the main subject matter of an insurance contract is limited to the description of what is being insured.

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Transparent excess terms: The Bill will amend the Australian Securities and Investment Commission Act 2001 to exclude terms that set the quantum of the excess or deductible in an insurance contract from the unfair contract terms regime as long as they are presented transparently.

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Third party beneficiary: The Bill will amend the Australian Securities and Investment Commission Act 2001 to allow for third party beneficiaries of insurance contracts to bring actions against insurers under the unfair contract terms regime.

1.12 Under the Insurance Contracts Act 1984 parties to insurance contracts have an obligation to act with the utmost good faith. The Bill does not impact this obligation, with the duty of the utmost good faith operating independently of the unfair contract terms regime.

1.13 Diagram 1.1 provides a high level summary of the operation of the unfair contract terms regime, with changes made by this Bill in red italics.

Diagram 1.1 Summary of the operation of the unfair contract terms regime for financial products and services ^[13]

Comparison of key features of new law and current law

Detailed explanation of new law

Extending the unfair contract terms regime to apply to insurance contracts

1.14 Section 15 of the Insurance Contracts Act 1984 currently prevents insurance contracts being made subject to relief under any other Commonwealth Acts on the grounds that the contract is harsh, oppressive, unconscionable, unjust, unfair or inequitable.

1.15 To allow the unfair contract terms regime to apply to insurance contracts, section 15 of the Insurance Contracts Act 1984 is amended to enable relief relating to the unfair contract terms regime in section 12BF of the Australian Securities and Investments Act 2001 to apply to insurance contracts. A definition of 'Insurance Contracts Act insurance contract' is also added to the Australian Securities and Investments Commission Act 2001 . [Schedule 1, items 1 and 9, subsection 12BA(1) of the Australian Securities and Investments Commission Act 2001 and subsection 15(2) of the Insurance Contracts Act 1984]

1.16 The unfair contract terms regime will not be extended to cover medical indemnity insurance contracts. Medical indemnity insurance is subject to a separate regulatory regime under the Medical Indemnity Act 2002 and other related Acts. [Schedule 1, item 5, subsection 12BL(1A) of the Australian Securities and Investments Commission Act 2001]

Applying the current unfair contract terms regime to insurance contracts

1.17 The central elements of the existing unfair contract terms regime will apply to insurance contracts. The amendments provide that the unfair contract terms regime applies to insurance contracts covered by the Insurance Contracts Act 1984 where:

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at least one party to the contract is a consumer or a small business (as defined in subsections 12BF(3) and (4) of the Australian Securities and Investments Commission 2001 respectively); and

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the contract is a standard form contract (as defined in section 12BK of the Australian Securities and Investments Commission 2001 ).

1.18 An insurance contract can be a standard form contract even if a consumer can choose between several options such as levels of premium, excess or sum insured. The criteria for determining whether an insurance contract is standard form is outlined in subsection 12BK(2) of the Australian Securities and Investments Commission Act 2001 and includes factors like bargaining power and opportunity to negotiate terms, amongst other factors.

1.19 Similarly, an insurance contract can still be a standard form contract if it is intermediated by a broker as long as the circumstances of the case meet the criteria in subsection 12BK(2) of the Australian Securities and Investments Commission Act 2001 for determining whether a contract is a standard form contract.

Example 1.1

Matthew is a consumer wishing to purchase home contents insurance. He owns a laptop and camera that he also wants to make sure is insured but he is confused by the complexity of the insurance products he researches online. He requests that a broker recommend the best insurance policy. The broker, acting for Matthew, seeks contracts from several insurers, including contents policies that offer portable items cover as an optional extra. The standard form contract is prepared by the insurer without taking into account Matthew's specific characteristics and the broker does not negotiate any contract terms on Matthew's behalf. These contracts would be considered standard form contracts and Matthew, as the party to the contract, has standing to bring an action under the unfair contract terms regime.

Example 1.2

Anne, aged 45, is a busy mother of 3 who applies online with Life Insurer X for Death and Total and Permanent Disability cover up to the value of $150,000. After she answers some medical eligibility questions her application is accepted on standard terms. This would be considered a standard form contract and Anne, as the party of the contract, could bring action under the unfair contracts terms regime.

Example 1.3

Elissa is a 30-year old GP who applies for life insurance cover via her financial adviser. Her financial adviser assists her in completing the application. As part of her application, Melissa answers a number of medical and occupational questions. Based on her responses, the insurer issues her with Death, Total and Permanent Disability and Disability Income Insurance to the value she applied for at standard rates. This would be considered a standard form contract and Elissa, as the party to the contract, has standing to bring action under unfair contract terms regime.

