House of Representatives

Financial System Legislation Amendment (Financial Claims Scheme and Other Measures) Bill 2008

Financial System Legislation Amendment (Financial Claims Scheme and Other Measures) Act 2008

Explanatory Memorandum

Circulated By the Authority of the Treasurer, the Hon Wayne Swan Mp

Chapter 7

Other measures : life insurance

Outline of chapter

7.1 Schedule 4 of the Bill amends the Life Insurance Act 1995 (Life Insurance Act) to strengthen the judicial management framework in line with the amendments to the Insurance Act 1973 .

Context of amendments

7.2 The Life Insurance Act already contains an adequate judicial management framework. However, key amendments would ensure the judicial manager has power and flexibility to manage a failing life insurer, implement the arrangements or changes necessary to enable the company to become financially viable again and promote financial system stability in Australia.

Summary of new law

7.3 This schedule gives the judicial manager of a life insurer the key additional power to facilitate the recapitalisation of a life insurance company.

7.4 The amendments also ensure that judicial management has priority over all other forms of external administration under the Corporations Act.

Comparison of key features of new law and current law

New law Current law
Judicial managers of life insurers will have additional powers to recapitalise the company, as well as change its constitution, rules or other governance arrangements.
Where a judicial manager is appointed, it overrides other forms of external administration under Chapter 5 of the Corporations Act.
Judicial managers lack the power to recapitalise a life insurer or alter its governance arrangements.
Judicial managers do not have explicit authority that supersedes other external administrators.

Detailed explanation of new law

Financial system stability in Australia

7.5 The object clause in the Life Insurance Act is amended so that it includes a reference to judicial management of a life insurer whose circumstances are unsatisfactory. These appointments are made to ensure the stability of the financial system in Australia and to protect the interests of policyholders. [Schedule 4, item 1, subsection 3(2)(d) and item 15, subsection 175(1)(a)]

Judicial management and other external administration

7.6 The following amendments ensure that a judicial manager appointed by the Federal Court takes precedence over other forms of company external administration, where it is considered necessary to protect policyholders' interests and/or ensure financial system stability.

7.7 Judicial management overrides any other form of external administration of the life insurer, as defined under Chapter 5 of the Corporations Act. [Schedule 4, item 11, section 165A and items 2 and 35]

7.8 If the Court orders the appointment of a judicial manager, the order may specify that judicial management is taken to commence on a particular day and at a particular time. If the court does not so specify, judicial management is taken to commence when the order is made. This provision provides certainty as to commencement. [Schedule 4, items 3-5 and 9-10]

7.9 There is no explicit requirement on who can be a judicial manager. [Schedule 4, items 8 and 38]

7.10 A person who proposes to appoint an external administrator to a life insurer must give prior notice to APRA. APRA can be heard at an application hearing. This requirement ensures that APRA has timely notice of these applications and can respond where necessary. For example, APRA may wish to oppose the appointment of an external administrator under Chapter 5 of the Corporations Act on the grounds that it has applied for, or intends to apply for, the appointment of a judicial manager. [Schedule 4, item 25, section 179C]

7.11 A person who applies for the appointment of an external administrator without first notifying APRA commits a strict liability offence. The maximum penalty for the offence is 60 penalty units. [Schedule 4, item 25, subsection 179C(4)]

7.12 This is a strict liability offence, as it may be difficult to show that the person's omission to notify APRA in this circumstance was intentional. This provision provides maximum incentive for such persons to ensure APRA is notified prior to an application for an external administrator to be appointed to a life insurer.

7.13 While a judicial manager is appointed to the entity, all other forms of external administration are terminated and no other external administrator can be appointed. A purported appointment of another form of external administration, in contravention of this provision, is invalid. This ensures, for example, that creditors of the company cannot enforce a lien or charge over company property by appointing a receiver or other external administrator. [Schedule 4, item 11, section 165A]

7.14 However, the Life Insurance Act does not override other aspects of the Corporations Act. Absent the appointment of a judicial manager, creditors, ASIC and other persons may still exercise their rights under the Corporations Act to appoint other types of external administrators. Subject to the moratorium on proceedings whilst a judicial manager is appointed, members, creditors and ASIC may also exercise their rights to wind up a life insurer. [Schedule 4, item 25, section 179B]

7.15 Where the liquidator of a life insurer proposes to apply to court in relation to a winding up, they must give prior notice to APRA. [Schedule 4, item 26, subsection 183(1)]

7.16 APRA can currently request information from the liquidator concerning the liquidation of the entity under section 185. This ensures that APRA has access to information that may be relevant to protecting the interests of the entity's policyholders. An additional note will clarify that action can be taken against the liquidator who does not comply with such a request. [Schedule 4, item 27]

Contractual obligations

7.17 A contract with the life insurer cannot be terminated, or contractual obligations owed to the life insurer avoided, on the grounds that a judicial manager has been appointed. Where contractual clauses provide for specified events as grounds to terminate or vary the contract, this provision would override those clauses.

