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Major Changes to Flood Insurance Proposed.

9 December, 2011

 

In brief:

 

Flood cover may become mandatory in home building and home contents insurance policies, among other significant changes proposed in the Natural Disaster Insurance Review Panel’s final report on its inquiry into flood insurance and related matters.

 

How does it affect you?

 

  • A standard definition of ‘flood’ for insurance policies is proposed.

 

  • Flood cover in home building and home contents insurance policies may become mandatory.

 

  • The Federal Government is considering a system of premium discounts for policyholders in areas that are subject to flood risk, along with the establishment of a flood risk reinsurance pool.

 

  • Also being considered are changes to the Insurance Code of Practice that would affect the way in which insurers handle claims and disputes relating to natural disasters.

 

Background

 

Following a series of natural disasters, including the Queensland floods and Cyclone Yasi, in late 2010 and early 2011, the Federal Government commissioned the Natural Disaster Insurance Review Panel to conduct an independent inquiry into flood insurance and related matters.

 

On 14 November 2011, the Review Panel released its final report, containing 47 recommendations to the Government, addressing issues including:

 

  • mandatory flood cover;

 

  • the establishment of a flood reinsurance pool;

 

  • a standard definition of ‘flood’; and

 

  • improving consumer awareness of the nature of their home insurance cover; and

 

  • insurance claims handling and dispute resolution processes.

 

Mandatory flood cover and the flood reinsurance pool

 

The Review Panel recommends that all insurers have to offer flood cover as part of home, home contents and home unit insurance policies. It does not recommend that home insurance itself (for all perils, including flood) be made compulsory for all homeowners.

 

To address the affordability of flood insurance cover, the Review Panel recommends the introduction of a system of premium discounts that would be available to most purchasers of home, home contents and home unit insurance policies in areas subject to flood risk. Only existing dwellings would be eligible for the discounts, and the discounts would be phased out gradually over time.

 

The flood premium discounts would be delivered through the establishment of a flood risk reinsurance pool. The proposal would require insurers to retain a portion of the flood risk, and to underwrite and price that portion of the risk themselves. The remainder of the risk could be ceded to the reinsurance pool at a discounted reinsurance premium. It would be at the insurers’ option whether to cede risks to the pool, but the pool would be required to accept all risks at pre-agreed prices.

 

The reinsurance pool would be funded, as needed, by the Federal Government, thereby guaranteeing the payment of claims. Whenever a funding shortfall occured in the reinsurance pool, the Government would meet it, and then seek reimbursement for a portion of the shortfall from the government of the state or territory in which the flood occurred.

 

In relation to small businesses, the Review Panel recommends that all insurers offering small business insurance be obliged to include flood cover on an opt-out basis in all their small business package policies. However, it does not recommend that premium discounts be provided to small businesses, nor that the reinsurance pool offer reinsurance for small business risks.

 

A standard flood definition and improving consumer awareness


In order to address consumer confusion around the various definitions of ‘flood’, the Review Panel recommends that the Federal Government introduce a standard definition of ‘flood’ for home building and contents insurance policies. The standard definition would be mandatory, with no ability to opt out or vary the definition, and would be in the following terms:

 

“Flood means the covering of normally dry land by water that has escaped or been released from the normal confines of:

  • Any lake, or any river, creek, or other natural watercourse, whether or not altered or modified; or
  • Any reservoir, canal or dam.”

 

The Review Panel also makes a number of recommendations that seek to improve consumer awareness at the time of purchase of home and home contents insurance policies, including:

 

  • amending s35(2) of the Insurance Contracts Act 1984 (Cth) so that policyholders are not deemed to be clearly informed of a deviation from ‘standard cover’ merely by being provided with a copy of the insurance policy or the product disclosure statement;

 

  • requiring that a plain English one-page ‘Key Facts Statement’ be provided to purchasers, to allow them quickly and easily to check the basic terms of the insurance policy, including the nature of the cover and any key exclusions; and

 

  • where full replacement or full flood cover is not provided, insurers must include a ‘health warning’ in the Key Facts Statement.