Example 1.4

BBB Limited is a small business seeking professional indemnity insurance. BBB Limited requests that a broker recommend the best insurance policy. The broker, acting for BBB Limited, seeks quotes from several insurers. In preparing the contracts, the broker negotiates changes to a number of specific clauses to suit the nature of BBB Limited's business. These contracts would not be considered standard form contracts and BBB Limited, as the party to the contract, cannot take action under the unfair contract terms regime.

1.20 If an insurance contract is subject to the unfair contract terms regime, a term in that insurance contract may be declared unfair and therefore void. A term is considered unfair if it meets all three criteria in section 12BG of the Australian Securities and Investments Commission Act 2001 which currently apply to general contracts. These criteria are that the term:

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would cause a significant imbalance in the parties' rights and obligations arising under the contract; and

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is not reasonably necessary in order to protect the legitimate interests of the party that would be advantaged by the term; and

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would cause detriment to a party if it were to be applied or relied on.

1.21 Section 12BH of the Australian Securities and Investments Commission Act 2001 sets out examples of terms which could be unfair. These examples are intended to be product-neutral and apply across a wide variety of financial contracts. In some cases they may be not relevant for insurance products, for example a term that guarantees the insured (but not the insurer) the ability to renew an insurance contract is unlikely to be considered unfair.

1.22 The court will determine whether unfairness arises in a particular contract on a case-by-case basis.

1.23 Further examples of terms which could be unfair in an insurance contract include:

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a term that allows the insurer to, instead of making a repair, elect to settle the claim with a cash payment calculated according to the cost of repair to the insurer, rather than how much it would cost the insured to make the repair;

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a term that is an unnecessary barrier to the insured lodging a legitimate claim (for example, requiring the payment of a large excess before the insurer considers a claim or requiring the insured to lodge the claim within an unreasonably short timeframe);

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a term in a contract that contains unexpected payment arrangements (for example, that would enable the insurer to unilaterally start making direct debit deductions to an account of the consumer despite the consumer selecting a different payment method);

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a term in a disability insurance contract that uses an outdated, and therefore inaccurate and restrictive, medical definition to determine whether the consumer meets the criteria to be eligible to have a claim paid; or

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a term in a contract that significantly reduces the cover offered where compliance with the preconditions for being covered is unfeasible (for example, a term in a travel insurance policy that only covers loss of luggage when it has been personally attended by the insured at all times).

1.24 While it is ultimately a matter for the court to determine whether a term is unfair, many terms in insurance contracts will be reasonably necessary to protect the legitimate interests of the insurer. For example, a term in a life policy within the meaning of the Life Insurance Act 1995 that allows the insurer to unilaterally increase premiums would not be considered unfair if it was used in response to a change in the actuarial pricing of risk required to underwrite the policy. Similarly, specific terms in standard form contracts may be required for an insurer to obtain any reinsurance from a third party or appropriately reflect the underwriting risk accepted by the insurer. Depending on the circumstances of the case, such terms may be reasonably necessary to protect the insurer's legitimate interests.

1.25 Section 12BI of the Australian Securities and Investments Commission Act 2001 prevents some terms in a contract from being considered unfair, including the main subject matter of the contract, the upfront price payable and any term required by a law of the Commonwealth, a State or a Territory.

1.26 The main subject matter of a contract is undefined in the current law. For insurance contracts, the main subject matter will be defined (see below).

1.27 The upfront price payable under a contract is currently defined in subsection 12BI(2) of the Australian Securities and Investments Commission Act 2001 . This definition will apply to insurance contracts, meaning that the insurance premium paid, as long as it meets the criteria of subsection 12BI(2) of the Australian Securities and Investments Commission 2001 , cannot be considered unfair. See below for a discussion of excesses and deductibles in insurance contracts.

1.28 Terms required, or expressly permitted, by a law of the Commonwealth or a State or Territory are not covered by the unfair contract terms regime (see section 12BL of the Australian Securities and Investments Commission Act 2001 ). For insurance contracts, this would include terms defined in the standard cover regime and the definition of 'flood' in regulation 34 of the Insurance Contracts Regulations 2017 .

1.29 Section 12BF of the Australian Securities and Investments Commission Act 2001 provides that a term in a relevant standard form consumer contract is void if it is unfair. If there is a dispute as to whether a term is unfair, the parties or ASIC can seek a declaration from the court under section 12GND of the Australian Securities and Investments Commission Act 2001 that the contractual term is unfair. The court's ability to do this does not limit its ability to make other declarations which may include declarations that the term is only unfair in the circumstances of the case at hand. This will also be the case for insurance contracts. The only difference will be that in the case of insurance contracts, third party beneficiaries will also have the right to seek the court's declaration that a contractual term is unfair (see below).

