Does the Insurance Act permit the Prudential Authority (PA) to allow a traditional insurer to underwrite its own risks, as well as third-party risks, or is the underwriting of both risks limited to cell-captive insurers?
The Financial Services Tribunal (FST) has ruled on this question following a reconsideration application brought by Abacus Insurance Limited against a decision by the PA.
Abacus is wholly owned by Abacus Holdco (Pty) Ltd, which is wholly owned by retail group Pepkor Holdings Limited.
Pepkor’s non-life risk portfolio was underwritten by CFAO Insurance Limited, but CFAO exited the Pepkor group and no longer holds an insurance licence. As a result, Pepkor wanted Abacus to underwrite its non-life risk portfolio.
But Abacus’s licence permits it to underwrite third-party risks only – risks related to policyholders other than Abacus or the companies within which it is situated.
Therefore, in May 2021, Abacus applied to the PA to vary its licence to add classes and sub-classes to the licensing conditions so that it could underwrite the non-life risks of its parent company in addition to the non-life risks of third parties.
The PA declined Abacus’s licence variation application in May 2022.
The Authority’s position was that the provisions of the Insurance Act, when properly construed and read in context, draw a distinction between traditional insurers and cell-captive insurers, with only the latter permitted to insure both third-party risks and first-party risks.
Furthermore, the Insurance Act restricts a cell-captive insurer to underwriting first-party and third-party risks under different cell structures, the PA said. If Abacus were permitted to underwrite both types of risk, the Authority would be allowing Abacus to undertake cell-captive insurance without the regulatory framework governing cell-captive insurers applying to it.
The PA also contended that a traditional insurer should not be permitted to conduct first-party and third-party business under the same licence because of potential conflicts of interest.
Abacus argued that the PA’s interpretation of the Insurance Act did not accord with the well-established principles of statutory interpretation.
As can be deduced from the above, the FST was called upon to decide how the Insurance Act should be interpreted in respect of the restrictions placed on traditional insurers.
No express prohibition
Both the PA and Abacus agreed there is no provision in the Insurance Act that expressly prohibits a traditional insurer (an insurer permitted to underwrite third-party risks) from underwriting first-party risks.
The tribunal said the absence of this express prohibition was significant because the legislature, where it deemed necessary, had included various express prohibitions in the Act – for example, in section 25 (licensing conditions).
With this mind, it was relevant that the legislature did not expressly prohibit traditional insurers from underwriting first-party risks, nor from underwriting first-party and third-party risks (or conducting first-party and third-party business) under the same licence. If the legislature had intended to prohibit or prevent an insurance company from insuring or underwriting both first-party risks and third-party risks, it would have done so expressly.
Is there an implied prohibition in the definition section?
The PA submitted the definition of “first-party risks” in section 1 of the Act meant there was an implied prohibition on traditional insurers conducting first-party business. The tribunal quoted this definition and emphasised the phrase “in respect of”.
“First-party risks” means:
(a) in respect of a captive insurer, the operational risks of–
(i) the group of companies of which the insurer is a part;
(ii) any associate of a company that is part of the group of companies referred to in sub-paragraph (i); or
(iii) any joint arrangement that a company that is part of the group of companies referred to in sub-paragraph (i) participates in;
(b) in respect of a cell-captive insurer, the operational risks of the cell owner and the operational risks of–
(i) the group of companies of which the cell owner is a part;
(ii) any associate of a company that is part of the group of companies referred to in sub-paragraph (i); or
(iii) any joint arrangement that a company that is part of the group of companies referred to in sub-paragraph (i) participates in.
The FST made the following observations:
- The definition section does not deal with which insurers may insure against first-party risks and which may not.
- The purpose of the definition section is not to deal with which insurers may insure against first-party risks and which may not.
- That the definition section attributes specific, separate meanings to the words “first-party risks” in relation to “captive insurers” and “cell-captive insurers” does not limit or confine the insurance of first-party risks to “captive insurers” and “cell-captive insurers”. It simply defines/attributes a meaning to the term “first-party risks” in respect of those insurers.
- The phrase “in respect of” denotes “with reference to” or “in connection with”. It does not, in its ordinary grammatical meaning, express a prohibition in respect of categories/entities not mentioned thereunder.
- The definition section opens with these words: “In this Act, unless the context indicates otherwise…” Therefore, the application of any definition is subject to context.
- The purpose of a definition in legislation is to ascribe the meaning to be assigned to words in that legislation. The Authority elevated the definition of “first-party risks” to a substantive statutory provision, whereas the definition imposes neither obligations nor does it confer rights.
Faulty reasoning
The Act defines “third-party risks” only in respect of cell-captive insurers: “third-party risks mean in respect of a cell-captive insurer, risks other than first-party risks.”
Applying the reasoning that the PA sought to advance to the definition of “third-party risks” would create an implied prohibition against captive insurers underwriting third-party risks, the tribunal said.
If the legislature had been satisfied that such an implied prohibition was included in the definition, it would not have gone any further. But the legislature expressly stated in section 25(5) that a captive insurer may not insure third-party risks.
Applying the PA’s interpretation to the definition of “third-party risks” would result in a conclusion that only cell-captive insurers may insure third-party risks. Traditional insurers would not be allowed to insure either first-party or third-party risks, because they fall under neither definition.
“The results are entirely unbusinesslike and would give rise to an absurdity that is at odds with the purpose of the statute,” the FST said.
The PA can mitigate the potential risks
Regarding the PA’s concerns about the potential risks that may arise if a traditional insurer underwrites first-party and third-party business, the FST said the Authority could use its powers under the Act to mitigate those risks. For example, section 25(8) provides that the Authority may impose licensing conditions.
In conclusion, the FST there is no implied prohibition in the Insurance Act on traditional insurers underwriting both its own risks and those of third parties. It set aside the PA’s decision to decline Abacus’s licence variation application and remitted the matter to the Authority for further consideration.
