Chapter 2Problem and current situation
The problems caused by high insurance premiums in Northern Australia
How can you begin to expand Northern Australia without insurance coverage?
2.1This question, posed in a submission to the inquiry, reflects the fact that the development of Northern Australia depends heavily on the availability and affordability of insurance—particularly cyclone insurance.
2.2Evidence to the committee suggested that at least half of all flooding in Northern Australia is cyclone related.
2.3As noted in chapter one, without affordable insurance in Northern Australia:
businesses are deterred from expanding;
investors are deterred from investing;
developers will not take on projects;
people are either reluctant to move to Northern Australia or may even relocate to the southern states;
a range of social infrastructure facilities such as aged care may no longer be able to operate profitably;
older people are reluctant to move into apartments, which means they do not leave their homes for families to occupy; and
rents increase, which puts strain on people who have lower incomes.
2.4In sum, without affordable insurance, Northern Australia cannot flourish.
2.5Accordingly, the questions before the committee were:
whether the implementation and operation of the Cyclone Reinsurance Pool (the pool, or CRP) has been effective;
what may need adjusting to ensure the pool delivers substantial benefits to businesses, residents, and communities across Northern Australia;
whether the community expectations that have been raised about what may reasonably be expected from the operation of the pool in terms of premium savings for policy holders are able to be realised; and
the timeliness of review mechanisms.
2.6The next section provides historical data on cyclones and projections for future cyclone activity. The rest of the chapter then sets out what currently happens. To that end, the chapter provides key information about the pool, including the requirements for insurers to join. It then covers the estimated premium savings, the relevant legislation and regulations, as well as the monitoring by the Australian Competition and Consumer Commission (ACCC) and the Australian Prudential Regulation Authority (APRA).
Historical data on cyclones and projections for future cyclone activity
2.7Information provided in responses to questions on notice by the Bureau of Meteorology (the Bureau) indicated that the median length of cyclones that have made landfall in Northern Australia since 2000 is 3.5 days, and the average length is 4.7 days. The Bureau provided a list of 14 cyclones of greater than 7 days duration between 2000–01 and 2021–22 (Table 2.1) and noted that there ‘has been no significant change in the length of cyclones since 2000’.
2.8The Bureau of Meteorology advised the committee that the number of tropical cyclones observed in the Australian region since 1982 has decreased, while non-satellite observations indicate there has been a longer-term decrease in the number of tropical cyclones since 1900. On the matter of cyclone intensity, the Bureau stated that it is difficult to quantify trends in cyclone intensity over time, because of their relatively small number and uncertainties in estimating the intensity of individual cyclones.
2.9With these qualifications, the Bureau provided evidence suggesting that although it is likely that the total number of tropical cyclones will decrease or remain unchanged, it is very likely that the proportion of tropical cyclones that reach category 4 or 5 intensity, and the mean peak wind speed of tropical cyclones, will increase. Further, it is also very likely that:
total rainfall associated with tropical cyclones will increase with global warming; and
there will be a further elevated risk of storm surge and freshwater flooding because of a combination of rising baseline sea levels, increased average tropical cyclone intensity and increased tropical cyclone rainfall rates.
Table 2.1Cyclones of greater than 7 days duration, 2000-01 to 2021-22
Source: Bureau of Meteorology, answers to written questions on notice, 16 December 2022 (received 16 January 2023), pp. 1-2. Note: numbers are cyclone intensity. Q = Qld.
2.10The Bureau also provided an overview in its submission of the historical frequency of tropical cyclones in the Australian region, noting that about 50 per cent of tropical cyclones in Australia become severe tropical cyclones of Category 3 or above (see Figure 2.1 for further detail). Most significant landfalls have been north of the Tropic of Capricorn, but major impacts have also occurred further south, particularly in Western Australia.
Figure 2.1Historical overview of tropical cyclones in the Australian region
Source: Bureau of Meteorology, Submission 5, pp. 5–6.
