Insurance Contracts Act 1984 (ICA) Royal & Sun Alliance Response to Issues Paper on s54

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1 Insurance Contracts Act 1984 (ICA) Royal & Sun Alliance Response to Issues Paper on s54 1. Introduction Royal & Sun Alliance Insurance Australia Limited (R&SAIAL), a subsidiary of the Promina Group, is a leading player in the Australian Professional Indemnity (PI) and Directors & Officers Liability (D&O) market. It has written such risks for many years. A wide range of occupations is underwritten for both classes of business, including, for PI, professions such as accountants, architects, engineers, lawyers and others, and, for D&O, most types of risk. R&SAIAL does not write Medical Malpractice business for qualified medical practitioners or hospitals. 2. Nature of the Risk Exposures The nature of PI/D&O claims differs according to the type of risk written, but generally relates to economic loss occurring as a result of professional advice provided and/or poor corporate governance practices. Personal injury is involved in claims against medical practitioners, but can also be involved in relation to claims against other professionals (designers, real estate agents and others). 3. Claims Made R&SAIAL invariably underwrites these risks under Claims Made and Notified insurance contracts. This means that we indemnify our policyholders against claims made during a policy year, notwithstanding the fact that the act or omission that gave rise to the claim may have occurred prior to the inception, or in an earlier period, of our policy. Effectively, therefore, such policyholders have the benefit of current policy terms (limits/cover) for what could, under other types of policy, be regarded as stale claims. Recent judicial decisions of the High Court (as noted in the Issues Paper) have used s54 essentially to vitiate the requirement of notice during the policy period, regardless of whether such omission is deliberate or inadvertent. 1

2 R&SAIAL s current suite of Claims Made and Notified policies contains a notification of circumstances clause (sometimes referred to as a deeming clause). As noted in the Issues Paper, such a clause permits a policyholder who has become aware of facts that may give rise to a claim to notify us of those facts within the current policy period. Any resulting claim will be deemed to be made, and therefore will fall for consideration, under the policy in force at the time of such notification. Like many insurers, R&SAIAL is in the process of removing the notification of circumstances/deeming clause from its policies because of the High Court s interpretation of s54, which, as we say, essentially vitiates the notice requirement. In so doing, we will rely upon the statutory right conferred upon policyholders of such policies under s40 (3) of the Insurance Contracts Act to provide this vital component of cover under this type of policy. By relying on s40 (3), instead of a notification of circumstances/deeming clause, we provide the insured with the same coverage. The difference between the two approaches, however, is that whilst the courts have thus far specifically enforced the notice requirement under s40 (3), the same courts have used s54 to excuse the insured s non-compliance with the seemingly identical grant of coverage under the notification of circumstances/deeming clause. Such a result is illogical and arbitrary and illustrates the problem with applying s54 to the notice aspect of claims made policies. 4. Reasons for Claims Made Concept There are a number of reasons why PI and D&O insurance is underwritten on this basis (and these are set out on page 4 of the Issues Paper). One of the primary benefits provided by the claims made and notified basis of underwriting is certainty for both parties to the contract. On the one hand, the insurer knows at the end of the policy period the universe of potential claims for which a policy may be called upon to respond and for which the insurer must reserve accordingly. For the insured, on the other hand (and bearing in mind that claims made forms of insurance frequently relate to risks involving advice given, or management actions taken, over a period of time), the benefits are: a) the greater certainty of being able to pinpoint the date a claim was made (or when awareness of a set of circumstances was gained), rather than trying to determine when the causative event took place, and 2

