In October 2021, the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) published a report concerning issues faced by small businesses operating in the Australian amusement, entertainment, and leisure sector in obtaining insurance. The ASBFEO also considered the suitability of possible alternatives to insurance.
In the report, the ASBFEO identified Discretionary Mutual Fund arrangements (DMFs) as a potential alternative to insurance for the sector as Australia emerges from the COVID-19 pandemic, and business in the sector begins to reopen.
Australian DMFs have been established for several Australian industries, including the construction and hospitality industries, and also in the higher education sector.
What is a DMF and how does it differ from insurance?
A DMF offers insurance-like protection to its members. DMFs can be established by companies or associations – more than one entity is necessary to establish a mutual fund – which then become the members of the DMF.
Members make financial contributions to a fund which is used for the payment of claims, and to meet the operational expenses of the DMF.
A key feature of DMFs is that unlike insurance contracts, which provide a contractual indemnity to pay claims if the terms and conditions of the contract are met, DMFs only promise that a claim for loss will be considered. Whether a claim is actually paid is ultimately at the discretion of the DMF. That is, unlike an insurance contract, there is no contractual right to payment of a claim.
It is this feature that legally distinguishes DMFs from insurance contracts.
Regulation of DMFs in Australia
In Australia, DMFs are not legally considered to be true contracts of insurance, which means that:
- DMFs are not regulated prudentially by the Australian Prudential Regulation Authority (APRA) under the Insurance Act 1973, or covered by the Insurance Contracts Act 1984, as is the case with insurance contracts; and
- barring legislative amendments, DMFs are not subject to the legal framework governing insurance, neither are they covered by the various legal and regulatory protections governing insurance.
However, as DMFs constitute financial products and services, operating a DMF requires an Australian Financial Service Licence (AFSL).
When assessing and granting an AFSL, the Australian Securities and Investments Commission (ASIC) may impose specific conditions on the licence. In addition, the general obligations and responsibilities of any AFSL holder include:
- Conduct and disclosure;
- The training, competence, knowledge, and skill of the responsible managers, financial advisers, and their representatives/agents;
- Compliance with financial services laws and ASIC guidelines for financial service providers; and
- Management of risk and conflicts of interest.
A DMF for the amusement, entertainment, and leisure sector?
In a submission to the ASBFEO, the Australian Amusement, Leisure and Recreation Association (AALARA) raised issues in relation to claims, coverage terms and pricing of insurance.
The ASBFEO noted that a continued lack of insurance coverage in this sector could result in the closure of businesses, job losses, and a reduction of economic activity generated by the sector.
This is due to a general hardening of the insurance market, as it reassesses the costs and terms on which it is commercially and financially viable for the industry to provide cover to the leisure sector.
The ASBFEO identified certain issues facing some Australian small businesses attempting to obtain insurance. The issues include:
- Inconsistent definitions of ‘small business’ and ‘small business insurance’ used in the Australian Financial Complaints Authority (AFCA) rules, the General Insurance Code of Practice, and Australian legislation, which can result in gaps in protections available for small businesses;
- Insurance industry service and practice standards; and
- Insurance product documentation.
ASBFEO small business insurance survey results
The ASBFEO conducted a survey with over 800 small businesses in Australia, which reported the following issues:
- Insurance is an essential service, which means that unavailability or unaffordability of insurance products makes small businesses unviable;
- Industries such as adventure tourism, caravan parks, accommodation venues, and amusement industry operators are reporting that insurance is becoming less available, and that available cover does not suit business needs;
- Applying for or renewing insurance policies can be a lengthy and confusing process; and
- A lack of confidence regarding whether and when insurance policies will pay out.
Benefits of a DMF as identified by the ASBFEO
The ASBFEO identified the following benefits of establishing a DMF for the leisure industry:
- DMFs are a proven model for delivery of insurance-like cover to industries with clearly defined membership bases;
- DMFs are operated by directors with significant industry experience, who have the authority to accept or reject members according to their risk profiles, and can also mandate compliance, risk management, and training protocols as a prerequisite for membership; and
- DMFs can operate on lower profit margins, as they are not required to make returns for shareholders, which reduces costs to members.
Challenges outlined by the ASBFEO Report
The ASBFEO also identified several challenges to establishing and operating an industry DMF:
- Whether the industry can unify in support of a DMF;
- Detailed actuarial assessments are required to determine whether a DMF is financially and operationally viable;
- Whether a DMF will be acceptable to governments, licensing authorities and regulators as an alternative to insurance; and
- Whether, due to the discretionary nature of DMFs, the sector and patrons/consumers would accept a DMF as a viable alternative.
Alternatives to a DMF for the amusement, leisure, and entertainment sector
The ASBFEO identified the following further alternatives:
- Group insurance schemes – a potential structure for businesses and organisations operating in the same sector which can negotiate collectively as a group, providing a more attractive offer to an insurer through pooled resources;
- Challenge – AALARA has already unsuccessfully explored this option;
- Captive – a reinsurance company owned by a non-insurance parent company which insures or reinsures the risk of its parent, often established in offshore jurisdictions;
- Challenge – given the current appetite of insurers to operate in the leisure sector, there is considered to be little appetite for a captive;
- Self-insurance – setting aside money to pay for potential losses instead of relying on insurance companies to indemnify;
- Challenge – this option poses significant risks in the event of a high-value claim or multi-claim event;
- Reinsurance pool – a government-funded public/private collaboration where the government provides reinsurance to make a particular market more attractive to insurers;
- Challenge – this option is better suited to large-scale, catastrophic and infrequent risks, rather than more frequent, lower-value claims as occur in the amusement, leisure, and entertainment industry;
- Tort reform: The New Zealand solution – imposing statutory caps on claims amounts, with a view to lowering the risk to insurers and making insurance more affordable;
- Challenge – reform of this kind is a long-term solution to improve the Australian insurance landscape, whereas the industry requires more timely relief; and
- Hybrid models – a DMF purchases a form of reinsurance to cover and manage risk over what is manageable by the mutual fund itself;
- Challenge – concerns were raised by industry submissions that there is probably insufficient time to establish a hybrid model should the DMF be up and running by the end of 2021.
The ASBFEO reports challenges to each of the alternatives proposed, stating also that “they may not be as appropriate as the DMF currently proposed” by the AALARA.
Industry consultation: submissions
The ASBFEO’s interim report was published to allow the amusement, leisure, and entertainment sector, the insurance sector, and other interested parties the opportunity to provide feedback on the preliminary findings; namely, that the amusement, leisure, and entertainment sector would benefit from the establishment of a DMF. Submissions have now closed.
The ASBFEO has indicated that a further, final report is expected. At the date of this publication, that further report has not yet been publicly released.
As part of the interim report, the ASBFEO noted that, before a DMF could be established for the sector:
- the AALARA would need to undertake further research and submit a formal proposal for the establishment of a DMF for the sector;
- Government support would need to be sought at both state/territory and local levels; and
- Capital funding would need to be sourced.
It is far from certain that a DMF will be established for the sector, and there are several steps which would need to be taken before one could be established. In the meantime, there appears to be high demand for insurance cover and risk management assistance. There are opportunities for insurers who are willing to provide cover to the sector on appropriate terms and at appropriate rates.