On 3 December 2021, the Government released draft legislation for the establishment of a reinsurance pool for cyclones and related flood damage. The release of the draft legislation comes after multiple government enquiries and reviews found that insurance for households and small businesses caused by extreme weather events is becoming less accessible and affordable.
As a result, households are underinsured or have no insurance at all, exacerbating costs and pressures for communities and governments. These reviews include the National Disaster Insurance Review, the Northern Australia Insurance Premiums Taskforce, the Royal Commission into Natural Disaster Arrangements and the ACCC Northern Australian Insurance Enquiry. The pool was initially announced on 4 May 2021.
The law amends the Terrorism Insurance Act 2003 (Cth) and extends the legislation to cover cyclone events. Once passed, the Terrorism Insurance Act will be known as the Terrorism and Cyclone Insurance Act 2003 (Cth). Section 8A(1) will require a general insurer to reinsure cyclone risks with the Australian Reinsurance Pool Corporation (ARPC).
The commencement date is 1 July 2022. Large insurers will have until 31 December 2023 to reinsure all cyclone-risk policies through the pool while smaller insurers (with Gross Written Premium (GWP) of less than $300 million for householders insurance) will have until 31 December 2024.
An exemption will apply if the general insurer’s total GWP for affected insurance contracts is below the threshold amount, proposed to be $10 million. However, if the exempt general insurer chooses to participate, all reinsurance for cyclone and related flood damage risks must be placed with ARPC. There will be an exception for Lloyd’s underwriters operating in Australia, consistent with the current exemption under the Insurance Act 1973 (Cth).
What cyclone-related risks must be insured with the ARPC?
Currently, general insurers may choose to insure terrorism risks with the ARPC. If the new law is passed, insurers will be required to insure cyclone risks with the ARPC unless exempt.
Treasury proposes the following types of insurance products will be required to provide cover for cyclone and related flood damage under the new reinsurance pool. These contracts are known as ‘pool insurance contracts’ under the new law and include:
- Household policies: these include home and contents, residential landlord, residential property on agricultural land, onsite caravans and moveable homes if used primarily as places of residences, other arrangements where building is primarily used as a place of residence such as retirement villages, and the Defence service homes insurance scheme;
- Strata policies: strata and community title properties where at least 80% of the total floor space of units in the property are used wholly or mainly for residential purposes; and
- Small business property policies: business property policies including policies taken up by not for profits and charities with total sums insured of $5 million or less and small business marine property insurance such as for charter boats and marinas.
Policies are captured to the extent they insure loss or damage to eligible property owned by the insured, or business interruption arising from loss, damage or inability to use eligible property owned or occupied by the insured.
How will the new reinsurance pool work?
Under the proposed law, the pool will be funded by charging reinsurance premiums to insurers consistent with the expected claims and operating expenses for the pool. The pricing formula is to be finalised before 1 July 2022 and will utilise data such as geography, building characteristics and mitigation are proposed to be used to develop the pricing formula.
The goal of the pool is to be cost neutral to the Government over the longer term and to lower the reinsurance costs for most policies with a medium to high exposure to cyclone risk. It is also proposed the pool will have a minimal impact on policy premiums for lower cyclone risk properties and will maintain incentives for risk reduction and offer discounts for properties that undertake mitigation.
For the first three years of the pool’s operation, the cost of eligible cyclone and related flood damage claims above the policy holder excess will be covered by the pool. This is to manage the transition for insurers and to maximise the potential premium reductions through the pool. However from 1 July 2025, the pool will operate on a risk sharing arrangement with insurers where the pool will continue to cover a significant portion of eligible claims. The pool will be supported by an annually reinstated $10 billion Government guarantee and any shortfall will be paid for through the Government guarantee.
It is proposed APRA will allow insurers to fully recognise the risk transfer provided by the reinsurance pool through appropriate changes to the prudential framework. The ACCC will also monitor and collect data to ensure that savings are passed through to policy holders and the reinsurance pool is delivering on its intended outcomes.
Consultation on the proposed law is open until 17 December 2021.
Some items which may arise during the consultation include whether the scope of the proposed law is appropriate, by capturing the appropriate types of policies. For example, policies for strata schemes are only covered once a percentage threshold is met for residential purposes. Furthermore, insurance for hotels, motels, boarding houses and aged care facilities are excluded from the pool above a certain sum insured threshold designed for small businesses. The sum insured threshold will be set by regulation and is proposed to be $5 million.
While the reinsurance pool provides a short to medium term remedy, the Insurance Council of Australia has acknowledged that longer term solutions also need to be implemented to mitigate the effect of cyclone and related flood risks. We are keeping an eye on the consultation process noting the government intends to set up the pool by 1 July next year.