2.11Of further relevance, particularly at the time of writing this report (with a weakening La Niña), the Bureau advised that the number of cyclones in the Australian region ‘generally declines with El Niño and increases with La Niña’.
Key information about the pool
2.12The pool commenced operation on 1July 2022. The pool is backed by a $10 billion Australian Government guarantee, intended to cover any shortfalls from the pool.
2.13The pool ‘covers claims for cyclone and related flood damage arising during a cyclone event, which lasts from the time a cyclone begins until 48hours after the cyclone ends’, above policyholder excesses. Modelling from the Australian Reinsurance Pool Corporation (ARPC) suggests that 50–60 per cent of all flooding in Northern Australia is related to cyclones.
2.14The main objective of the pool is to lower insurance premiums for households and small businesses with high cyclone and related flood damage by allowing insurers to reinsure cyclone risks at a lower cost than would be the case if insurers purchased reinsurance from the private market.
2.15The ACCC, in its first report following the introduction of the pool, published data highlighting the cost disparity between average premiums in 2021–22 (see also Figure 2.2):
$2370 in Northern Australia compared with $1350 for the rest of Australia for residential combined building and contents insurance; and
$5740 in Northern Australia compared with $2940 for the rest of Australia for strata insurance.
2.16Insurers can reinsure for eligible risks Australia-wide, but the pool is targeted at premium reductions in medium to high-risk cyclone areas, which are mostly in Northern and Western Australia (see Figure 2.3). There is zero premium—the pool is not expected to cover premiums—for Tasmania, South Australia, the Australian Capital Territory and Victoria. Most of New South Wales (excluding northern New South Wales) is also zero premium.
Figure 2.2Average premiums for residential combined building and contents insurance in Australia, 2021-22
Source: ACCC, Insurance monitoring First report following the introduction of a cyclone and cyclone-related flood damage reinsurance pool, December 2022, p. 3.
2.17It is estimated that the pool will cover 3.3 million households, 220000 small businesses, and 140000 residential strata and small commercial strata properties (see Figure 2.4).
Figure 2.3Geographical areas expected to be impacted by the pool
Source: Finity, Cyclone Reinsurance Pool—Summary of the Actuarial Premium Rate Assessment, June 2022, p. 3.
Figure 2.4Events and property types covered by the pool
Source: Finity, Cyclone Reinsurance Pool—Summary of the Actuarial Premium Rate Assessment, June 2022, p.1.
2.18Household, strata and small business property insurance policies for cyclone insurance are covered by the pool, including:
residential home and contents, including landlord insurance and farm residential cover;
residential strata, including mixed-use strata schemes where 50 per cent or more of floor space is used mainly for residential purposes; and
commercial property policies with less than $5 million total sum insured across risks covered by the pool (property, contents and business interruption).
2.19There is no sum limit for domestic property that is wholly or mainly residential, or residential strata. Small and medium enterprises and commercial strata have a maximum insurance limit of $5 million. According to a February 2022 factsheet from the Department of the Treasury (the Treasury), from 1 July 2023, coverage for small business marine property insurance policies will be included by the pool. However, information on marine insurance does not appear to be available on the ARPC’s website.
2.20The ARPC administers the pool and calculates the premium rates that insurers are required to pay. The following government agencies have also been involved in establishing and monitoring the pool:
The Treasury’s Cyclone Reinsurance Pool Taskforce;
The ACCC;
Australian Government Actuary;
Australian Government Solicitor;
APRA; and
The Bureau of Meteorology.
2.21The ARPC is required to provide financial incentives for risk mitigation. At Senate Estimates on 9 November 2022, the Chief Executive of the ARPC stated that the ARPC had already provided financial incentives for risk mitigation in home insurance, but not yet for small business and strata.
Requirements for insurers to join the pool
2.22It is not yet mandatory for insurance companies providing coverage for cyclone damage to have joined the pool (see Figure 2.5). However, all eligible insurers have been able to join voluntarily since the pool commenced.
