No joy in many Hayne recommendations

by Resolve editor Kate Tilley

The Hayne Royal Commission's recommendations are good from a regulatory perspective but problematic and "perhaps ill thought through" from an insurance law perspective.

That was the view from Sparke Helmore partner Mark Doepel, who spoke at an AILA breakfast function in Brisbane. Some of his views were shared by fellow speaker John Anning, Insurance Council of Australia (ICA) general manager, policy regulation.

Mr Doepel said some politicians were keen to take credit for the Royal Commission (RC) occurring – Opposition Leader Bill Shorten had constantly reminded the public that former Treasurer now Prime Minister Scott Morrison voted against it 26 times.

But its genesis was a 2017 Senate inquiry into the banking industry. When Commissioner Kenneth Hayne was appointed, the RC's scope was expanded to include other financial services sectors.

Initially the RC sought instances of misconduct, but gave no guidance on what it required and Mr Doepel said banks and insurers that sought more information or time got "short shrift".

While PM Morrison said the RC would be "a lawyers' picnic", Mr Doepel said it was actually a smorgasbord – ANZ's legal fees were $77 million, and CBA's $134 million.

Once submissions were reviewed by lawyers assisting the two counsels assisting the RC, more information was sought on several, which proceeded to witness statements and selected case studies.

Mr Doepel said insurance received scant mention in the 28 Sept 2018 interim report, because it covered only rounds 1-5 and insurance was in round six.

Issues identified in round six that concerned the RC were:

• commissions and incentive schemes
• unfair product design, particularly in the life industry, eg antiquated definitions of medical conditions
• unethical sales practices, including pressure selling
• add-on insurance
• poor claims handling
• compliance for insurers and intermediaries
• disclosure and breach reporting
• regulation and codes of practice (CoPs).

Cmr Hayne's final report was received by PM Morrison on Friday 1 Feb but not made public until the following Monday afternoon. "The government was concerned about a stock market implosion," Mr Doepel said. Instead, $20 million was added to bank stocks the following day. He said the Australian Federal Police was investigating possible breaches of the report's embargo.

The government had said it would "act" on all 76 recommendations. "But action doesn't mean implementation," Mr Doepel said.

There were 24 cases of misconduct referred to regulators.

Specific recommendations about insurance included:

• A ban on direct selling via cold calls and pressure tactics.
• Funeral insurance no longer exempt from ASIC oversight and the ASIC Act's consumer protection provisions to apply. The RC highlighted funeral insurance's 16% claims ratio.
• A deferred model for add-on insurance and commission caps for motor dealers. “Most motor vehicle dealers make more from add-on insurance than selling cars.”
• Replacing the duty of disclosure with a new “duty to take reasonable care not to make a misrepresentation to an insurer”.
• Life insurers can't avoid a policy within three years for nondisclosure, unless they would not have entered into the policy on any terms.
• Applying the ASIC Act's unfair contract term (UCT) provisions to insurance.

Mr Doepel said Cmr Hayne found the duty of disclosure "outdated and stale" but, "if you work in the industry, you know the duty of disclosure is fundamental to the risk transfer to the insurer". The insured had an obligation to disclosure pre-contractually and that was not old fashioned.

Mr Doepel said the RC proposed a shift from a positive duty to disclose to a negative duty to avoid misrepresentation. "If implemented, Cmr Hayne's recommendation would uproot longstanding, settled jurisprudence on the duty of disclosure and open up debate [on] interpretation of the new duty.

"It's uncertain how this new duty will dovetail into the duty of utmost good faith (UGF) which already is owed by policyholders to insurers."

Mr Doepel said Cmr Hayne had been on "an interesting but misguided journey".

The UCT regime was problematic. Insurance had been exempt because terms and exclusions consumers may feel were unfair "provide greater certainty to insurers on coverage and enable appropriate pricing".