1.30 Subsection 12BF(2) of the Australian Securities and Investments Commission Act 2001 provides that an insurance contract will continue to bind the parties if it is capable of operating without the unfair term. This will also be the case for insurance contracts.

1.31 For the avoidance of doubt, the unfair contract terms regime does not affect the rights and obligations of parties to insurance contracts that are outlined in the Insurance Contracts Act 1984 .

Changes made to the unfair contract terms regime in its application to insurance contracts

1.32 The Australian Securities and Investments Commission Act 2001 is amended to tailor the application of the general unfair contract terms regime to insurance contracts. This is in recognition of the unique characteristics of insurance contracts.

Main subject matter of an insurance contract

1.33 Terms defining the main subject matter of any financial product or service contract are excluded from the unfair contract terms regime by section 12BI of the Australian Securities and Investments Commission Act 2001 . The exclusion of terms that define the main subject matter of a standard form contract ensures that a party cannot challenge a term concerning the basis for the existence of the contract. This is in recognition of the fact that the party had a choice whether or not to enter the contract on the basis of what was offered.

1.34 In line with Financial Services Royal Commission recommendation 4.7, for insurance contracts, the main subject matter is limited to the extent that the term describes what is being insured. [Schedule 1, item 4, subsection 12BI(4) of the Australian Securities and Investments Commission Act]

1.35 Commissioner Hayne considered that the benefits of extending the unfair contract terms regime to insurance contracts would be undermined if a broader definition of what terms define the main subject matter were adopted.

1.36 Where a term describes what is being insured and is the basis for the existence of the contract, that term is the main subject matter of the contract and not subject to the unfair contract regime. While it is anticipated that relatively few terms in insurance contracts will qualify for this exemption, this will be determined on a case by case basis.

Example 1.5

Isla purchases home insurance for a house at 17 Drayton Street. The contract describes the house as a four bedroom, brick veneer freestanding house. This description (a four bedroom, brick veneer freestanding house at 17 Drayton St) is the main subject matter of the contract and therefore outside of the unfair contract terms regime.

Example 1.6

Jess purchases car insurance. The contract describes the car as a 2018 Kia Carnival S 2.2-litre four-cylinder turbo-diesel with a modification to take wheelchairs. This description (a 2018 Kia Carnival S 2.2-litre four cylinder turbo-diesel with a modification to take wheelchairs) is the main subject matter of the contract and therefore outside of the unfair contract terms regime.

1.37 For insurance contracts which are not property-based, it is expected that only terms that are the basis for the existence of the contract and describe the intangible thing being insured will be considered to define the main subject matter.

Example 1.7

Tom is a 46-year-old marine biologist who earns an income of $100,000 a year. He purchases income protection insurance for the value of $6,250 a month and discloses no significant ill health. The contract describes Tom as a 46-year old man with no significant ill health and also states the sum insured is $6,250 a month. Both the description of Tom and the statement of the sum insured are the main subject matter of the contract and therefore outside of the unfair contract terms regime.

Example 1.8

Yvonne buys life insurance cover for herself and her husband Bob, for the value of $100,000 for each life insured. The description of Yvonne, Bob and statement of the sum insured is the main subject matter of the contract and therefore outside of the unfair contract terms regime.

Transparent excess and deductible terms exclusion

1.38 Under current law, a term setting out the upfront price that is payable under a contract is excluded from the unfair contract terms regime (see section 12BI of the Australian Securities and Investments Commission Act 2001 ). However, the definition of upfront price payable does not encompass the excess or deductible of an insurance contract due to the exclusion from that definition of any consideration that is contingent on the occurrence or non-occurrence of a particular event (see subsection 12BI(2) of the Australian Securities and Investments Commission Act 2001 ). This means that terms setting the quantum or existence of any excesses or deductible of an insurance contract are subject to the unfair contacts term regime and may be considered unfair.

1.39 Excesses and deductibles are similar, but slightly different types of terms under an insurance contract. Excesses are an amount contributed by the insured when making a claim under an insurance contract. Deductibles are an amount deducted from a payment made by an insurer as a result of a claim under an insurance contract.

1.40 Both excesses and deductibles can be directly related to the upfront price of an insurance contract. A high upfront premium and a lower excess or deductible can be equivalent to a lower upfront premium and a higher excess or deductible. Subjecting excesses and deductibles to the unfair contract terms regime may simply result in insurers offering lower excesses and deductibles and higher premiums, which is not the policy intent.

1.41 Excesses and deductible terms should be subject to the unfair contract terms regime if they do not form the basis for the existence of the contract. Excesses and deductibles which the insured chooses to increase or decrease as part of the contract (with resulting premium changes) should not be subject to challenge. However, excesses or deductibles that do not form the basis for the existence of the contract should be subject to the unfair contract terms regime. As such, only terms that are transparent to the insured at the time of purchasing the contract are not subject to challenge under the unfair contract terms regime.

