Flood – Implications of the Natural Disaster Insurance Review Panel report
Soon after the floods hit Queensland I prepared a paper on Flood and sent it off to friends and colleagues within the industry in an effort to assist them with client questions and claims.
As I was not operating the blog at that time, I attach a copy in case you did not get to see it: Insurance on Flood and other Water Perils – the facts.
The Federal Government commissioned the Natural Disaster Insurance Review Panel to conduct an independent inquiry into flood insurance and related matters. I met with members of the review panel on two occasions and with the help of my colleague, Max Salveson, we prepared a submission at the personal request of Mr Trowbridge. Again, I attach a copy for those interested. [If you are interested in obtaining a copy of our submission please write to me via the contact button at the top of the page and I will gladly send you one.]
On 14 November 2011, the Review Panel released its final report, containing 47 recommendations to the Government, addressing issues including:
1. Insurance is not to become mandatory
2. mandatory flood cover for residential properties and their contents;
3. no mandatory flood cover for SMEs;
4. a standard definition of ‘flood’;
5. improving consumer awareness of the nature of home insurance cover;
6. insurance claims handling and dispute resolution processes.
7. Other recommendations
I offer the following comments on each of the 6 points.
1. Insurance is not to become mandatory
In line with our advice to the panel, it remains that people have a right to insure or not insure their house, contents, car or business. Some classes, such as Compulsory Third Party (“CTP”) and WorkCover are, in fact, mandatory in all states and territories of Australia.
2. Mandatory flood cover residential properties and their contents
What the Review Panel did recommend was that all insurers have to offer flood cover as part of home, home contents and residential strata insurance policies.
To address the affordability of flood insurance cover, the Review Panel recommends the introduction of a system of premium discounts that would be available to most purchasers of home, home contents and residential strata insurance policies in areas subject to flood risk.
Very importantly, and in my view, wisely, the panel recommends that only existing dwellings would be eligible for the discounts, and the discounts would be phased out gradually over time. Clearly a strong signal is sent to councils, developers, and residents that there is a very real risk in living in a flood area.
If the Natural Disaster Insurance Review Panel’s recommendations are implemented flood premium discounts would be delivered through the establishment of a flood risk reinsurance pool. The proposal requires insurers to retain a portion of the flood risk, and to underwrite and price that portion of the risk themselves.
The remainder of the risk is to be ceded to the reinsurance pool at a discounted reinsurance premium. It would be the insurers’ option whether to cede risks to the pool, but the pool would be required to accept all risks at pre-agreed prices. This method allows insurers to retain control of their own risk appetite.
The reinsurance pool is to be funded, as needed, by the Federal Government, thereby guaranteeing the payment of claims. Whenever a funding shortfall occurs in the reinsurance pool, the Federal Government is required to meet it. The Federal Government, under this model, would then seek reimbursement for a portion of the shortfall from the government of the state or territory in which the flood occurred. I see this a real stumbling block with the states and territories, particularly those with high risk of being involved and/or of different political persuasion.
3. No mandatory flood cover for SMEs
In relation to small businesses, the Review Panel recommended that all insurers offering small business insurance be obliged to include flood cover on an opt-out basis in all their small business package policies. However, it does not recommend that premium discounts be provided to small businesses, nor that the reinsurance pool offer reinsurance for small business risks.
My view is that an opt-out model is going to be very difficult for insurers to price as they do not know, in advance of quoting, what proportion of Insureds will opt out.
4. A standard definition of ‘flood’
In order to address perceived consumer confusion around the various definitions of ‘flood’, the Review Panel recommended that the Federal Government introduce a standard definition of ‘flood’ for home building and contents insurance policies. The standard definition would be mandatory, with no ability to opt out or vary the definition, and would be in the following terms:
Flood means the covering of normally dry land by water that has escaped or been released from the normal confines of:
a) Any lake, or any river, creek, or other natural watercourse, whether or not altered or modified; or
b) Any reservoir, canal or dam.
I would make a couple of observations. Confusion over definitions are just as prevalent in SME (business pack) policies as domestic and as there is an ability to opt-out of flood cover under an SME policy it is arguably more important than to have a standard definition on a policy that may not cover flood than one that does.
On the other hand, if this definition were to be adopted as standard on an SME policy there may be a derogation of cover where the existing policy provides a wider cover such as where “flash flood” is currently covered.
5. improving consumer awareness of the nature of home insurance cover
The Review Panel also made a number of recommendations that seek to improve consumer awareness at the time of purchasing home and home contents insurance policies. These recommendations included:
a) amending s35(2) of the Insurance Contracts Act 1984 (Cth) so that policyholders are not deemed to be clearly informed of a deviation from ‘standard cover’ merely by being provided with a copy of the insurance policy or the product disclosure statement;
b) requiring that a plain English one-page ‘Key Facts Statement’ be provided to purchasers, to allow them quickly and easily to check the basic terms of the insurance policy, including the nature of the cover and any key exclusions; and
c) where full replacement or full flood cover is not provided, insurers must include a ‘health warning’ in the Key Facts Statement.
