The recent mis-selling scandal in the Australian financial services industry has highlighted the potential for catastrophe-style loss events for the casualty and financial & professional lines market.
Over the past year, the Australian financial services market has been rocked by allegations of misconduct in the country’s banking and insurance sectors, with the publication of a lengthy report in February 2019 by the Australian Royal Commission.
The report was scathing in its criticism of banks and financial advisors especially, but also insurers and pension providers. Conduct in the industry had “fallen short” of that expected and, in some cases, had broken the law.
The Commission uncovered an industry-wide culture of greed, driven by companies’ “pursuit of profit” and individuals’ “pursuit of gain”, while the provision of service to customers was “relegated” to second place. Banks, insurers, intermediaries and pension providers mis-sold products, offered inappropriate advice and charged fees for no service. The report also identified conflicts of interest, where financial advisors were paid by providers and acted in the interests of banks and insurers, and not the client.
The Commission has referred 24 cases of potential breaches of criminal or civil law to the Australian Prudential Regulation Authority (APRA) or the Australian Securities and Investments Commission (ASIC).
The report called on regulators to consider maximum fines and custodial sentences, and a new law provides increased civil penalties and criminal sanctions against banks and other financial sector institutions and their executives guilty of misconduct. These powers include an increase in maximum civil penalties to $525m or up to 10% of profits.
The scandal is expected to see at least A$850m paid out in compensation.
While generating much noise in Australia, the implications of the Commission’s report for the insurance industry are still emerging. Regulatory investigations, potential prosecutions and litigation have yet to run their course, let alone translate into insured losses.
The mis-selling and conduct issues could trigger a number of insurance coverages purchased by banks, insurers, intermediaries and superannuation firms. These include directors’ and officers’ liability, professional liability and combined policies sold to financial institutions.
Much of the exposure sits in the Australian market, although the London market and international reinsurance market could also see claims. However, the degree to which regulatory investigation and defence costs, as well as fines and compensation, are covered by insurance is an open question.
Potentially, there could be coverage issues around notification and the application of policy wordings. Importantly, some coverage will hinge on the form of misconduct, with deliberate acts generally excluded. The Australian market has hardened significantly over the past year and cover and capacity in some areas has become restricted (although the London market has been able to support some Australian clients with capacity). Some underwriters have sought to exclude potential claims not yet notified and arising from the Royal Commission’s investigation for new or renewed policies.
This is not the first occurrence of misconduct or mis-selling in financial services. The UK has seen a number of similar cases, including the pension mis-selling scandal of the late 1980s and early 1990s, and the recent payment protection insurance mis-selling, which has seen the industry pay some £34bn in compensation since 2011.
The findings of the Royal Commission present a reminder of the potential for liability events that cut across multiple sectors and product lines. The format of this scandal could be used as the basis for realistic disaster scenarios in the casualty sector, potentially triggering a wide range of liability insurance coverages.
Australia is a litigious society, where class actions and litigation funders combine with consumer-friendly legislation and courts. Similar trends are emerging in other markets, albeit not to the same extent. For example, a number of data breaches have sparked class actions in the US, while emissions cheating in the automotive sector has given rise to collective actions in Europe.
Consumers are emerging as a powerful interest group and regulators are showing a growing willingness to hold companies and their directors to account. Incidents of mis-selling and conflicts of interest are almost certainly to feature in other territories and other sectors in coming years.
Published 27 August 2019