07 April 2006
An insurer (or reinsurer) goes into liquidation in Australia. Do Australian insureds get priority in the distribution of the assets, or must they take their chances along with other creditors? This turns on what are an insurer's "liabilities in Australia". The High Court today said that "liabilities in Australia" has a broad meaning, including all liabilities as defined under the Insurance Act 1973 and those which the law would otherwise consider to have arisen, in the course of business, in Australia.
The decision in AssetInsure Pty Limited v New Cap Reinsurance Corporation Limited (In Liq) which was run as a test case not only clarifies what happens to creditors of collapsed insurers, but also potentially affects solvent insurers' capital adequacy requirements It is a decision that APRA will be looking at very closely (Clayton Utz has been acting for the appellant).
What is a "liability in Australia"?
When a general insurer goes into winding-up, section 116(3) of the Act says that its assets in Australia "shall not be applied in the discharge of its liabilities other than its liabilities in Australia unless it has no liabilities in Australia".
The key problem is the meaning of "liabilities in Australia" in section 116(3) of the Insurance Act. Before this case, everyone thought it included only those insurance liabilities described in the Act as having the requisite connection with Australia, but Justice Windeyer at first instance and then the NSW Court of Appeal surprised many by saying it went beyond that. It gave "liabilities in Australia" a broad definition, meaning that
The High Court today held that the definition of "liabilities in Australia" under the Act is not an exhaustive definition of what might in fact be classified as a liability in Australia for the purposes of the Act.
Section 31(4) (now section 116A) says that if certain qualified conditions are satisfied, being various connectors with Australia, a liability under a contract of insurance is a liability in Australia, but, as the High Court pointed out, it does not mean that in no other circumstances will an insurance liability be a liability in Australia.
"Liabilities in Australia" in section 116(3) is not limited to liabilities under contracts of insurance, but covers all liabilities arising in the course of business in Australia. In this case, there was a liability undertaken by an Australian reinsurer which further reinsured (retroceded) certain risks overseas, which did not provide for satisfaction of any liability in any particular place and which did not meet any of the connecting factors with Australia set out in section 31(4) of the Act. The High Court confirmed the decision of Justice Windeyer at first instance that, provided the liability satisfied the general law concerning the situs of the debt, then it did not matter that the liability did not satisfy section 31(4) of the Act.
Reinsurance vs retrocession proceeds
Section 562A of the Corporations Act deals with the application of the proceeds of reinsurance contracts when a company is in liquidation. The question is whether a "relevant contract of insurance" under section 562A includes a contract of reinsurance, such that the priority under that section then extends to the reinsurance of a contract of reinsurance (a retrocession contract), or is limited to reinsurance of direct insurance policies only. The High Court held that retrocession contracts are included, meaning that section 562A governs the redistribution of the proceeds of a retrocession contract as well.
Implications for insurers
The High Court has clarified the meaning of "liabilities in Australia". This decision might force a rethink of the drafting of the section and legislative reform if the Government considers that a more limited class of insureds in Australia, as defined in the Act, ought to have priority.
A more troubling issue is the status of insurers' returns regarding capital adequacy requirements. Insurers must tell APRA about their liabilities in Australia - this information is then used to determine the minimum capital requirements. For the last 30 years, insurers have complied with guidelines which have defined liabilities narrowly in line with section 116A of the Insurance Act, and before that section 31(4). The High Court noted that an insurer's capital requirement is affected by the extent of all its liabilities, and this decision means that insurers may well need to seek advice regarding the manner in which their returns are being prepared. Likewise, APRA might now need to rethink its guidelines in the light of this decision, as insurers' returns, made on one view of their "liabilities in Australia", might now be in question.