While a Key Facts Statement is a good idea on paper trying to compile one is a nightmare. Home and Contents policies provide so many features and benefits and conversely have so many exclusions, conditions, warranties and no doubt the consumer movement, the ever present media and lawyers will attempt to capitalise on anything left out of the Key Facts Statement.
We already have the policy wording, the product disclosure statement (“PDS”) and now a Key Facts Statement. Has this gone too far? Perhaps the answer is to do away with the current PDS and legislate what is a “Key” fact.
6. Handling of claims and dispute resolution
The Review Panel recommended a number of changes to the General Insurance Code of Practice [if you wish to review a copy of the June 2011 version, please click on the following link ICA Code of Practice ] to improve insurers’ handling of claims and disputes relating to natural disasters, including:
a) repealing clauses 4.3 and 4.4 of the Code, so that claims arising from natural disasters are subject to the same minimum standards as other claims;
b) imposing a four-month time limit (subject to exceptional circumstances) on insurers to decide whether to accept or reject liability for a claim, for all claims including those made during natural disasters [my own view is that if the first quarter of 2011 with the Brisbane Floods, Floods in Central Queensland, North West Western Australia and Victoria, the huge storm in Melbourne, Cyclones Yasi and Carlos, plus the bush fires outside Perth and the earthquakes in New Zealand all in a few weeks of itself is not “exceptional circumstances” then I do not know what is.];
c) requiring that insurers’ internal dispute resolution processes are independent of their claims department, and have the authority to overturn original decisions and to accept claims [this is only reasonable and makes it a fairer playing field for those that operate on this basis now]; and
d) introducing a general fairness test to be applied to claims and complaints handling. [I await with interest what this test entails, hopefully not another form of the unspoken presumption in favour of the Insured]
7. Other recommendations
Other recommendations of the Review Panel included :
a) establishing an agency sponsored by the Federal Government to manage the national coordination of flood risk management and operate the flood risk reinsurance pool;
b) requiring all home building insurance policies that offer sum insured cover to be modified by the end of 2014, so as to offer full replacement cover in the event of total loss of the home [if pricing the opt-out option was difficult to price, this one will be a nightmare. It can only push up the cost of insurance to all, but of course will be of great benefit to those that have not insured fully in the past when it comes to a total loss. In most cases where this is offered a full inspection of the home is made before cover is granted. The other issue is the risk of materials and labour escalation falls fully with the Insurer in the case of a large natural disaster and again pricing for this is extremely difficult. I keep coming back to the affordabilty of the product and the fact that some who currently insure will cease to do so];
c) applying unfair contracts terms laws to general insurance, so that general insurance policyholders are given the same legal remedies as other consumers; [this is only reasonable] and
d) requiring that all Australian Prudential Regulation Authority-authorised general insurers adopt and comply with the General Insurance Code of Practice. [this is only reasonable and makes it a fairer playing field for those that have already signed up].
The issue with all of this with the mandatory granting of flood cover for domestic classes and opt-out for SME coupled with full replacement cover on all homes is going to be affordability of cover. We have to remember that there is still heavy fire service levies imposed on home, contents, strata (residential and commercial) and SME business packs (including on business interruption cover) in Victoria, New South Wales and Tasmania (not on domestic risks in Tasmania). Even the rest of the states the burden of GST and Stamp Duty which is compounded as a tax on a tax means Australian’s are the most heavily taxed on insurance country in the world. [to learn more on this go to www.notaxoninsurance.com.au]
The last thing the government or our economy can afford is to make insurance unaffordable and people run the risk of not insuring. The recommendation for a flood reinsurance pool is fairly critical to the long-term viability of the other proposals. However, the indications are that the Federal Government does not appear to be prepared to embrace such an arrangement, or other forms of premium support, [the returning the budget to surplus appears to be the primary concern of government] and questions therefore arise as to whether the industry may, with appropriate approvals to deal with the competition effects, be able to establish such an arrangement itself, so that there is some pooling of risk and, thus, the ability to make premiums more affordable even if they may still be relatively high.
The paper really ignores the real risk of dam burst which could effect any community down stream of a dam. The paper only addresses breifly the other water risks of tsunami (which is wrongly mixed up with storm surge), high water or storm surge. It also recommends that landslide be an insured peril. Again there are many places around Australia where homes have been built in landslide prone areas and currently insurers will not accept this risk. These home onwers are to be rewarded by having the risk moved from them to an insurer.
Disclaimer: This post has been prepared as a guide and is not intended to exhaustive. While the utmost care has been taken in the preparation of the article, it should not be used or relied upon as a substitute for detailed advice or as a basis for making a business, financial or insurance decision.