Australia: The 2009 Review of the Terrorism Insurance Act 2003

Insurance Update

In response to the lack of available terrorism insurance after the terrorist attacks of 11 September 2001, the Australian Government enacted the Terrorism Insurance Act (2003) (the Act). The Act established a scheme for replacement terrorism insurance coverage for commercial property and associated business interruption and public liability claims. Sections 6 to 8 of the Act deems terrorism risk cover (and overrides terrorism exclusion clauses) into ''eligible insurance contracts'' to the extent that the losses excluded are ''eligible terrorism losses'' arising from a ''declared terrorist incident''.1

The Australian Reinsurance Pool Corporation (ARPC) manages the scheme. Insurance companies are able to reinsure the risk of claims for eligible terrorism losses through ARPC.

Given the nature of terrorism insurance, where losses are difficult to model and the nature of losses are potentially catastrophic (the estimated loss from the September 11 attacks was over US$30 billion), it is not surprising that some key insurance players have been reluctant to enter or re-enter the market. Whilst the market for terrorism insurance has somewhat recovered since 2001, there is still a lack of affordable coverage. Therefore, the scheme is essentially designed to ensure that terrorism insurance coverage is available to those organisations that either consider such coverage necessary or are required to hold it.

The Act is reviewed every three years to determine whether the scheme remains necessary, and if so, whether any amendments are needed. The 2009 review has recommended that the Act continue in force.

The key findings of the 2009 review are set out below.

  1. Is there a continuing need for the Act? - The last three years has demonstrated that Government Schemes have been successful in addressing the shortage of global reinsurance for terrorism risks. The review concluded that there is still a need for Government intervention and that the Act ought to continue to operate to protect the Australian economy from the adverse economic effects of the withdrawal of terrorism insurance. Nonetheless, care is to be taken to ensure that the scheme does not create a disincentive for the private sector to enter or re-enter the market.
  2. Refinements to the Scheme - The review considered refinements to the operation of the scheme in the following areas:
    • Premiums and the Pool - Insurers who reinsure terrorism risk through ARPC pay premiums to ARPC which are calculated as a percentage of the premium of the underlying policy which falls within one of three tiers. The tiers are based on geographic location and correspond to the relative risk of the locations within each tier. After the cost of administration is accounted for, ARPC can spend the premiums as it pleases with no legislative restraints currently in place.
    • The review recommended that in order to encourage the reemergence of the commercial sector into the terrorism risk market, ARPC should be required to continue charging premiums for reinsurance at the current rates, subject to further review. It also recommended that once the pool reaches $300 million, ARPC should have the discretion to determine whether to use premiums to build the pool further, purchase reinsurance for the scheme or undertake a combination of the two.
    • Retrocession - At 31 December 2008, ARPC had entered into retrocession contracts with reinsurers from the Australian, European and Bermuda markets, providing around $2.3 billion of additional capacity.

      The review recommends that the ARPC continue to collect premiums at current rates and investigate the use of premiums to purchase further retrocession for the scheme.

    • Retentions - Retention is the terrorism risk retained by insurers. The review considered whether the current retention levels are appropriate. This is ultimately a balancing act between providing a sufficient amount of coverage at an affordable rate, whilst also ensuring that the scheme does not undercut the reasonable rates at which commercial insurers can re-enter the market. This is a critical element of the scheme, as it directly affects the scheme's ability to facilitate the re-emergence of the commercial market for terrorism risk insurance. The review found that whilst raising retention levels may trigger such a re-emergence, any increases in retentions would be premature in light of the low appetite for terrorism insurance.
    • Line of Credit - When the terrorism insurance scheme was established, a $1 billion line of credit facility was instituted to supplement the reinsurance pool. The repayment of this line of credit was guaranteed by the Commonwealth. In light of the increased cost of maintaining the facility and the sizable pool of funds that the scheme can access, the review recommended that ARPC need not maintain the facility. Rather, it was recommended that additional retrocession capacity be purchased with the funds that were dedicated to maintain the facility
    • .
    • Residential Property - The scheme has been confined, at least by legislation, to commercial property and infrastructure projects (section 3 of the Act). This was due to the Government's concern that a lack of terrorism insurance available for such properties and projects would adversely affect investment in the property sector.

      Consideration was had as to whether the Scheme ought to be extended to include high-rise buildings that are predominantly for residential purposes as well as defence force and student accommodation involving commercial property financing. It was found that the practical effect of the Terrorism Insurance Regulations 2003 and the Corporations Regulations 2001 was that insurance contracts fell within the scheme during the construction phase of any such project, regardless of whether the property would be used for residential or commercial purposes once complete. It is only on completion and sale of the structure that the insurance contract no longer falls within the definition of an ''eligible insurance contract''. It is therefore not surprising that developers and lenders have found themselves somewhat immune from the withdrawal of terrorism insurance.

      It was recommended that the ARPC examine further the effects of extending the scheme to mixed-use high-rise buildings that are not predominantly for commercial use with regard to the objectives of the scheme as a whole.

The 2009 review demonstrates that stakeholders have considered the scheme to be stable and efficient in its present form. While retrocession may be regarded as an expensive method of accessing capital, by retroceding part of its obligations, ARPC is not only sourcing the additional capacity that it requires, it is also providing an incentive to commercial players to enter/re-enter the market.

ARPC's risk modeling and loss estimation capabilities are highly regarded and its communication with insurers to ensure that the scheme is properly understood has been successful. ARPC has also been successful in maintaining continued growth of its investments from the collection of premiums and investment income.

It seems premature to expect the private sector to insure terrorism risk alone. However, the challenge for the scheme in the future will be to continue striking the balance between providing sufficient insurance coverage for terrorism risks without creating a disincentive for private insurers to enter/re-enter the market.

Terrorism Insurance Act Review: 2009

1 Sections 6-8

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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