The federal government says its reinsurance pool for northern Australians will cover cyclone and related flood damage and reduce premiums by over $1.5 billion over 10 years. The scheme will start in July 2022 with the backing of a $10 billion government guarantee.
But how viable is this plan?
Fred Hawke (pictured), a consultant with Clayton Utz and faculty member of the Australian College of Insurance Studies (ACIS), has more than four decades of experience in insurance and law. Hawke said his initial reaction to the plan was one of guarded optimism. He’d prefer more details on how it’s going to work but suggested a possible model.
“Probably along the same lines as the Australian Reinsurance Pool Corporation, which was set up after 9/11 to deal with the total unavailability of Commercial Property & Liability insurance against terrorism but tweaked for flood cover. They may even use the same funding vehicle and mechanism - the ARPC backed by a government guarantee.”
However, Hawke said it remains to be seen whether the government will carve out and reinsure only the flood risk, provide a blanket, stop-loss reinsurance of last resort, or develop some other alternative.
There’s also an important practical consideration concerning the source of any reinsurance funds.
“One thing which does strike me,” said Hawke, “is that almost all of the Australian insurance industry’s reinsurance is purchased on the international markets, from companies who are beyond the Australian government’s regulatory reach but are domiciled in jurisdictions with which it probably has bilateral investment treaties.”
Hawke hopes the government has taken a close look at whether this issue means their plan to provide state-subsidized reinsurance infringes international trade laws.
“It’d be bl**** ironic if we got dragged into the WTO by China or Bermuda over this. Even if we were, I imagine the federal government might well consider it an acceptable price to pay, to avoid the alternative of having to admit that parts of Queensland have become effectively uninhabitable,” he said.
Hawke said for insurance companies operating in Australia’s north, the reinsurance plan is both good and bad news.
“On the one hand, they can maintain a presence in a market which has otherwise become unviable and preserve their image as the community’s safeguard against natural disasters, with the bottom line underwritten by the taxpayers. On the other hand, they will have less excuse for bailing out altogether from the vexatious business of providing flood insurance in cyclone-prone areas and will be expected to continue to provide it, with all the fraught logistic and reputational issues which that entails.”
Hawke said the cost and difficulty of preparing for and managing large-scale, natural disaster claims will remain, including availability of resources such as trained claims personnel, loss adjusters, claims preparers and securing access to insured properties.
“It also will do nothing, at least in the medium term, to ensure an adequate supply of trades and materials for rebuilding, let alone address the transport and logistics problems,” he said.
However, he said the insurers who are prepared to front this insurance coverage for the federal government can expect to reap some kudos for themselves, in return for spending the taxpayers’ money.
“They also, however, will remain the whipping posts and stoning pillars for complaints and hardship stories, every time there is a flood and the industry response is deemed inadequate,” he added.
He said unless the reinsurance applies to all property risk on a geographic basis there are also bound to be issues over its application to contentious claims.
The Australian Competition and Consumer Commission (ACCC) has already expressed concern over the government’s plan contending that it supports the insurance industry rather than affordability. Hawke thinks the problem goes deeper than that.
“It has to do with the very nature of insurance, which is society’s canary in the coal mine for risk awareness and mitigation. The phrase ‘market failure’ often gets tossed about when prices rise high enough to become embarrassing, but, often enough, and I suspect in this north Queensland situation, the market has not failed at all but has merely performed its proper function of efficiently and accurately pricing the risk,” he said.
The basic, operating principle of insurance is that the claims of the few are met from the premiums of the many. When the few become the many, the open market insurance of that risk is no longer feasible, said Hawke.
“If you live in an area where category 4 cyclones have now become an annual occurrence, the price you are being charged for your insurance may in fact be eminently reasonable, but of course that’s not much comfort if you can’t afford it,” he said.
Governments are then faced with a choice between two, equally unpalatable, alternatives. One is to expand the pool of contributing insureds.
“The guy with a house on the top of Mt Waverley in Melbourne would have to insure it against tropical cyclones, whether he liked it or not so that his insurer could offer the cover to those who do need it at a ‘reasonable’ price,” said Hawke.
“ASIC (Australian Securities and Investments Commission) and the ACCC would both have kittens but neither would really have anything to complain about, since there would be no windfall profits for insurers involved - just a wider sharing of the risk,” he said.
The more politically acceptable alternative is for the government to step in and underwrite the risks themselves.
“They do so at a loss of course but that’s all right, it’s Ralph’s money. Since one of the main drivers of insurance cost in Australia is the price of reinsurance, the strategy almost certainly will work and drive down the retail cost of the relevant cover significantly,” said Hawke.
