NO.064

TERRORISM INSURANCE

The Federal Government announced today the detailed plans of a scheme for replacement

terrorism insurance.

The announcement follows calls from the community for the Government to intervene

in an area of clear market failure and subsequent discussions with key industry

stakeholders – including insurance and reinsurance companies, banks, representatives

of property owners, industry associations, insurance brokers and actuaries.

Expert advice was also provided to the Government on the issue by Trowbridge

Consulting.

The Scheme will provide for a pool of funds (initially planned to accumulate

to about $300 million) funded by premiums. The pool will be supplemented

by a back-up bank line of credit of $1 billion, underwritten by the Commonwealth,

as well as a Commonwealth Government indemnity of $9 billion, giving aggregate

cover of up to $10.3 billion when the pool is fully funded.

Legislation to set up the Scheme will be introduced into Parliament shortly.

The main features of the Scheme are:

• The Scheme will cover commercial property and infrastructure facilities,

  and include associated business interruption and public liability.

• The legislation would compel insurance companies to provide cover for terrorism

  risk on all policies in all classes of insurance included under the Scheme.

  Insurance companies would be able, but not obliged, to reinsure their terrorism

  risk exposure with the proposed Scheme.

• Premiums will depend on the risk of insured properties and facilities,

  and cost from around 2 per cent to a maximum of 12 per cent of the

  related property insurance premiums.

• Federal and State Governments are not covered by this scheme as they self-insure.

  Property or infrastructure owned by Federal or State Government business enterprises

  will be covered by the Scheme.

• The Government will establish a new statutory authority, the Australian

  Reinsurance Pool Corporation to manage the Scheme including the pool fund.

• Should a terrorist event occur, insurers will bear the first $1 million

  per insurer or $10 million per incident and after that, the Government

  Scheme will operate to pay claims.

• The definition of a terrorist act in the legislation will be based on a

  definition commonly used in the market (the `Munich Re’ definition). The Scheme

  will cover damage caused by terrorist activity, including causes such as fire,

  flood, explosion, impact of aircraft, biological and chemical, but not nuclear

  causes. Otherwise cover will be on the same basis as related property insurance

  policies.

• The Scheme will operate only until the market for terrorist risk insurance

  recovers. The Government will regularly review the insurance market to determine

  when the Scheme will be terminated.

The Scheme may also extend to underwritten State and Territory workers’ compensation

and compulsory third party motor vehicle insurance, subject to discussions with

those Governments, and their agreement to participate in arrangements. The Commonwealth

would seek an appropriate contribution from the State and Territory Governments

were this to occur.

The Scheme will operate from 1 July 2003, subject to passage of the relevant

legislation. Should there be any terrorist event before this date, the Government

would consider appropriate assistance.

Further details of the Scheme are in the Attachment.

MELBOURNE

25 October 2002

Contact:

David Alexander 02 6277 7340

Lorraine Allan (Treasury) 02 6263 2025

ATTACHMENT

COMMONWEALTH GOVERNMENT SCHEME FOR THE PROVISION OF TERRORISM

INSURANCE COVER

OVERVIEW

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.

An assessment of the Australian market by Trowbridge Consulting, assisted by

Chiltington International, in June and July 2002 found that virtually no terrorism-related

insurance cover is available for commercial property and business interruption.

Where cover is available, it is at prices that far exceed the perceived cost

of the risk, with large excesses and relatively low maximum coverage, compared

to the market cover previously available.

The Government announced in May 2002 that it would offer remainder insurance

for losses above the cover available from individual insurers, possibly after

a pooling arrangement. It has determined that any intervention would need to

be consistent with:

• the need to maintain, to the greatest extent possible, private sector involvement;
• ensuring that risk transferred to the Commonwealth is appropriately priced;
• allowing the re-emergence of the commercial markets for terrorism risk

  cover; and

• global solutions.

After industry consultations conducted with the assistance of Trowbridge Consulting,

the Government decided to adopt a hybrid pool/post-funded model broadly consistent

with these parameters and principles. This is expected to provide a sufficient

level of certainty and public confidence in coverage available against terrorist

risk, with premiums more affordable than currently exist at market prices.

THE SCHEME

Four layer model

The arrangements will operate with four layers to meet the costs of any claims

made.

• First layer – retention of some risk by insureds and insurers;
• Second layer – pool of approximately $300 million, to be funded by

  premiums collected from property owners over three to four years;

• Third layer – commercial loan facility for $1 billion; and
• Fourth layer – Commonwealth Government indemnity for up to $9 billion.

Coverage

The Scheme will cover insurance for commercial property. It will also extend

to business interruption risk policies associated with those properties that

are insured, and public liability policies.

Insurance company exposures in relation to their underwriting of certain States’

and Territories’ compulsory workers compensation and compulsory third party

(CTP) motor vehicle schemes may be included subject to discussions with State

and Territory governments.

Private residential property will be excluded, since market cover is becoming

available in this area. Other classes of insurance may be incorporated at a

later date if significant economic damage from lack of cover is observed.

Risk cover would be for any terrorist event, as defined in legislation, except

events involving damage from nuclear causes. Coverage under the scheme is defined

to include areas for which cover was previously commercially available. Cover

for damage arising from nuclear causes has not been commercially available for

many years. Government assistance in relation to damage from nuclear causes

could be considered consistent with a national disaster.

In addition, coverage will be available for Commonwealth and State business

enterprises and Commonwealth-owned airports leased commercially. Coverage will

extend throughout all States and Territories, together with offshore facilities,

providing that premiums are collected.

