What is the obligation?
Under s912B of the Corporations Act, AFS licensees must have arrangements for compensating retail clients for losses they suffer as a result of a breach by the licensee or its representatives of their obligations in Ch 7 of the Corporations Act. (also refer ASIC RG 126)
This obligation does not apply to APRA regulated insurers (see reg 7.6.02AAA(3)) but does apply to Underwriting Agencies, Insurance Brokers, Insurance Claim Managers and Claimant Intermediaries who hold an AFS Licence.
These arrangements must:
- satisfy the requirements in the Corporations Regulations, which are that licensees must obtain PI insurance that is adequate, considering the nature of the licensee’s business and its potential liability for compensation claims (see reg 7.6.02AAA); or
- be approved by ASIC as alternative arrangements
For the purposes of this article, I will be focusing on PI insurance under reg 7.6.02AAA.
What this means for AFS Licensees and consumers
ASIC’s approach to administering the compensation requirements means that all AFS licensees that provide financial services to retail clients must have PI insurance that meets the minimum standards, unless an exemption applies.
Tt is important, however, to recognise the limitations of PI insurance as a consumer protection mechanism.
PI insurance is not designed to protect consumers directly and is not a guarantee that compensation will be paid. It is designed to protect the insured (i.e. the AFS licensee) against the risk of financial losses arising from poor quality services (e.g. poor advice or execution of services) and other misconduct by a financial services provider (e.g. fraud by its representatives).
The insurance is not intended to cover product failure or general investment losses, claims for loss solely as a result of the failure (e.g. insolvency) of a product issuer or where a return on a financial product has not met expectations. Nor is it intended to underwrite the products of a product issuer.
ASIC recognise that the PI insurance that is currently available in the market is unlikely to provide a source of funds when an AFS licensee has become insolvent before the claim was brought. Ideally, insurance policies would continue to cover the licensee after it has become insolvent or otherwise ceased business, but ASIC understands that this insurance is generally not available in the current market to the average licensee. ASIC also recognise that insurers may exclude some areas of cover in policies for risk management reasons. (see RG 126.8 – 126.11)
Disclosure to retail clients
AFS Licensee must disclose to retail clients the kind of compensation arrangements they have in place and whether these arrangements comply with s912B: see regs 7.7.03A and 7.7.06B. The disclosure must be presented as a statement in your Financial Services Guide (FSG) or website disclosure information and the FSG or website disclosure information of your representatives. (RG 126.19)
Adequate PI Insurance
What is adequate? (See Section C RG 126)
The Corporations Regulations require you to hold PI insurance that is adequate, considering:
(a) your liability for claims brought through the Australian Financial Complaints Authority (AFCA) scheme (see reg 7.6.02AAA(1)(a)); and
(b) the nature of the financial services business carried on by you, including:
- the volume of business;
- the number and kind of clients; h
- the kind or kinds of business; and
- the number of representatives (see reg 7.6.02AAA(1)(b)).
Amount of cover
To be adequate overall, a PI insurance policy must have an adequate amount of cover. To be adequate, the limit of indemnity under the policy should cover a reasonable estimate of retail clients’ potential losses.
Scope of cover
Section 912B requires that the insurance must cover loss or damage suffered by retail clients due to breaches of obligations under Ch 7 by the AFS licensee and its representatives. This obligation extends to all financial services covered by Ch 7. Losses caused by negligent, fraudulent or dishonest conduct that amounts to a breach of Ch 7 and gives rise to liability to retail clients must be covered
Terms and exclusions
If exclusions in a PI insurance policy undermine the policy objective, ASIC advise that it is hard to see how the cover can be adequate. This applies especially to exclusions that relate directly to the minimum scope of cover described in the Scope of Cover above. (RG 126.41)
Features of adequate PI cover
(refer table 4 RG 126 for the full list of minimum requirements)
Amount of cover minimum requirement: ASIC consider that, to be adequate, a PI insurance policy must have a limit of at least $2 million for any one claim and in the aggregate for AFS licensees with total revenue from financial services provided to retail clients of $2 million or less.
For AFS licensees with total revenue from financial services provided to retail clients greater than $2 million, minimum cover should be approximately equal to actual or expected revenue from financial services provided to retail clients (up to a maximum limit of $20 million)
Scope of cover minimum requirement: The policy must indemnify the AFS licensee against liability for loss or damage suffered by retail clients because of breaches of Ch 7 by the licensee or its representatives. This includes liability:
- for fraud or dishonesty by officers, employees & other representatives of the licensee; &
- under AFCA awards
Persons covered minimum requirements The policy must cover the acts of the AFS licensee and all of its representatives (either under the policy or separately covered by a policy under which the licensee has a right of indemnity).
Note 1: AFS licensees need to take into account all of their representatives (i.e. not just authorised representatives) when considering the type and extent of cover that will be adequate. A client will generally have the same remedies against the licensee as it has against its representatives.
Note 2: The AFS licensee’s policy does not need to indemnify the licensee for acts of its representatives if such acts are adequately covered by the representatives’ own PI insurance and the licensee has a contractual right to be indemnified by its representatives.
Automatic reinstatement Minimum requirement: The policy must include at least one automatic reinstatement.
Note 1: Automatic reinstatement means that if the limit of the policy is exhausted before the end of the policy period, the limit of indemnity is reinstated for the balance of the period to cover any new claims that might arise. This is important, as AFS licensees must ensure their PI insurance is adequate at all times.
Note 2: Automatic reinstatement is not necessary where the limit is at least twice the minimum amount of cover referred to in the ‘Amount of cover’ policy feature above
Excess/deductibles factors to consider:
Is the excess at a level that the business can confidently sustain as an uninsured loss, taking into account the AFS licensee’s financial resources?
Note 1: A business with a lower cash flow available to meet claims might require a larger amount of cover and/or cover with a lower excess. If there is a limited asset base available to meet claims, a policy with a lower excess might be preferable. ASIC understands that currently available PI insurance policies generally have an excess. ASIC considers that whether an AFS licensee has sufficient cash flow to meet the excess for a reasonable estimate of claims is a relevant consideration in determining whether a PI insurance policy is adequate for that licensee.
Note 2: If a PI insurance policy has a significant excess or deductible in proportion to the limit of indemnity, it may not be adequate. However, if the AFS licensee can demonstrate that for other reasons (e.g. other financial resources, systems and controls in place) that their arrangements are adequate overall, they may wish to apply to have this kind of arrangement considered as an alternative arrangement
Legal costs minimum requirement: Defence costs must be ‘in addition’ to the minimum limit or the level of cover must be sufficiently increased to take into account these costs.
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