2.23Requirements for insurers depend on their gross written premium, or the total amount that policy holders pay for insurance on policies issued by a particular company during a calendar year. On this basis, insurers are divided into the following groups:
insurers with a gross written premium of less than $10 million are exempt from joining the pool;
small insurers with a gross written product of less than $300 million have until December 2024 to join the pool; and
large insurers with a gross written premium of $300 million or more have until December 2023 to join the pool.
Figure 2.5Key dates for insurers to join the pool
2.24As of early February 2023, two insurers—Allianz Australia and Sure Insurance—had joined the pool. In total, according to the ARPC, about 14 insurers that work in Northern Australia are involved in the implementation of the pool.
2.25In an ‘onboarding’ document produced for insurance companies, the ARPC suggested that when deciding when would be the best time to join the pool, insurance companies should consider, among other factors:
when it is mandatory for them to join the pool;
their current reinsurance arrangements and the periods of coverage;
the impact on final pricing to consumers;
how much time it will take to get any pricing changes out to market; and
the time needed to implement pricing changes and ARPC data transfer requirements.
2.26The ARPC also stated in the same document that it ‘encourages insurers to review their responsibilities’ under the relevant prudential standard‘and seek guidance’ on, among other matters, when would be a convenient time for the insurer to join the pool.
2.27The reasons given by insurers for why they had not joined the pool by November 2022, when the committee took evidence for the inquiry, are discussed in chapter three.
Estimated premium savings
2.28Estimated premium savings as of 30 September 2022 are provided in Figure 2.6. The Chief Executive of the ARPC advised at Senate Estimates on 9 November 2022 that there will be a:
32 per cent saving for premiums in high-premium areas. There’ll be a 13 per cent saving for home insurance policies in all of Northern Australia on average, and six per cent for everyone across low-, medium- and high-risk areas… For small business it will be 13 per cent. But for strata we’re unable to provide a number at the moment because the data set is too small for strata.
2.29Sure Insurance, which declined to make a submission or appear at the public hearing, told the Senate Economics Legislation Committee in March 2022 that ‘a mandatory participation model… will almost certainly deliver price rises for a large proportion of Sure’s tens of thousands of policy holders… and, potentially, for other insurers alike’. Sure Insurance proposed a no-disadvantage test—that is, that insurers not be required to join the pool if they would be able to charge policy holders less than the pool price by not joining. As noted above, Sure Insurance has now joined the pool.
Figure 2.6Estimated premium savings by class of business
Source: ARPC, Submission 6, p. 3
Benefit for insurers
2.30According to the ARPC, joining the pool will lead to a number of benefits for insurers, including:
insurers will not be required to hold capital, as they are otherwise required to by APRA, meaning that insurers may have surplus capital to invest in their business; and
insurers will be able to provide reduced premiums in medium- and high-risk areas than what would have otherwise been the case, meaning there is the potential for insurers to sign up more policy-holders.
Relevant legislation
2.31The key piece of legislation underpinning the establishment and operation of the pool is the former Terrorism Insurance Act 2003, which was created following the withdrawal of terrorism cover by insurance companies after the events of 9/11. Amendments made on 30 March 2022 by the 46th Parliament to the Terrorism Insurance Act 2003 included:
changing the title of the Act to the Terrorism and Cyclone Insurance Act 2003; and
establishing a framework for a cyclone and cyclone-related flood damage reinsurance pool by extending the terrorism reinsurance scheme administered by the ARPC.
2.32Amendments in the same bill were also made to the Insurance Act 1973 to create a civil penalty for insurers who do not reinsure eligible cyclone risks with the ARPC.