Insurance contracts required tailored application-and-acceptance processes. Imposing UCT provisions "begs the question – what exactly is a fair term in insurance. Must consumer policies now pass the pub test to remain enforceable in Australia?"

Mr Doepel said recommending ASIC monitor claims practices and making claims handling a financial service and therefore subject to s912A of the Corporations Act was perhaps unnecessary because s13 of the Insurance Contracts Act required application of the duty of UGF. "Is s912A, which is an obligation not a duty, setting a lower bar?"

In the Q&A session, Mr Doepel said there was concern about third party administrators (TPAs), which would likely require Australian financial services licences (AFSLs), and law firms' in-house claims companies, plus Lloyd's syndicates that managed claims in house in London.

Mr Anning agreed there was a potential problem. "We don't want smash repairers" requiring AFSLs.

Mr Doepel said Cmr Hayne's work was "remarkable but he has misunderstood his task". His role should be like a coroner's, determining the cause of death, not apportion guilt or blame.

Like the post-HIH RC tort reforms that created "a patchwork of legislation that was not properly thought through", Mr Doepel feared a similar response in the post-Hayne RC environment.

Mr Anning said he had no argument with the six underlying principles Cmr Hayne had identified:

• Obey the law
• Do not mislead and deceive
• Act fairly
• Provide services that are fit for purpose
• Deliver services with reasonable care and skill
• When acting for another, act in the best interests of that other.

But he argued all financial service sectors should not be treated alike. He said Treasury appeared to be taking a "black-and-white view" which ignored practical differences between life, general insurance (GI) and other sectors. "I hope common sense will prevail in the [legislative] drafting," he said.

While RC recommendations were considered "holy writ", some were "odd and don't make sense".

Mr Anning said ICA had been due to finalise its GI CoP review by 1 May but had delayed because of the RC recommendations. "The board wants certainty about what parts of the CoP will be enforceable," he said.

While Cmr Hayne said CoPs were toothless, Mr Anning said the RC had misunderstood self-regulation. "It's not black letter law, it's the industry delivering above its legal requirements."

Mr Anning said the industry was relieved conflicted remuneration had at least three years for a review, but said insurers and brokers agreed on the need for greater transparency and simplification on commission payments. "Volume payments may have a limited time span."

He told the industry to expect more aggressive enforcement from regulators – which would "litigate first and discuss later" – and a stronger focus on consumer outcomes.

Prepare for Hayne pain

GD Law principal David Newey, who spoke at Underwriting Agencies Council seminars in Sydney, Brisbane and Melbourne on industry expectations from the RC, said Cmr Hayne's final report had been unfairly criticised for not "naming and shaming" or punishing wrongdoers.

However, the RC did achieved that and more, as there had been self reports of misconduct and numerous referrals to ASIC.

Mr Newey said other changes afoot for the industry were already in play.

"There's a lot more than just the RC happening; there are a lot of herbs and spices that will increase flavours for the consumer, and increase costs for the industry," he said.

"There are a lot more eyes watching over the industry and the Federal Government has given regulators an extra $170 million in funding to investigate and prosecute people guilty of misconduct."

The additional $170 million was for ASIC, APRA, the Commonwealth Director of Public Prosecutions and the Federal Court to ensure regulators were "appropriately resourced to hold those who engage in misconduct to account".

Mr Newey warned that fees under the new ASIC industry-funded scheme would increase because of the extra oversight and additional compliance costs would have to be passed on to insurance buyers. "I'm not against better regulation, but it comes at a cost."

