The long awaited bill regulating the activities of direct offshore foreign insurers (DOFIs) has recently been released (Financial Sector Legislation Amendment (Discretionary Mutual Funds and Direct Offshore Foreign Insurers) Bill 2007).

This follows the announcement on 3 May 2007 by the Minister for Revenue and Assistant Treasurer of various measures to enhance the integrity of the Australian insurance market. These relate principally to DOFIs and discretionary mutual funds.

These important measures continue to generate much debate in Australia. This has been ongoing since the release of the Potts report in May 2004, a response to the HIH Royal Commission’s observations on DOFIs for the protection of less sophisticated purchasers of insurance from these types of insurers.

Scope of the proposals

The intention of the bill is to subject DOFIs to prudential regulation in Australia through amendments to the Insurance Act 1973 (Cth). This will be achieved by extending the current definition of “carrying on insurance” so that it captures anyone carrying on insurance both directly or through the actions of another. Marketing activities and advertising activities will be considered insurance business for the purposes of the Act if they have (or are likely to have) an effect in Australia.

The bill will cover captive insurers, who, it was thought, might be subject to a specific exemption. It will capture DOFIs, their direct and indirect onshore agents, direct and indirect brokers of DOFIs, and brokers’ agents.

The Bill bans financial services licensees and their authorised representatives from dealing in general insurance products unless it is through a general insurer or a Lloyd’s underwriter within the meaning of the Insurance Act 1973 (Cth). There is scope for an exemption for a person authorised under the Act by the Australian Prudential Regulatory Authority.

In September 2007, the Treasury published an exemption discussion paper. This proposed three exemptions from the requirement that a DOFI should be authorised under the Act. The proposed exemptions are:

  • High-value insureds; 
  • Atypical risks exemption; and 
  • Customised exemption

High value insureds

This exemption will apply to DOFIs providing insurance products to Australia’s largest publicly listed and private businesses.

The test for whether an insured is “high value” will require an insured to have: 

  • a consolidated gross operating revenue for it and the entities it controls of $200m or more for the financial year; or 
  • consolidated gross assets for it and the entities it controls of $200m or more, as at the end of the financial year; or
  • 300 or more employees at the end of the financial year.

Two alternative tests are also being considered: a premium-based test (an aggregate premium in excess of $30,000 per annum) and an insurance-cover based test (insurance cover in excess of $30m).

A typical risks exemption

This exemption is for risks which cannot currently be placed as standalone insurance with authorised insurers.

Examples will include kidnap and ransom, malicious product tampering, commercial shipping hull, asbestos, nuclear, political environmental impairment and war.

Customised exemption

This exemption is for specific risks that authorised insurers may not be willing to insure and which do not fit within the first two exemptions afforded to entities on a case-by-case basis.

It is intended to deal with circumstances where, for example, authorised insurers refuse to renew insurance for a risk where a high-profile or expensive claim has resulted in the past; where the necessary terms and conditions are not offered; or where there has been a significant increase in premium prices as a result of the hardening of the insurance cycle.

In conclusion

Comments have been sought by the Treasury in relation to the recently released discussion paper. There will be an accompanying change in the prudential framework imposing a different level of prudential stringency for insurers in a lower risk category. The idea is to recognise the differing risk profile of captive insurers that only insure the risks of their own corporate parent company or group, as compared to the risk profile of an open market insurer.

Discretionary mutual funds (DMFs) will not be subject to prudential regulation at this stage. A rigorous and compulsory data collection regime will be established to determine whether the regulation of DMFs is in fact warranted.

The amending legislation is expected to be enacted in 2008.