2.33The Terrorism and Cyclone Insurance Act 2003 (the Act), as amended, sets out the following relevant matters:
the circumstances under which cyclone risks must be reinsured with the APRC. That is, if a general insurer undertakes insurance that includes undertaking liability under pool insurance contracts in respect of eligible cyclone losses, unless that insurer’s total gross written cyclone premiums amount to less than $10 million for a calendar year.
the conditions that must be met for a weather system to be declared a cyclone for the purposes of the Act. That is, the Bureau of Meteorology is required to notify the ARPC if a weather system is a cyclone and when it is downgraded, with the ARPC to then declare the day and time that a cyclone began, was downgraded or re-intensified (see Figure 2.7).
the definition of an eligible cyclone loss. That is, losses arising from any of the following caused by a weather system declared to be a cyclone event, during the claims period for the cyclone event (which is currently 48 hours, as set out in regulations—see below):
- wind, rain, rainwater or rainwater runoff;
- a storm surge (as defined by regulations); and/or
- a flood (as defined by regulations).
- The Act also sets out the functions and powers of the ARPC, requirements for a reviewing actuary, and how often the Act is to be reviewed, with a report to be provided ‘as soon as practicable after 1 July 2025’ and ‘at least once every 5 years’ subsequently.
- Under the Act, the ARPC is required to prepare and provide the Minister (in this instance, the relevant ministerial portfolio is the Treasury) with a Financial Outlook Report on or before 15 October after the end of each financial year. This report must be published on the ARPC’s website within 10 days of being provided to the Minister. The ARPC stated in its submission that it is due to publish a Financial Outlook Report in 2024 on the adequacy of existing premium rates and the ongoing impacts of climate change.
Relevant regulations
2.36A number of legislative instruments have been made under the authority conferred by the Terrorism and Cyclone Insurance Act 2003. Key among these is the Terrorism and Cyclone Insurance Regulations 2003 (the Regulations), which updated the former Terrorism Insurance Regulations 2003. The Regulations provide the following (see also Figure 2.7):
definitions of a cyclone and when a cyclone ends or re-intensifies;
definitions of storm surge and flood;
the threshold amount at which point insurers will be required to join the pool (currently total gross written cyclone premiums amounting to $10 million or more for a calendar year);
the end of the claims period for a cyclone event—currently 48 hours after the ARPC declares a cyclone event to have ended; and
the content of the Financial Outlook Report, including an assessment of the adequacy of the premiums the ARPC requires from insurers as well as projections for financial outcomes for the scheme.
Figure 2.8Definitions under the Terrorism and Cyclone Insurance Regulations 2003
Source: Terrorism and Cyclone Insurance Regulations 2003, ss 3A, 34(1).
Monitoring and regulation of general insurers
2.37The ACCC monitors insurance premiums to assess the impact of the Cyclone Reinsurance Pool and evaluate whether savings are being passed through to policy holders. It also monitors the prices, costs and profits of insurance cover related to cyclone damage, including before and after the introduction of the pool. The ACCC is required to provide at least one report on this work each calendar year.
2.38In its December 2022 report, the ACCC focused on ‘the background and context to the Pool’s introduction and the ACCC’s monitoring role’, because no insurer had joined the pool at the time of publishing the report. The report noted the following reasons for why insurers had not yet joined the pool:
insurers had existing reinsurance arrangements, which are typically taken out on a ‘whole of book’ basis;
the timing of the development of the pool and of finalised reinsurance premium rates meant that insurers were ‘not in a position to join the Pool when it commenced operation in July 2022’;
time needed for insurers to make administrative, system and process changes, which may require a considerable amount of time and resources; and
concerns about an ongoing administrative and technical burden imposed by joining the pool, related, particularly, to ‘the difficulty of determining whether relevant claims arise within a “cyclone event” as defined in the relevant legislation, or outside of this period’.
2.39APRA sets prudential and reporting standards for the general insurance industry, with general insurers being required to adhere to minimum capital, governance and risk management requirements. In 2022, APRA finalised changes to a number of general insurance reporting standards to support the operation of the pool. The changes, which took effect from 1 July 2022, ‘ensure that the reinsurance recoverables from the ARPC are not subject to a capital charge in recognition of the Australian Government guarantee that supports the scheme’.