Mr Newey identified game changers from the RC as:

• Disclosure requirements, driven by use of the terms ‘independent' or ‘unbiased' under the Corporations Act. That would be “a thorn in the side” for those who received over-riders for volume, non-monetary payments, and commission. Organisations and individuals could not describe themselves as independent if they received commissions (apart from commissions rebated in full to clients); remuneration calculated on the basis of volume of business placed; and remuneration from financial product issuers “which may reasonably be expected to influence” the person or organisation.
• Defining claims handling as a financial service. TPAs, probably loss adjusters, and anyone making decisions on claims, including investigating and interpreting policy coverage; conducting settlement negotiations; preparing estimates of loss or damage or likely repair costs; and making recommendations about loss mitigation, would need AFSLs.
• A deferred sales model for add-on insurance.
• More prosecutions from APRA and ASIC. “Prosecutions and penalties will reflect the need for general and specific deterrence. Fines need to be a warning to others.”
• The banking executive accountability regime (BEAR) would likely be expanded to apply to insurers. BEAR identifies and registers “accountable persons”; requires accountability statements to be created and submitted for each accountable person and an accountability map for the entity; and establishes remuneration policies requiring a portion of accountable persons' variable remuneration be deferred for at least four years and reduced commensurate with any failure to meet their obligations. APRA must be notified of any accountability-related changes or breaches of accountability obligations.
• Conflicted remuneration for brokers would be examined in two-three years, but Cmr Hayne's view was fees for financial services should be paid by users not commissions paid by product suppliers. Brokers would need to charge fees for service in the future, rather than relying on commissions.
• A last-resort compensation scheme was likely but “it's not a freebie. Insurers will pay through levies”.
• If a Labor Government were elected, whistleblower legislation was likely, with employees remunerated to a maximum of $250,000 for “dobbing in” poor conduct.
• Underwriting guidelines needed to be closely examined for target market determinations with ASIC overseeing products.
• Changing the duty of disclosure would make s21A and s21B of the Insurance Contracts Act unnecessary. “That's a big change. The duty of disclosure has been in statute since 1984, but we will move to the recently implemented UK model,” Mr Newey said.
• UCT legislation could lead to policy terms being challenged and use of UCTs could be a breach of the duty of good faith. ASIC could prosecute insurers for breaches of that duty, which could lead to licence condition variations. “The main subject matter of a contract is not reviewable under UCT legislation but will be defined narrowly, leaving most terms exposed to review.”
• The APRA review by former ACCC chair Graeme Samuels was “sure to shake up the regulator”.
• Bans on hawking would prohibit unsolicited meetings, phone calls and contact; and require no call registers; but not apply to emails, letters, brochures or advertisements.
• The GI CoP would be sanctioned by ASIC, have enforceable provisions, sanctions for breaches, and remedies modelled on the Competition and Consumer Act.
• Consumers could elect for courts or the Australian Financial Complaints Authority (AFCA) to deal with CoP breaches.
• AFSL-holders would have to take reasonable steps to co-operate with AFCA in resolving disputes and make available all documents and records on disputed issues.

When TPAs were licensed, complaint resolution would be a challenge with both insurers and TPAs subject to external dispute resolution through AFCA. “Insurers will need to carefully consider how TPAs are used to maintain the integrity of their own dispute resolution processes,” Mr Newey said. Being classified as a financial services provider meant entities needed:

• adequate arrangements for managing conflicts of interest • compliance with AFSL conditions and financial services laws
• to maintain competence to provide financial services
• ensure authorised representatives were adequately trained and competent to provide financial services
• dispute resolution systems, including internal dispute resolution.

When TPAs were licensed, complaint resolution would be a challenge with both  insurers and TPAs subject to external dispute resolution through AFCA. "Insurers will need to carefully consider how TPAs are used to maintain the integrity of their own dispute resolution processes," Mr Newey said.

Being classified as a financial services provider meant entities needed:

• adequate arrangements for managing conflicts of interest
• compliance with AFSL conditions and financial services laws
• to maintain competence to provide financial services
• ensure authorised representatives were adequately trained and competent to provide financial services
• dispute resolution systems, including internal dispute resolution.

Mr Newey said the intrinsic value of an insurance policy lay in the ability to make a successful claim when an insured event occurred and that was a fundamental premise for the industry.

"There are interesting challenges ahead," he warned.