Following the collapse of HIH and the subsequent "insurance crisis" the industry Down Under is back on track, says Jacqueline McGarry

It has been an eventful year for the Australian insurance and reinsurance industry with higher profits demonstrating a recovery from the slowdown of 2001-2002. Increased regulation and reform of industry standards have highlighted the growing trend towards greater accountability and transparency, particularly in the wake of prosecutions over the 2001 collapse of general insurer HIH and further scandals and investigations. A surge of tort reform has also seen claims reduce.

Insurer profitability and tort reform

State and federal governments have introduced many changes to tort law, including caps on payouts and time restrictions on bringing legal action. The effect has been to slow the number of claims being filed and amounts being paid to insureds.

While plaintiff lawyers say the reforms are unfair, Mal Brough, federal assistant treasurer, has warned against slowing tort reform, claiming that would lead to another "insurance crisis" similar to that which followed the HIH collapse. "Three years ago the insurance industry was in crisis following a rapid increase in litigation, unsustainably low premium pricing and the collapse of HIH. It triggered a succession of events, which saw premiums spiral out of control - if insurance was available at all, and a dramatic loss of confidence in what is an important industry to the Australian economy. The industry has a role to play in restoring confidence, but loose talk of winding back reform can only unsettle the industry," he said.

Michael Hawker, Insurance Council of Australia president and CEO of the nation's largest general insurer, IAG, said the industry's increased profitability was not due to tort reform. "There has been much comment on insurers' return to profitability, including some misconceptions about profit drivers. One false impression is that tort law reforms have significantly boosted insurers' financial results," he said.

Hawker attributed the boost to environmental factors (including drier than average weather); a more judicious approach to capital, risk, and reinsurance management; significant improvements in companies' operating efficiencies and expense ratios, due to mergers and market consolidation; and a turnaround in the equities market. "There are many challenges ahead for the insurance industry, but we are now in a much more sustainable, robust position," he said.

US investigation spreads Down Under

In October last year, New York Attorney General Eliot Spitzer began investigating allegations that some US brokers were involved in steering and bid rigging. The Australian regulatory authority - the Australian Securities & Investments Commission (ASIC) - then reviewed the remuneration practices of 15 brokers as part of an assessment of compliance with legal obligations, to determine whether there was any evidence of those practices in the Australian industry. It found no evidence of systemic misconduct of the kind or scale uncovered in the US but did identify deficiencies in Australian brokers' management of conflicts of interest and disclosure of remuneration.

The report found that more than half the brokers ASIC reviewed had contingent remuneration arrangements and most of them placed a significant proportion of business with insurers that paid contingent remuneration. It also found the amounts of contingent remuneration received by the brokers reviewed had increased substantially over the last three financial years. But the report was criticised for its lack of depth and there was speculation that the Australian situation could be worse than originally realised.

Brad Greer, Risk Management Institution of Australasia (RMIA) president, believes "bad practices" among brokers may be more widespread. "It is disappointing that some of the safeguards for insurance buyers that existed in the former Insurance (Agents & Brokers) Act were not brought into the new legislation, the Financial Services Reform Act (FSR). For example, in the past, brokers could not receive contingent commissions, that is, commissions based on the number of contracts arranged, the total amount of premium payable under such contracts or the total amount of sums insured," he said. Such practices are now legal, providing inherent conflicts were appropriately managed and remuneration properly disclosed.

Greer says some brokers have now decided not to accept contingent commissions, but ASIC had uncovered instances where commissions were insufficiently disclosed and conflicts of interest not managed and disclosed. "Given that ASIC only sought information from a limited number of brokers, there is a fear that bad practices are more widespread in the industry. RMIA's view is that an insurance transaction is a three-way partnership between insurer, broker and risk manager and that all relevant information needs to be disclosed to each of the parties involved," he added.

Noel Pettersen, National Insurance Brokers' Association (NIBA) CEO, hopes the results of the six-month inquiry will give insurance buyers renewed confidence that brokers were acting in their best interests when negotiating risk insurance products on their behalf.

Broker survey sees premiums drop

Increased competition between insurers has been significantly driving down premium rates in Australia, according to a NIBA survey. The survey, released in July, assessed the peak renewals period of 30 June. Brokers said 53% of clients had experienced premium decreases, with the most substantial reductions occurring in public liability.

NIBA brokers handle about 80% of the commercial insurance business transacted in Australia each year and about 50% (or A$7bn in premiums) of Australia's total insurance business. Another trend noted by brokers was insurers' increasingly flexible attitudes to rates. One survey respondent said discussion with insurers could result in a 20% reduction on a premium rate that was on par with last year's rates. Not all classes saw premiums drop. Most brokers said business interruption and directors & officers premiums rose up to 9%, although the rise was not as high as last year.

APRA reforms continue

The Australian Prudential Regulation Authority (APRA) released a discussion paper on prudential supervision of general insurance, stage two reforms, in May. It dealt with risk management, reinsurance, audit and actuarial arrangements and outsourcing. For reinsurance the objective was to ensure insurers had a framework to manage selection, implementation, monitoring, review, control and documentation of reinsurance arrangements. Key requirements included:

- A framework for reinsurance management that included a reinsurance management strategy (REMS), sound reinsurance management policies and procedures and clearly defined managerial responsibilities and controls;

- REMS must be submitted to APRA for approval annually and resubmitted for approval when any material changes are made;

- An insurer's reinsurance arrangements statement must be submitted to APRA; and

- An insurer must prepare and retain a declaration attesting to the documentation of its reinsurance arrangements within two months of the inception date of the reinsurance and again at six months. The declaration must be available for inspection onsite and provided to APRA on request.