Terrorist act

A definition of `terrorist act’ for the purposes of the Scheme, and a process

to determine when an event is a `terrorist act’, will be included in the legislation

establishing the Scheme. It is proposed the Treasurer, acting on the advice

of the Attorney General, would declare that a terrorist event has occurred before

any compensation could be paid. An outline of the proposed definition of `terrorist

act’ is at Appendix 1.

Timing

Subject to discussions with insurance companies and passage of the relevant

legislation, the Scheme will commence from 1 July 2003 and premiums will be

collected from this date. Should there be a terrorist event before the commencement

of the Scheme, the Government would take appropriate action in the light of

the particular circumstances.

Participation

All insurance provided by insurance companies licensed by APRA, together with

other insurance sold in Australia, would be required to include terrorism risk

cover for the classes of insurance covered. As such, all policies of insurance

covered by the Scheme will be required to include terrorist risk cover. The

Government arrangements would then provide 100 per cent reinsurance

of the terrorism risk for insurance companies (up to the limit of the government

indemnity). Insurers’ liabilities will be limited to the funds available from

the Scheme. Universal terrorism insurance is 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.

Farms will be required to be covered for terrorism risk if they hold insurance

against business interruption. Self-insurers would also be able to elect to

be included, although the details have still to be developed as such arrangements

may vary from party to party.

Funding the scheme

Premiums collected from insureds will be paid by insurers to the Scheme in

order to fund the pool and to repay any loan required in the event claims exceed

the resources of the pool. Insurers will remit premiums quarterly in arrears

to the Scheme.

Charges for the administration of the Scheme, the bank line of credit and the

Government indemnity will be met from the pool.

The following premium structure is proposed for the Scheme:

Class of insurance	Initial rate (from 1 July 2003)	Maximum rate (after an event)
Commercial Property*	2%	6%
– surcharge for CBD property	10%	30%
– surcharge for urban property	2%	6%
Public Liability	–	2%

Notes

* Commercial property includes agriculture and forestry, but excludes marine

property, transport and farms not covered for business interruption risk.

In essence, a two tier premium structure is proposed:

• an initial `standard rate’ scale targeted to building the premium pool

  at a rate of about $85 million per annum; and

• a maximum post-terrorist event rate scale, targeted to rebuilding the resources

  of the Scheme in the event of a major incident.

For commercial property, an initial premium of 2 per cent of underlying base

premium would generally apply, with surcharges of 10 per cent and 2 per cent

applying to properties located in capital city CBDs and other urban areas, respectively

(with CBD and urban property to be designated by postcodes). For public liability,

it is proposed that no initial premiums would be charged. The rationale is that

the overall risks from terrorism is very small relative to property risk, hence

only minuscule premiums could be justified, and which in many cases probably

would be uneconomical to collect. Public liability insurance does need to be

covered, however, since there is still a possibility of large losses to a concentrated

few insureds.

Governance arrangements

The Commonwealth will establish a statutory authority to oversee investment

of the pool fund (which may be in the form of a trust fund), negotiate the Commonwealth

facility, the bank credit facility, and agreements with insurance companies

to collect funds and to process claims.

Wind up of the scheme

Once commercial insurance and re-insurance markets begin to re-emerge, the

company will begin to wind up its operations.

In tandem with premium reviews, the availability of commercial insurance for

terrorism risk will also be formally assessed every two years. Factors such

as the rate at which cover under the Scheme will be withdrawn will be addressed

at the time any wind up decision is made.

Appendix 1

Definition of `terrorist act’ and the process for determining when

payment may be made from the Scheme

It is proposed that a definition of `terrorist act’ and the process to determine

when an event is a `terrorist act’ be placed in legislation.

The legislation would require a declaration to be made by the Treasurer, that

an act was a `terrorist act’ for the purpose of the Scheme.

The Treasurer will be required to consult with the Attorney-General and the

Attorney-General would advise the Treasurer whether, in the opinion of the Attorney-General,

the act was a `terrorist act’ (as defined for the purposes of the Pool). In

practice, the Attorney-General would seek advice from relevant intelligence

and law enforcement agencies before providing advice to the Treasurer.

An act would be a ‘terrorist act’ if the act:

(1) was done with the intention of advancing a political, ideological or religious

cause and with the intention of coercing or influencing by intimidation, the

Government of Australia or of another country; or intimidating the public or

a section of the public; and

(2) the act caused damage to property which resulted in either aggregate claims

to at least 2 insurance companies participating in the scheme of $10 million

or more, or claims to a single insurance company participating in the scheme

of $1 million or more.

In the event that the `terrorist act’ arose in the context of an act of advocacy,

protest, dissent or industrial action, the damage would only be covered by the

Pool if the act was intended:

• to cause serious harm that is physical harm to a person; or
• to cause a person’s death; or
• to endanger the life of a person, other than the person taking the action;

  or

• to create a serious risk to the health or safety of the public or a section

  of the public.

This exemption should be included because acts of advocacy, protest, dissent

or industrial action are often carried out with the intention of advancing a

political, ideological or religious cause and with the intention of coercing,

or influencing by intimidation, the Government. The exemption has the effect

of excluding accidental damage to property resulting from otherwise peaceful

protest activity that was not intended to become violent. This exemption is

that same as the exemption for advocacy, protest, dissent or industrial action

in the Security Legislation Amendment (Terrorism) Act 2002.

Administrative law review mechanisms may be available to persons aggrieved

by a decision of the responsible Minister that the proposed claim is not a `terrorist

act’ which is covered by the Pool.