 

Handling of claims and dispute resolution

 

The Review Panel recommends a number of changes to the General Insurance Code of Practice to improve insurers’ handling of claims and disputes relating to natural disasters, including:

 

  • repealing clauses 4.3 and 4.4 of the Code, so that claims arising from natural disasters are subject to the same minimum standards as other claims;

 

  • imposing a four-month time limit (subject to exceptional circumstances) on insurers to decide whether to accept or reject liability for a claim, for all claims including those made during natural disasters;

 

  • requiring that insurers’ internal dispute resolution processes are independent of their claims department, and have the authority to overturn original decisions and to accept claims; and

 

  • introducing a general fairness test to be applied to claims and complaints handling.

 

Other recommendations

 

Other recommendations of the Review Panel include:

 

  • establishing an agency sponsored by the Federal Government to manage the national coordination of flood risk management and operate the flood risk reinsurance pool;

 

  • requiring all home building insurance policies that offer sum insured cover to be modified by the end of 2014, so as to offer full replacement cover in the event of total loss of the home;

 

  • applying unfair contracts terms laws to general insurance, so that general insurance policyholders are given the same legal remedies as other consumers; and

 

  • requiring that all Australian Prudential Regulation Authority-authorised general insurers adopt and comply with the General Insurance Code of Practice.

 

Commentary

 

It would appear that the core proposal is the requirement that insurers offer flood cover at a premium determined by them for home building and home contents insurance policies. Insureds will be permitted to opt out of the cover and, no doubt, they will do so in one of two circumstances – where the relevant residence is clearly not subject to any flood risk; or where there is significant flood risk but the premium is unaffordable. The latter is likely to be the major problem area, unless there is some support mechanism that results in premiums becoming affordable, particularly for those already living in flood-prone areas. Logically, premiums will be quite high in some cases. This raises the spectre that, in future floods, the issue will not be whether or not cover had been available but, rather, the affordability of that cover, which may also be reflected in underinsurance, leading to similar issues to those faced after the Victorian bushfires of 2009.

 

This suggests that the proposal for a flood reinsurance pool is fairly critical to the long-term viability of the other proposals. However, the Federal Government does not appear to be prepared to embrace such an arrangement, or other forms of premium support, and questions therefore arise as to whether the industry may, with appropriate approvals to deal with the competition effects, be able to establish such an arrangement itself, so that there is some pooling of risk and, thus, the ability to make premiums more affordable even if they may still be relatively high.

 

Next steps

 

The Federal Government has proposed a series of measures in response to the Review Panel’s recommendations:

 

  • public consultation on the proposal requiring all insurers to offer flood cover in home building and home contents insurance policies, while allowing consumers to opt out of the cover. The closing date for submissions is 30 March 2012;

 

  • the introduction of the standard definition of ‘flood’, as recommended by the Review Panel, which all insurers must use if they offer flood cover to consumers in home and home contents insurance policies, and some small business and strata title insurance policies. Draft regulations will be released for consultation before the end of this year;

 

  • insurers will be required to provide their customers with a one-page Key Facts Sheet for all home and home contents insurance policies;

 

  • the industry has been asked to provide its views to the Federal Government on the recommended changes to the General Insurance Code of Practice to improve insurers’ handling of claims and disputes relating to natural disasters by the end of February 2012; and

 

  • a further consultation will occur in 2012, regarding a system of premium discounts and the establishment of a flood risk reinsurance pool.

 

 

For further information, please contact:

 

Dean Carrigan, Allens Arthur Robinson

dean.carrigan@aar.com.au

 

John Morgan, Allens Arthur Robinson

john.morgan@aar.com.au

 

Katherine Hayes, Allens Arthur Robinson

katherine.hayes@aar.com.au

 

Andrew Lazzaro, Allens Arthur Robinson

andrew.lazzaro@aar.com.au

 

 

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