With the impact of COVID-19 rapidly being felt by businesses, 2020 is likely to see a number of Australian insureds face insolvency. While this presents a number of challenges for (re)insurers in the Australian market, there are steps that (re)insurers can take to manage the situation and their exposures.
The scale and rapid escalation of the COVID-19 outbreak in the first quarter of 2020 has captured the world's attention. In an effort to 'flatten the curve', the Australian government has imposed travel restrictions, shut down entire industry sectors and implemented strict social distancing requirements. This is unavoidably suppressing business activity.
To support businesses to weather the storm, the Australian government has introduced massive stimulus packages and attempted to place the economy into an unprecedented state of hibernation. Despite these best efforts, the reality is that a number of businesses are likely to face insolvency. Insurers have already faced the first wave of claims arising from the immediate effects of COVID-19. However, insurers and their reinsurers need to be aware of their potential exposures arising from, and the implications of their insureds becoming insolvent.
In this article, we take a look at the circumstances when (re)insurers can be subject to third party claims when insureds become insolvent. We also consider how (re)insurers can minimise potential future exposures while capitalising on the Australian government's business support package.
Reinsurers can be exposed to claims by insureds where contractual 'cut through' rights have been agreed between parties. Where insureds can rely on such arrangements, they can bypass an insolvent insurer and effectively proceed directly against a reinsurer.
In addition to, and separately from, those rights, insurers can also be directly exposed to third party claims relying on statutory rights. Under a range of Australian statutory provisions, insurers can be directly exposed to third party claims in respect of the insured liability risks of their insolvent and deregistered insureds.
Where an insolvent or deregistered company owes a liability (either under contract or by way of damages, compensation or costs of legal proceedings) to a third party for which the company carries insurance, liquidators and third party claimants may in some circumstances recover that loss directly from the insurer. For example, section 562 of the Corporations Act 2001 (Cth) (Corporations Act) provides that:
A functionally similar provision exists in section 601AG of the Corporations Act. This permits third parties owed a liability by a deregistered company to recover that liability from the company's insurer, provided that the liability was covered by the insurance policy immediately before deregistration of the company.
Separate provisions apply to reinsurers. Under section 562A of the Corporations Act, and in summary, if an insurer enters into insolvency, the insurer's liquidator may recover any reinsured amounts and apply them against the insurer's outstanding liabilities under its primary policies.
In addition to these Australian Federal provisions, in New South Wales, third party claimants have broader rights to recover liabilities directly against an insurer (regardless of whether the insured is insolvent). Sections 4 to 6 of the Civil Liability (Third Party Claims Against Insurers) Act 2017 (NSW) allow third parties (with leave of the court) to recover liabilities owed by an insured directly from the insurer within the appropriate limitation period for the claim.
However, courts will not grant third parties leave if the insurer can establish that it is entitled to disclaim liability under either the insurance contract or in reliance on other legal rights. Where leave is granted to allow the third party to proceed against the insurer, the insurer will stand in the place of the insured for these claims.
To seek to limit exposures where an insured becomes insolvent, (re)insurers may include insolvency exclusions or provisions terminating the policy on an insured's insolvency into their policy wordings. Such provisions may, subject to their terms, be effective to prevent or restrict the insured's right to claim for liabilities (re)insured under the policy arising from or related to its insolvency.
Recent amendments to the Corporations Act restrict the right of parties to rely upon so called ipso facto clauses. Such clauses terminate (or give rise to a right to terminate) the contract if one of the parties enters into insolvency. This includes where one of the parties enters into voluntary administration, a scheme of arrangement to avoid insolvency, or appoints a controller or receiver. This restriction only applies to contracts entered into after 1 July 2018. For any contract entered into before that date, the contract can continue to be varied or novated up until 1 July 2023 before the restrictions apply.
Regulations made under the Corporations Act exclude 'financial products' from the scope of the restrictions applicable to the ipso facto regime. The definition of financial products in the Corporations Act covers most, but not all, insurance policies. Specifically, reinsurance contracts, health insurance and state insurance contracts such as motor, CTP and workers' compensation are not financial products in the Corporations Act.
Accordingly, there is some uncertainty as to whether all classes of insurance and reinsurance products are excluded. As such, there is also uncertainty as to whether insurers are able to rely upon ipso facto clauses to terminate cover in the event of an insolvent insured.
Insurers may therefore remain liable for any insured liabilities owed by the insolvent / deregistered insured to third parties for the entirety of the appropriate policy and / or limitation period. This liability is subject to any termination rights under the policy terms which are not knocked out by the ipso facto protections.
Where faced with such claims, insurers should still be able to rely on insolvency exclusions subject to the terms of the policy and the relevant circumstances.
However, against that background, the Australian government recognises that its COVID-19 measures are impacting the profitability of all businesses. Some of these impacted businesses may not survive the next 6 months, and possibly beyond. To support businesses and their supply chains (including exposures faced by banks and the insurance market) through this period, the government has introduced a safety net and moratoria against debt recovery proceedings to help businesses continue to trade through a temporary period of illiquidity.
The Coronavirus Economic Response Package Omnibus Act 2020 (Cth) provides a temporary:
These temporary measures apply from 25 March 2020 to at least 25 September 2020. The policy objective is that the Australian government's temporary support measures will prevent, or at least limit, the number of insureds who would otherwise become insolvent during the next 6 months.
This in our view will also indirectly assist the (re)insurance market by limiting to some extent exposures to third party claims that may otherwise have arisen. For example, third party claims against directors under D&O policies, and those arising from commercial and trading disputes.
We recommend that insurers:
Reinsurers are likely to face claims pressure over the next 6 months in respect of reinsured liabilities, both generally and arising from insolvency related claims. Reinsurers in turn may also consider revisiting insolvency exclusions and ipso facto clauses in underlying policies and in reinsurance contracts.
In addition, both insurers and reinsurers should revisit and review claims management protocols and approaches to consider whether modification or clarification is required in light of the unprecedented circumstances.
 See Corporations Act 2001 (Cth) ss 415D(1), 434J(1), 451E(1).
 Treasury Laws Amendment (2017 Enterprise Incentive No 2) Act 2017(Cth) s 17.
 Corporations Regulations 2001 (Cth) r 5.3A.50(2)(zn).
 See Corporations Regulations 2001 (Cth) rr 5.1.50, 5.2.50, 5.3A.50(2).
 See Corporations Act 2001 (Cth) s 763C.
 See Corporations Act 2001 (Cth) s 765A.