7.18 Without such provisions, the appointment of a judicial manager is likely to be an 'event of default' or other 'specific event' under many commercial contracts. These 'events' may have a number of consequences that are detrimental to the continuing operations of the life insurer. Such events may entitle the other party to the contract to cease meeting their contractual obligations, such as performing business services. If the contract is a loan or a type of debt, such events may allow the creditor to ask for immediate payment of the amount outstanding under the loan, and may have additional penalty clauses attached. If the contract relates to other transactions or trades, such events may entitle the other party to close out these transactions and ask for immediate settlement of any outstanding accounts. This applies to contracts made after the commencement of this section. [Schedule 4, item 11, section 165B and item 12]

7.19 These provisions protect the financial position of the life insurer and policyholder interests until the judicial manager has had time to make an assessment as to an appropriate course of action. These provisions also ensure the judicial manager can allow the life insurer to continue trading if it is appropriate.

7.20 Similarly to the situation outlined above, a contract with the life insurer cannot be terminated, or contractual obligations owed to the life insurer avoided, on the grounds that the life insurer has been subject to an APRA direction under section 230B. [Schedule 4, item 31, subsection 230C(1) and items 32 and 33]

Stay of proceedings

7.21 Currently, under section 160 of the Life Insurance Act, appointing a judicial manager ceases all legal proceedings against the life insurer, or in relation to the life insurer's property, except where the judicial manager or Court has consented otherwise. It also prevents any person commencing new proceedings unless the judicial manager or Court consents.

7.22 An amendment to this section will clarify that this moratorium does not apply to criminal proceedings or civil penalty proceedings. This ensures that law enforcement can continue during judicial management, and is similar to the exemption for criminal proceedings and prescribed proceedings under section 440 of the Corporations Act. [Schedule 4, items 6 and 7]

Recapitalisation

7.23 The recapitalisation of a financial institution is an internationally recognised method of addressing a distressed institution and restoring the institution's financial health. Capital provided to a distressed institution provides a cushion to support any losses and it enhances its ability to operate competitively in the market. Importantly, it does not impose a repayment obligation on an already weak institution.

7.24 A judicial manager may facilitate a recapitalisation: through issuing new shares or rights to acquire shares; selling those shares or rights; cancelling existing shares or rights; or varying or restricting rights attached to shares. The judicial manager could also reduce the company's share capital by cancelling any paid-up share capital that is not represented by available assets. [Schedule 4, item 13, section 168A]

7.25 As an example, a judicial manager could facilitate a capital injection into a life insurer by issuing new shares and selling them to a new investor. Under this example the new investor would gain a stake in the company and pre-existing shareholders would have their stake in the company diluted but would retain their shares in the company.

7.26 As an alternative to the above, it would also be possible to cancel existing shareholders' shares, which, for example, could be used to facilitate a new investor taking 100 per cent control of a life insurer.

7.27 The recapitalisation powers are intended to be strong and flexible in order to allow a judicial manager to respond quickly and decisively to a range of circumstances.

7.28 Prior to undertaking an action to recapitalise the life insurer, the judicial manager is required to obtain an independent valuation report which sets out the expert's opinion of the fair value for each of the shares and rights, or the fair value of the rights affected. The judicial manager is required to consider the report, and may draw on its content, but is not compelled to follow the recommendations of the report when determining the terms of a recapitalisation action. [Schedule 4, item 13, subsection 168B and items 15-22]

7.29 The requirements applying to the expert valuation report, in relation to issuing, selling or cancelling shares, are similar to those of compulsory share acquisitions under the Corporations Act. Where the expert valuation report is required to give the fair value of rights attached to shares, the legislation does not prescribe how the valuation may be conducted so as to provide flexibility to the expert valuer. This reflects the fact that there may be many types of rights attached to shares and different valuation methods would be appropriate for different types of rights. [Schedule 4, item 13, section 168B]

7.30 Where the valuation report concerns issuing, selling or cancelling shares, or restricting or varying share rights, the Minister can give written notice to the expert valuer about the valuation assumptions to be used in the report (these provisions specify that the instruments are not legislative instruments in order to assist readers, as the instrument is not a legislative instrument within the meaning of section 5 of the Legislative Instruments Act). [Schedule 4, item 13, subsections 168B(4) and (6)]

7.31 The judicial manager is also required to comply with further procedural requirements, such as notifying all affected shareholders. [Schedule 4, item 13, section 168A(2)]

7.32 APRA may determine that there is to be an exemption from the valuation requirement. APRA may give this exemption if it considers that it is in the interests of policyholders, and where applicable, the stability of the financial system, for recapitalisation to be completed before the valuation report is completed, as the time needed to complete a valuation report would be detrimental to policyholders' interests or the stability of the financial system. [Schedule 4, item 13, subsections 168B(1) and (8)]

