As part of its review of the issue of flood coverage in Australia, the Natural Disaster Insurance Review panel (the review panel) considered several options to increase the availability and affordability of flood insurance offered by the private insurance market in the aftermath of the 2010/2011 storms and flooding in Queensland and Victoria. One such option was to require all insurers to offer flood cover, with consumers having the option to 'opt out' (the proposal).
The review panel did not recommend this option. However, adopting a 'slowly but surely approach', Treasury has decided to nevertheless consult on the proposal (the consultation paper). The review noted that the proposal should increase consumer awareness and likely lead to greater coverage.1 Baby steps perhaps, but progress nonetheless.
As discussed in gadens lawyers June 2011 update (see Mathematical and Moral Gymnastics: Government releases Natural Disaster Insurance Review Issue Paper here), according to the review panel, under the proposal the take-up of flood insurance would undoubtedly be greater than under the status quo but would still remain limited. However, disputes over whether water damage arose from flood or storm could still occur for policyholders who 'opt out' of flood cover.
As a starting point for the proposal, Treasury has adopted the definition of flood proposed in its previous consultation paper 'Reforming flood insurance: Clearing the waters' (for further discussion about the definition of flood see gadens lawyers April 2011 update here). The consultation paper, however, acknowledges that the adoption of this definition does not resolve all of the disputes associated with classifying a cause of loss (i.e storm/flood distinction).
Under the proposal, all insurers will be required to include flood cover in home building and home contents policies which they offer to consumers. Including flood cover in these policies will be achieved through quoting an inclusive price for cover at the initial point of sale or renewal. Insurers will be able to choose whether to give consumers the option to 'opt out' of flood cover or not.
Where consumers with a flood risk 'opt out' of effecting flood cover, the insurer is also required to alert them that they have a 'flood risk'. The proposal suggests that such a warning could be presented as follows:
According to the consultation paper, requiring consumers to explicitly 'opt out' will force them to confront the reality that their homes are subject to flood risk each time they review their insurances. Awareness of flood risk will better equip property owners to take measures to mitigate that risk, including assessing their insurance needs.
Treasury indicates that implementing the proposal could substantially increase flood cover take-up by consumers. For the 93% of homes which are subject to no flood risk, the increase in take-up of flood insurance should be automatic as no additional premium is likely. However, for the remaining 7% of existing homes who face some flood risk, rates of take-up are likely to differ according to risk and the corresponding premium required to cover the risk.2
Outstanding concerns and the need for consultation
According to the review panel, around 7% of existing Australian properties face some flood risk, with 4% at low risk of flood. The indicative flood risk premium for these households is around $77 per year. Similarly, indicative flood risk premiums for those households at moderate risk of flood are up to $726 per year. This proposal could drive a higher rate of take-up among these households, who together comprise around 74% of all homes with any flood risk.3
However, for the remaining approximately 2% of existing homes at high or extreme risk of flooding, it is likely that take-up of flood cover may be lower. The reason being, that the indicative flood risk premium for a home with a flood risk average recurrence interval (ARI) of less than 1 in 15 years would be approximately $6,777 per year.
A number of questions as to funding of premiums remain. Who, how and when... are just some of them.
The consultation paper recognises that there are concerns that some insurers may be unable to provide the requisite cover. Requiring all insurers to offer flood cover may result in some companies defensively pricing flood cover or simply pulling out of flood prone areas due to unwillingness to take on such risks.
The consultation paper recognises the risk that the proposal could potentially raise prudential issues. To maintain financial strength, Treasury acknowledges that the regulator requires insurers to implement soundly based pricing for the flood risks they underwrite. Under the proposal, such risks would be dealt with under existing capital framework and insurers would be required to hold the requisite capital against their liabilities.
Treasury seeks feedback from stakeholders on the impact on the direct insurance market (raising issues such as capital, competition and on-costs etc) and on the availability of affordable reinsurance.
But not every home is insured...
The review panel acknowledged that key stakeholders (homeowners, insurers, councils and governments) need to have a vested interest in order to avoid moral hazard and to maintain incentives for good risk management, including flood mitigation.
The consultation paper acknowledges the need for legislative amendments in respect of standard cover, for further consideration of sub-limits and excesses and asks a multitude of questions about the best way to formally implement the proposal. However, the proposal (like most previous Treasury proposals to do with flood) again fails to address insureds that simply refuse to purchase insurance, regardless of what cover is included.
So where does that leave us?
It still remains unclear how cover for the '2% (at approximately $6,777 per year premium) of home owners' will be funded. In addition,no solution is provided for the individual who simply does not want insurance. For the former, preventing further development in such high risk areas may be an option. Alternatively, a reinsurance pool or government / taxpayer funded scheme may be required.
Despite apparently being at a developed and advanced phase of the 'big picture review' process, Treasury, the review panel and the various stakeholders have to date been unable to reach agreement as to an all encompassing answer to these fundamental questions.
Nevertheless, in taking the relevant baby steps forward and keeping the topic on the table, there is little doubt that improvement (of some sort) to the status quo is likely.
Treasury encourages all interested parties to examine the various questions posed. Some additional points of inquiry put to stakeholders include:
- cost bearing;
- flood mapping;
- aligning implementation with Key Fact Sheet rollout; and
- transition periods.
The closing date for submissions is 30 March 2012. To review the consultation paper in full, click here.
1 Natural Disaster Insurance Review Issues Paper, pp -11
2 The proposal, pp7-9
3 The proposal, pp8-9
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This report does not comprise legal advice and neither Gadens Lawyers nor the authors accept any responsibility for it.