3 b) the benefit of current policy terms for claims which conceivably can relate to stale events. There are therefore clear benefits for both insurer and policyholder with such a basis of cover, especially with the protection a policyholder has from the deeming provisions of s40(3) of the ICA. 5. Premium Setting Approach Our premium setting approach to these classes is actuarially driven, but, given the nature of PI and D&O claims, it can take many years for patterns of loss development (IBNER or Incurred But Not Enough Reserved) to emerge. The judicial decisions in question now require insurers under Claims Made and Notified Policies additionally to take into account loss reporting patterns when making their projections (IBNR or Incurred But Not Reported). Accordingly, it is R&SAIAL s strongly held view these recent judicial interpretations of Section 54 in the cases detailed in the Issues Paper have de-stabilised the underwriting of PI/D&O policies. There is now clearly much more volatility present in relation to our actuarial projections, and the estimation of R&SAIAL s future liabilities under this type of insurance contract is much more uncertain. 6. Effect of Regulatory Requirements Another factor that can strongly influence an insurer s view of the relative attractiveness of different classes of business is the changed capital requirements imposed by APRA from mid-2002 onwards. These have a direct effect on the price of long-tail insurance and its attraction to insurers, especially underwriters of PI/D&O insurance, since the new regulations have generally resulted in an increase in the capital required in order to support long tail portfolios. Accordingly, the longer the tail, the greater the capital required to support such business, and thus the greater the profit needed in order to provide an adequate return on capital. 3

4 Multi-line general insurers such as R&SAIAL need, therefore, to weigh up the relative attractions of long- and short-tail business when making decisions about their internal allocation of capital, and volatility in the performance of a particular portfolio is a distinctly unfavourable factor when making such decisions. We have seen this process at work in recent times in the Australian and world insurance markets, leading to a significant shortage of capital available for long-tail portfolios. 7. Key Issues R&SAIAL s strong view is that the balance which the ICA seeks to achieve between the interests of consumers and those of insurers has been adversely affected by the judicial decisions in question. The effect of the run of decisions summarised in the Issues Paper is that insurers can no longer rely upon portfolio loss experience under Claims Made and Notified policies developing in the way in which underwriters of this policy form clearly intended. It should also be borne in mind that the placement of this form of insurance is generally made through professional intermediaries, who are well able to advise policyholders on the nuances of dealing with insurers of Claims Made and Notified policy forms. Since the decisions in question are largely decisions of the High Court, legislative amendment is clearly required to redress this balance in the short term. Waiting for the right case, and for an insurer bold enough to raise s54 issues once more with the High Court in the hope of achieving a fairer outcome, is not likely to produce early beneficial results. 8. Legislative Reform R&SAIAL s view is that no legislative amendments are required to s40 of the ICA, as this section, based on case law since the ICA first came into operation in 1986, appears to operate fairly and in a balanced way. Indeed, R&SAIAL has no problem with the type of coverage provided by either s 40(3) or a notification of circumstances/deeming clause as long as the notice requirement is enforceable against the insured. As regards s54, R&SAIAL considers that Option 4 set out in the Issues Paper represents the clearest and fairest solution to the current problems brought about by recent judicial interpretations of this section. 4

5 Thus: a) Sub-section 1 of the proposed new s54 would be solely applicable to: (i) policies other than those described in s40, and (ii) policies described in s40, but only to the extent that the issue between the insured and the insurer does not relate to the notice of a claim or of facts in terms of s40(3) and, in respect of both types of policy, would apply as it currently does b) Sub-section 2 of the proposed new s54 would be solely applicable to policies as described in s40 (and would also apply to the deemed cover under s40(3)). It would provide that, in relation to such policies, the notification by anyone entitled to indemnity under such a policy of a claim (or of circumstances under s40(3)) is not a matter in respect of which s54 will provide relief. The word anyone is bolded because it is common for parties other than the policyholder under PI and D&O policies to be entitled to claim indemnity, and the drafting of the proposed amendment should take this into account. c) Sub-section 3 of the proposed new s54 would, in the interests of protecting policyholders who could be adversely and unfairly prejudiced by a strict operation of the proposed new sub-section 2, provide for a statutory extended reporting period of a maximum of 15 days after the normal expiry or renewal date of a policy falling under that proposed new sub-section. This extended reporting period would relate solely to claims (or facts under s40(3)) which arose prior to the normal expiry or renewal date of the policy d) R&SAIAL believes that the creation of a statutory right to run-off cover, as touched upon in the Issues Paper under Other Issues, would only exacerbate the current difficulties surrounding Claims Made and Notified policies. Such cover is freely available in the commercial market at cost, and R&SAIAL is not aware of any difficulties surrounding its availability (outside of the current debate in relation to medical malpractice cover provided by discretionary trusts). Accordingly, there does not appear to be an issue that requires a remedy, statutory or otherwise. 5

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