7.33 An exemption made by APRA from the valuation requirement is not a legislative instrument (this provision is included to assist readers, as the instrument is not a legislative instrument within the meaning of section 5 of the Legislative Instruments Act). [Schedule 4, item 13, subsections 168B(8) and (10)]

7.34 In the interests of a timely recapitalisation, this power overrides any Corporations Act requirements, markets listing rules, any contractual arrangements and any provision in the entity's constitution. This means that members will not be able to seek members' remedies under the Corporations Act or seek a court injunction under that Act to delay the recapitalisation. This means that recapitalisation may occur even if the company constitution prohibits issuing a specified class of shares or prohibits a share issue unless certain 'entrenched' requirements are satisfied. The judicial manager may also amend the company constitution, rules or other governance arrangements to carry out recapitalisation. [Schedule 4, items 13, subsection 168A(4)]

7.35 A recapitalisation transaction cannot be used to trigger default or protective clauses under a contract with the life insurer, so that the other party to the contract cannot deny contractual obligations, accelerate debt payments or close out transactions merely because the judicial manager has implemented a recapitalisation. This limitation only applies to contracts made after the commencement of the section. [Schedule 4, item 13, section 168C and item 14]

The recapitalisation mechanism above ensures the judicial manager has power to carry out the transaction effectively and quickly. At the same time, it protects the interests of those affected by the transaction, particularly the entity's shareholders.

Business transfer

7.36 Prior to a Court confirming a transfer of life insurance business scheme, the Court must have regard to the interests of policyholders, and if a report relevant to all or part of the scheme has been filed with the Court under section 175, the contents of the report. [Schedule 4, items 28-30]

Exemption from competition assessments

7.37 A range of actions taken by the judicial manager are exempt from competition assessment under the Trade Practices Act 1974 . This is because a competition assessment may frustrate, unduly delay or create undue uncertainty in relation to action that promotes the interests of policyholders and financial system stability in Australia. Such an exemption ensures that the judicial manager and APRA have maximum flexibility when considering ways to rehabilitate a distressed life insurer. [Schedule 4, item 23, section 179A]

7.38 This applies to acquisitions occurring on or after commencement of this provision. [Schedule 4, item 24]

Minister's power to authorise contracts or arrangements to protect policyholders or financial stability

7.39 Ministers have inherent powers to enter into contracts or arrangements on behalf of the Commonwealth. However, in order to be able to make payments in accordance with the Commonwealth's obligations under such contracts or arrangements an appropriation authority is required. A special appropriation mechanism is introduced into the Banking Act in order to allow such authority to be obtained in a timely manner if required.

7.40 The Minister may, with the written approval of the Finance Minister, authorise the making of contracts or arrangements for the purposes of protecting the interests of policyholders and financial system stability in Australia. [Schedule 4, item 34, section 251A and item 36]

7.41 This does not limit any other powers of the Minister to enter into contracts or arrangements.

7.42 The Minister must specify an amount in the authorisation to be credited to the Financial System Stability Special Account (the FSS Special Account). [Schedule 4, item 37]

7.43 The FSS Special Account is established in the Banking Act in order to provide an appropriation authority for payments under contracts and arrangements authorised under the Banking Act, the Insurance Act and the Life Insurance Act. [Schedule 2 item 23, sections 70E to 70H]

7.44 The balance of the FSS Special Account attributable to such authorisations - total amounts credited under these authorisations but not yet expended for the purpose of meeting payments under authorised contracts or arrangements - must be less than $10,000,000,000 at any time. The amount specified can be amended but not revoked.

7.45 If the Minister has authorised a contract or arrangement, the Minister is also provided with a borrowing power, subject to the written approval of the Finance Minister. [Schedule 4, item 34, section 251B]

7.46 The Minister may borrow on behalf of the Commonwealth for up to 24 months for amounts totalling not more than $10,000,000,000 at any time. The borrowing power is intended as a contingency measure in order to ensure that the Commonwealth could obtain sufficient liquidity to meet obligations under contracts or arrangements if payments were required at very short notice. If cash was available at the time from consolidated revenue it is not envisioned that the use of the borrowing power would be required.

7.47 Similar provisions for authorising a contract or arrangement and associated borrowing are to be included in the Banking Act and Insurance Act. [Schedule 2, item 23, sections 70C and 70D, and schedule 3, item 26, sections 131A and 131B]

7.48 The authorisation by the Minister regarding the making of contracts or arrangements takes effect from the time it is made. The exclusion of an authorisation under this Part from the effect of subsections 12(1) and 12(2) of the Legislative Instruments Act 2003 is necessary to ensure that delays in the registration do not unduly delay an authorisation which is ultimately done in the interests of policyholders or financial system stability in Australia.


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