1.42 The Australian Securities and Investments Commission Act 2001 is amended so that a term in an insurance contract which sets out the quantum or existence of the excess or deductible payable under an insurance contract will be excluded from the unfair contract terms regime if the term is transparent (as defined in subsection 12BG(4) of the Australian Securities and Investments Commission Act 2001 ). [Schedule 1, item 3, subsection 12BI(1) of the Australian Securities and Investments Commission Act 2001]

Example 1.9

James renews his car insurance for a 2014 IS300 Lexus, paying a $500 premium. A 'basic' excess of $1000, payable when any claim is made, was clearly presented in the quote and also on the renewal notice. The quantum of the excess ($1000) is not subject to challenge under the unfair contract terms regime.

Third party beneficiaries

1.43 Under the existing unfair contract terms regime in the Australian Securities and Investments Commission Act 2001 a court can only declare that a term is unfair on application by a party to the contract or ASIC (see subsections 12GND(1) and (2) of the Australian Securities and Investments Commission Act 2001 ).

1.44 Third party beneficiaries of insurance contracts are recognised in the Insurance Contracts Act 1984 as having the ability to bring actions under that Act. This is because there are circumstances where they will be required to take action in the place of the contracting party. The Bill amends the Australian Securities and Investments Commission 2001 to allow third party beneficiaries of insurance contracts to also bring actions against insurers under the unfair contract terms regime. [Schedule 1, item 6, paragraphs 12GND(1)(c) and 12GND(2)(c) of the Australian Securities and Investments Commission Act 2001]

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For example, death benefit nominees under a life insurance policy or individuals covered under certain group insurance policies (e.g. policies purchased by small sporting associations on behalf of club members to cover personal injury incidents) are likely to be able to bring actions under the unfair contract terms regime in relation to contracts covered by the regime.

1.45 Third party beneficiaries are defined in the Insurance Contracts Act 1984 as a person who is not a party to the contract but is specified or referred to in the contract, whether by name or otherwise, as a person to whom the benefit of the insurance cover provided by the contract extends (see section 11 of the Insurance Contracts Act 1984 ).

1.46 The definitions of consumer and small business, tests of unfairness and definition of standard form contracts continue to relate to the parties to the insurance contract, not third party beneficiaries (see sections 12BF, 12BG and 12BK of the Australian Securities and Investments Commission Act 2001 ). This means that, while third party beneficiaries can bring actions, the actions will only be successful if the tests of unfairness and standard form are met with reference to the parties that negotiated the contracts, not the third party beneficiaries.

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For example, a contract for insurance purchased on a group basis by a large superannuation trustee would likely not be covered by the regime. A superannuation trustee would be unlikely to meet the definition of a small business or consumer, and is likely to have significant bargaining power in negotiating such contracts, so the contract would not meet the definition of a standard form contract.

The Duty of the Utmost Good Faith

1.47 The Insurance Contracts Act 1984 provides that parties to an insurance contract have a duty to act with the utmost good faith (see Part 2 of the Insurance Contracts Act 1984 ). The duty covers any matters in relation to the insurance contract including negotiation before the contract is signed and claims handling after a contract has been formed. The amendments in the Bill do not impact the existing operation of the duty of utmost good faith.

1.48 The Insurance Contracts Act 1984 and Australian Securities and Investments Commission Act 2001 have been amended to include notes to make it clear that the unfair contract terms regime and the duty of utmost good faith operate independently of one another. [Schedule 1, item 2, section 12BF of the Australian Securities and Investments Commission Act 2001 and Schedule 1, item 8, section 12 of the Insurance Contracts Act 1984]

1.49 A breach of the duty of the utmost good faith will not necessarily equate to a breach of the unfair contract terms regime. A breach of the unfair contract terms regime will not necessarily equate to a breach of the duty of the utmost good faith. Each regime operates independently of the other. However, it is possible that some scenarios may give rise to relief under both sets of provisions. In such scenarios, a party may bring actions before the court under either or both regimes, and the court will be able to take into account the concurrent operation of the two regimes when considering what orders to make.

Application and transitional provisions

1.50 The unfair contract terms regime will apply to new or renewed insurance contracts from the date of commencement of Schedule 1 to the Bill. Schedule 1 to the Bill will commence on 5 April 2021. A term of a contract varied after the commencement of Schedule 1 to the Bill will also be covered by the unfair contract terms regime. [Schedule 1, items 7 , section 324 of the Australian Securities and Investments Commission Act 2001, and item 10 of the Bill]

1.51 Therefore, the application of the unfair contract terms regime to insurance will commence at the same time as the new Design and Distribution Obligations set out in Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019 . This reduces the regulatory burden on industry compliance.