Basis of the schemeBackground
The Terrorism Insurance Act 2003 establishes a scheme for replacement terrorism insurance coverage for commercial property and business interruption. The Scheme will commence on 1 July 2003.
The scheme is in response to calls for government intervention in an area of clear market failure as cover for terrorism insurance was withdrawn progressively by insurance and reinsurance companies in the aftermath of the terrorist attacks in the United States on 11 September 2001. Where cover has still been made available since that time, premiums have been at levels that exceed perceived cost of risk with large excesses and low maximum coverage.
The scheme has been developed in consultation with key stakeholders including insurance and reinsurance companies, banks, property owners and industry associations, brokers and actuaries. The Government also received expert advice from Trowbridge Deloitte.
For a copy of the Reinsurance Agreement For Terrorism Risk, or to find out more, Contact us.
The Scheme
The Terrorism Insurance Act 2003 effectively deems terrorism risk cover into eligible insurance contracts and establishes the Australian Reinsurance Pool Corporation to manage the scheme.
As terrorism exclusion clauses are rendered ineffective by the legislation, payouts available to holders of eligible insurance contracts for terrorism losses will depend on the underlying coverage in the eligible insurance contract. For example, if a terrorist act caused a fire, then a policyholder would be able to claim for subsequent loss, if their insurance policy would normally cover damage from fire.
Coverage
The scheme covers insurance for loss of or damage to commercial property that is owned by the insured, insurance for business interruption arising from loss of or damage to or inability to use eligible property, and insurance for liability of the insured arising from ownership or occupation of eligible property.
Private residential property is not included in the scheme.
Risk cover is for any declared terrorist incident, except events involving damage from nuclear causes (see below).
Coverage will be available for Commonwealth and State business enterprises as well as Commonwealth-owned airports leased commercially.
Farms will benefit from cover for terrorism risk if they hold insurance against business interruption.
The Regulations also exclude certain other types of insurance coverage, including: marine insurance, aviation insurance, motor vehicle insurance, life insurance, health insurance, private mortgage insurance, medical indemnity insurance, and professional indemnity insurance.
Australian Reinsurance Pool Corporation
Insurance companies will be able to reinsure the risk of claims for eligible terrorism losses through the Australian Reinsurance Pool Corporation. Premiums insurance companies pay for reinsurance to the Australian Reinsurance Pool Corporation will build up the first layer of funds (an expected pool of $300 million) available to cover claims from declared terrorist incidents. 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.
The following reinsurance premium structure is initially mandated for the Scheme:
| Class of insurance | Initial rate (from 1 October 2003) |
Maximum rate (after an event) |
|
|---|---|---|---|
| Commercial Property | - Tier A | 12% | 36% |
| - Tier B | 4% | 12% | |
| - Tier C | 2% | 6% | |
| Business Interruption | - Tier A | 12% | 36% |
| - Tier B | 4% | 12% | |
| - Tier C | 2% | 6% | |
| Public Liability | - | 2% | |
In essence, a two tier reinsurance premium structure is proposed:
- An initial ‘standard rate’ scale targeted to building the premium pool at a rate of about $100 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 and associated business interruption, an initial premium of 2 per cent of underlying base premium would generally apply (Tier C), with surcharges of 10 per cent and 2 per cent applying to properties located in most capital city CBDs (Tier A) and other urban areas (Tier B), respectively (with Tier A and Tier B to be designated by postcodes). For public liability, it is proposed that no initial premiums would be charged.
A transition period for eligible insurance contracts entered into up to 1 October 2003 is necessary, as terrorism risk coverage will be deemed into existing contracts without any charges for such coverage being levied until the date of renewal. During this period, reinsurance will be provided by the ARPC free of charge.
The premium paid by policyholders will not necessarily equal the reinsurance charge paid by insurers, since insurance companies will need to recoup administrative expenses and separately price the up to $1 million per annum risk they must retain when reinsuring with the ARPC. In assessing price increases, policyholders should be mindful to the rate charged to insurers by the ARPC.
Definition of ‘terrorist act’
A definition of ‘terrorist act’ for the purpose of this scheme together with the process to determine when an event is a ‘terrorist act’ is set out in Section 6 of the Act.
The legislation requires a declaration from the Treasurer, following consultation with the Attorney General, that an act was a ‘terrorist act’ for the purpose of the scheme.
