Following the events in the United States of September 2001, cover for terrorism risk was progressively withdrawn by insurance and reinsurance companies. Significant commercial and financial difficulties have resulted from the withdrawal of such coverage. With a large pool of assets uninsured for terrorism risk, financiers and investors face uncertainty that could result in adverse economic circumstances, delaying commencement of investment projects and altering portfolio management decisions.
The Terrorism Insurance Bill 2002 establishes the framework to implement the scheme for replacement terrorism insurance announced by the Treasurer on 25 October 2002. The development of the Scheme followed calls from the community for the Government to intervene in an area of clear market failure and subsequent discussions with key industry stakeholders.
The Bill renders terrorism exclusion clauses in eligible insurance contracts ineffective in relation to loss or liabilities arising from a declared terrorist incident. Eligible insurance contracts have a starting point definition of insurance for loss of or damage to eligible property located in Australia, and associated business interruption and public liability cover. Eligible property is defined as buildings or other structures or works on, in or under land; and their contents. The definition of eligible insurance contracts will be further refined through regulations.
The compulsory application of the Bill to all eligible insurance contracts is essential to allow accumulation of a credible funds pool within a reasonable period. Universal terrorism insurance is also designed to avoid problems of undiversified risks (for example, insuring only high risk buildings) and uncertainty as to who will be eligible for compensation in the event of a terrorist act.
The Bill also establishes a statutory authority — the Australian Reinsurance Pool Corporation — which will provide reinsurance cover to insurers for losses arising from a declared terrorist incident. The Minister will appoint a chair and up to six other part time members to the Corporation. The Corporation will appoint a full time Chief Executive Officer.
Insurers who seek terrorism reinsurance through the Australian Reinsurance Pool Corporation will retain part of the risk of liability from a declared terrorist incident. The Treasurer will set the retention by issuing directions to the Corporation. Initially it is anticipated that the retention will be set at the lesser of $1 million or 4 per cent of gross Fire/ISR premium revenue per insurer per annum, and $10 million across the industry per event.
The Treasurer will also be able to direct the Australian Reinsurance Pool Corporation on premiums to be charged (based on underlying base premium) for the reinsurance. Premiums collected from insureds will be paid by insurers to the Scheme in order to fund a $300 million pool and to repay any loan required in the event claims exceed the resources of the pool.
The Government’s objective is to operate the Scheme only while terrorism insurance cover is unavailable commercially on reasonable terms. As such, reviews of the Scheme and the global terrorism risk reinsurance market will be conducted every two or three years, to assess the state of the market and the possible wind-up strategy of the Scheme. The uncertainty in the market makes it impossible to stipulate on establishment the details or timing of the windup of the Scheme and the use of funds accumulated by the Scheme. Components of the Scheme, including pricing, classes of insurance required to provide terrorism risk cover and level of underwriting available, are deliberately flexible, not being set in legislation, in order to encourage the reemergence of the commercial market.
Financial Impact Statement
The Bill provides that the Commonwealth guarantees the due payment of money that may become payable by the Corporation to any person other than the Commonwealth. The Treasurer must specify a pro rata (percentage) reduction in claims to be paid out by insurers, if, in the absence of such a reduction percentage, the total amounts payable by the Commonwealth as a result of this guarantee would be more than $10 billion.
The ABS advised that the Australian Reinsurance Pool Corporation would be classified as a Public Financial Corporation. As a result, premium income and any payment of claims will not impact on the underlying cash balance of the general government sector. The budget impact of the scheme would result from the receipt of fees for the indemnity expected to be provided by the Commonwealth, establishment costs of $2 million and any costs borne by the general government should the entity default on its loans or other liabilities. The guarantee will be recorded as a contingent liability in the Commonwealth’s accounts.
The Australian Reinsurance Pool Corporation is not subject to income tax under a law of the Commonwealth.