ASIC releases consultation paper on new compensation and insurance requirements for AFS licensees
In this month’s update, we focus on the new compensation and professional indemnity (PI) insurance requirements that will apply to all existing, non-APRA regulated Australian financial services licensees from 1 July 2008, and to all new licence applicants after 1 January 2008.
Current compensation requirements
At present, some licensees, including responsible entities of managed investment schemes, are required to maintain a PI insurance policy covering professional indemnity and fraud by officers that covers claims of at least (usually) $5 million. Other licensees have been required to lodge security bonds with ASIC. These requirements have been imposed under transitional compensation arrangements in place since FSR commenced.
The new compensation requirements
Corporations regulation 7.6.02AAA will apply from 1 July 2008 to all licensees whose licence commenced before 1 January 2008, other than “exempt licensees”. “Exempt licensees” comprise APRA-regulated general insurance companies, life insurance companies and authorised deposit-taking institutions, and certain related entities guaranteed by an APRA-regulated licensee.
For a non-exempt licensee whose licence commences on or after 1 January 2008, the regulation will apply immediately from the date of commencement of their licence.
The regulation prescribes compensation arrangements for the purposes of section 912B, and will require a licensee to hold PI insurance cover that is adequate, having regard to both the licensee’s maximum potential claims liability under the external dispute resolution (EDR) scheme of which it is a member, and the nature of its financial services business (volume, clients and representatives).
Licensees will also need to include a statement in their Financial Services Guides about the kind of compensation arrangements they have, and whether those arrangements satisfy section 912B (regulation 7.7.03A). This FSG requirement will apply from the date on which regulation 7.6.02AAA applies to the licensee.
ASIC’s consultation paper on the new compensation requirements
Introduction
The ASIC Consultation Paper was released on 23 July 2007. The paper sets out how ASIC proposes to administer the new compensation requirements, and seeks industry views by 14 September 2007. Once those views have been considered, ASIC will issue a regulatory guide (scheduled for November 2007).
ASIC has defined the “Policy Objective” behind the new requirements as being “to reduce the risk that a retail client’s losses (due to breaches by a licensee) cannot be compensated by the licensee due to the lack of financial resources, as far as practically possible”.
The primary way for licensees to comply with the new compensation requirements will be to have “adequate” PI insurance. Alternatively, a licensee can apply to ASIC for approval of alternative compensation arrangements that will be assessed on a case by case.
“Adequate” PI insurance
ASIC considers that PI insurance will be “adequate” if it is fit for achieving the Policy Objective as far as practically possible. ASIC considers that whether a PI insurance is adequate depends on the amount of cover, the scope of cover and whether the terms and conditions of the cover undermine the overall effect (in particular, the exclusions and excess).
Amount of cover
ASIC proposes that:
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a licensee’s PI insurance policy should have a per claim limit at least as high as the maximum monetary limit that applies to their EDR scheme;
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for insurance brokers, the aggregate amount of cover required under the superseded Insurance (Agents and Brokers) Act would be adequate;
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for other licensees, the aggregate amount of cover would depend on total gross revenue derived from business with retail clients, being:
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for licensees with up to $1 million of retail client revenue – a minimum $2 million of cover; and
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for licensees with retail client revenue greater than $1 million – a minimum cover of two times revenue up to a capped maximum of $20 million cover.
Scope of cover
ASIC proposes that an adequate PI insurance policy must:
- cover loss or damage suffered by retail clients because of breaches of obligations under Chapter 7 of the Corporations Act, including negligent, fraudulent and dishonest conduct;
- cover breaches by both the licensee and its representatives (including authorised representatives);
- be available to cover compensation awards made by the licensee’s EDR scheme; and
- as far as possible, provide run-off cover.
Exclusions and excesses
Exclusions that may result in a PI insurance policy not being fully adequate include EDR scheme awards and fraud/dishonesty by representatives. If a PI insurance policy’s excess is so large that the majority of claims are likely to be below the excess, the policy is unlikely to be adequate.
What if a PI insurance policy is only partially adequate?
ASIC acknowledges that the ability of PI insurance to achieve the Policy Objective is subject to practical limitations. ASIC also notes that research conducted for ASIC suggests that what PI insurance will cover is currently limited by what the insurance market will provide (the research report accompanies ASIC’s media release). ASIC is expecting the insurance industry to develop new products that will help PI insurance policies meet the Policy Objective.
Where a licensee’s policy is only “partially adequate”, ASIC will expect the licensee to identify and estimate their exposure to uninsured claims and ensure that their cash flow is sufficient to cover this exposure.
What should you be doing now?
All existing and prospective licensees should be familiarising themselves with the new PI insurance requirements and ASIC’s proposed policy. We will update you when ASIC issues its final regulatory guide.
Existing licensees with PI insurance policies that are falling due for renewal should be taking this opportunity to assess the proposed renewed policy against the new requirements, and discussing any gaps with their insurance broker and legal adviser.
Existing licensees should also ensure their FSGs are updated with descriptions of their compensation arrangements by 1 July 2008.