John Laker, APRA chairman, said the regulator had tried to take industry concerns about over regulation into account, but reinsurance was one area on which it would not give ground. "We have taken a strict approach to so-called financial reinsurance, more aptly called 'limited risk-transfer arrangements', that may mask the true financial position of an insurer." He told an insurance conference, "This audience needs no reminder of the issues with which we and our counterparts abroad are currently dealing with because of the deceptions perpetrated by the use of such transactions. We call time on the practice of allowing reinsurance recoveries on the balance sheet to be backed by scant, even non-existent documentation. The days of reinsurance promises being forged with a handshake must end if reinsurance is to provide genuine protection for policyholders and other stakeholders."

Submissions on the proposed reforms closed on 5 August and final standards are due for release early next year.

Proposed rules for onshore captives

In February, APRA released a proposal to reassess the definition of a captive and formulate criteria for "eligible captives" to be exempt from APRA regulation.

Currently, onshore captives are classified as insurers under the Insurance Act, which means they must comply with the same regulations as general insurers. However, the industry had sought consistent prudential treatment of onshore and offshore captives, regardless of their domicile.

APRA proposed that where a captive insurer was a wholly-owned company within a corporate group and provided insurance only to other companies within the corporate group; had no third parties insured; did not write statutory classes; and did not provide reinsurance unless it was to another captive; it could apply for exemption from regulation. That would mean eligible captives were no longer subject to reporting requirements under the Financial Sector (collection of data) Act 2001 and would not have to pay levies to APRA.

An informal discussion group of risk managers, representing many Australian corporates, examined the proposal and told APRA that the criteria were too restrictive. Its submission, supported by RMIA, said most major captive domiciles defined a captive as an insurance subsidiary of an organisation whose primary business function was not to transact commercial insurance, but to insure the risks of the parent company and its subsidiaries. It submitted that APRA adopt a similar test and suggested there be a classification method to reflect the scope of a captive's business activities, either pure captive, group captive or rent-a-captive.

APRA member Steve Somogyi said more than 20 submissions were received on the captives report and the proposal needed review. "We got quite a lot of feedback from existing captives and those who support the industry. We need to take those comments on board." Somogyi said some issues that needed to be re-thought were clarifying the definition of a third-party contract, including providers of reinsurance to captives, and rules for offshore captives. Somogyi said there was no timeline for drafting a new proposal and other reforms had taken precedent. "There is no urgency at this point."

Changes to the proposal could depend on future changes to the Insurance Contracts Act 1984. A review of the act began in 2003 and a report was released in January. It found the act generally struck an appropriate balance between the interests of insurers and consumers. Recommendations were made to update the act and recognise developments in the insurance market, clarify provisions in light of judicial interpretation and address some anomalies.

A draft bill addressing the recommendations was expected to be released in August, but has been delayed. A spokesperson for Chris Pearce, federal parliamentary secretary to the treasurer, said a proposals paper could be released soon, but a draft bill was unlikely to be finalised until early 2006.

Investigation into General Re and HIH

In April, APRA announced it would investigate General Reinsurance Australia over reinsurance practices. The ongoing investigation centres on General Re's complex financial and finite reinsurance products and marketing of those products. Estelle Pearson was appointed as an inspector for General Re on 14 April.

Ross Jones, APRA deputy chairman, said APRA's primary goal was protecting policyholder interests by ensuring Australia's general insurance industry developed and maintained "a rigorous approach" to risk management, liability valuation and reporting. "This includes ensuring any transactions entered into are properly recorded and appropriately treated in regulatory and financial reporting," he said, and that APRA's supervision confirmed General Re met minimum regulatory capital requirements. But an APRA spokesperson would not comment further while the investigation was ongoing.

Tony McGrath, liquidator for HIH and FAI, has said General Re was a "causal factor" in the HIH collapse. Berkshire Hathaway, which purchased General Re in 1998, detailed McGrath's claim in its 2004 annual report, saying McGrath had advised two subsidiaries of General Re, General Reinsurance Australia (GRA) and Kolnische Ruchversicherungs-Gessellschaft (KR), of claims arising from transactions GRA had entered into with FAI in May and June 1998. FAI was bought by HIH before its collapse. "The liquidator contends, among other things, that GRA and KR engaged in deceptive conduct that assisted FAI in improperly accounting for such transactions as reinsurance, and that such deception was a causal factor that led to the insolvency of HIH," the report said.

By August 2005, there were three jailings and four guilty pleas in Australian courts over charges relating to the HIH collapse. Ray Williams, former HIH CEO, and Rodney Adler, former director, were each jailed for four and a half years. Terry Cassidy, former managing director, was sentenced to 15 months in jail. William Howard, former general manager, pleaded guilty to two charges of misconduct and was given a three-year suspended sentence on the basis of ongoing assistance to ASIC's investigations into the collapse. The trial of three more former HIH executives - Timothy Mainprize, Daniel Wilkie and Stephen Burroughs - began on 12 September. Each has pleaded not guilty to charges relating to their conduct as officers of FAI.

Jacqueline McGarry is a journalist with KT Journalism.