07 Mar 2011

Insurance Industry Roundtable

Fred Hawke joins BRR Media's Insurance Industry Roundtable to discuss possible reforms to flood insurance.


Insurance Industry Roundtable 
David Bushby. BRR Media
Fred Hawke. Insurance & Risk Partner at Clayton Utz
Colin Smith, Strategic Insurance and Risk Solutions
Andrew Mair, Executive General Manager (Intermediated Distribution), Vero

David Bushby
Good afternoon and welcome to the Insurance Industry Roundtable, looking in particular at the flood insurance landscape following on from the recent flooding in Queensland, New South Wales and Victoria.

Here to shed some light on the issues facing the industry we have Fred Hawke who is an Insurance law partner at Clayton Utz in Melbourne, Colin Smith from Strategic Insurance & Risk Solutions, and Andrew Mair who is the Executive General Manager (Intermediated Distribution) at Vero which is an intermediated general insurance company, part of the Suncorp Group.

David Bushby
It has been quite an overwhelming start to the year with record-breaking floods in Queensland then compounded by Tropical Cyclone Yasi battering what we once knew as the Sunshine State, then barely a fortnight later we have one of New Zealand's worst natural disasters devastating Christchurch, all of which have huge insurance implications.

Today we do want to go back to the Queensland floods which prompted various debates around insurance coverage for floods, what's covered, what's not covered, whether we need to change how we define what a flood is, and what role the Government might play in this sector.

Andrew Mair from Vero I want to start with you. Can you just broadly set the scene here? Have we moved beyond some of that emotive criticism that we saw shortly after the Queensland floods, what's happening at that level?

Andrew Mair
I think it may have dissipated a bit but we certainly are still seeing a fair amount of conversation around a number of those topics that you just alluded to.

In terms of a sequence of weather events as an industry we have never had to endure such a quick succession of multiple events like that in terms of major catastrophes so it has certainly been a big test for insurance companies.

At the end of the day by and large the industry has responded particularly well given the pressure that it's under. I know we are talking about things like the role of government and wordings and definitions and things like that, but the main focus for us at the moment is on paying claims and making sure that the people who have got cover are getting what they deserve.

David Bushby
Is it broadly possible to even answer this question: Are the majority of claims being paid out? Give us a sense of how big an issue this is in terms of people's confusion over what's covered and what's not.

Andrew Mair
Look it certainly is a big issue.

If I can just sort of split it between domestic and commercial for a second. From a Suncorp perspective and from a Vero Perspective our domestic policy covers flood so our clients don't have issues with their houses – others don't necessarily have the same sort of level of cover that we offer.

From a commercial point of view it is true that not everyone has flood cover. It is certainly something that you know when we are given the right information we can price. Probably one of the issues that this flood or this sequence of weather events has highlighted. is under-insurance, and in business interruption in particular – all of those things that people haven't really focused on have been brought to the forefront.

David Bushby
Indeed. Fred Hawke at Clayton Utz, I want to bring you in here. What's your broad sense of the issue at the moment?

Fred Hawke
Well David I agree with Andrew that there are going to be very difference legal issues and coverage issues according to whether the insurance is domestic and consumer, or whether it's business and commercial.

For domestic policy-holders who are not insured with a company that provides flood cover the real issue will be legally whether they're covered or not, which will depend on whether it was properly explained to them that when they bought the insurance that it didn't cover floods.

There are some regulatory requirements around flood cover that have been in place for many years which seem to have been pretty much ignored in a lot of the media debate, so the main issue for consumers is "were we told properly when we took this policy out that it didn't cover flood?".

Colin Smith
I wouldn't mind just asking you Fred for your view.

One of the concerns I've had for the typical homeowner is the product disclosure statement that have been effectively legislated in terms of a retail client. Do you feel that those product disclosure statements actually give the insurers a first line of defence in that if they've issued the statement properly, even though it might be 20 pages, we are in accordance with the law and we say in that product disclosure statement "read all this", but the average person doesn't read it all.

Fred Hawke
Well Colin the answer to that will be firstly whether a product disclosure statement you say has been legislated.

All that the legislation says is that a product disclosure statement has to be clear, concise and effective.

Now if it is 50 pages long it may not be clear, concise and effective simply by virtue of its length but there's also a separate issue entirely which is the requirements for notices of derogation from standard cover.

Whether you can comply with a derogation notice by applying a flood exclusion simply by giving the consumer a copy of the policy wording before they enter into the contract, or simply by giving them a product disclosure statement, is a separate legal question and it will depend on just how clear, concise and effective that notice is.

If there was a big black-boxed statement on the front page of the PDS saying this policy does not cover flood, it changes the cover from the standard flood cover provided under the regulations and excludes floods, then the insurer will be fine.

But if it's buried in page 34 and you have to duck and dive to a couple of definitions to work out what flood is, then it may not be effective derogation and that insurer may be covering flood whatever their policy says.

David Bushby
Look can I just interrupt here and maybe stick with you here Fred in terms of what is covered and what is not covered in relation to floods. I understand there will be a difference between the consumer and the business side. Maybe if we can start with the business side. What is covered? Is that easy to explain?

Fred Hawke
Well yes. The main things will be property policies, business interruptions and material damage policies – what in Australia we call the ISRs, Industrial Special Risk policies. They cover material damage to insured commercial product and the resultant business loss.

Now while the Standard Mark IV ISR I think has a flood exclusion on it, a lot of businesses will have bought flood cover. That exclusion is often modified, and sometimes deleted entirely so the main issues are how you calculate their indemnity entitlement.

There are going to be issues around whether the full limited indemnity under the policy is available for the flood cover where it arises from, for example, utility supply interruption or customer supply interruption. That's where there has been material damage caused not to the insured premises but to, say, the local electricity supplier, or to a water utility, or to a major customer of the business, and as a result the insured's business is interrupted.

The other major issue for businesses that I can see coming up is going to be distinguishing the impact on the business during the period of indemnity of other issues besides the actual damage to insured property caused by the flood – for example, impact on the community at large, depression of business activity, people leaving the area, people simply not coming back, or business activity being generally suppressed over a wide area, what they call depopulation issues that sometimes happen after catastrophes.

All of these may affect a business during the indemnity period and the questions the insurers will be asking themselves is how much of this impact on the business is attributable to the actual damage, either to their property or to the utility supplier's property, and how much is just simply other factors affecting the business during the indemnity period.

David Bushby
Well Andrew can I just cross to you from the business perspective. Is that a question that is quite a difficult to answer? How do you get through an issue which is quite complex?

Andrew Mair
Yeah it certainly is complex. Just picking up on a couple of things Fred alluded to – certainly what he said reflects truly with us as well.

The larger corporate clients through their brokers tend to have covered themselves adequately or at least have something in place from a flood perspective. Because we and brokers deal with very small businesses all through the whole spectrum, there is certainly not a consistency of coverage from small all the way through to those large complex businesses.

I think particularly at the smaller end with the smaller businesses there's certainly a lot of potential for confusion about what is covered and what's not covered.

It might be worth also just talking about the policies which are broken up into section 1 and section 2. For the section 2 to be triggered you've really got to have that flood cover sitting in there in section 1 in the first place. There is a multitude of wordings out there so it's hard to be specific about every wording, but by and large if you haven't purchased flood cover the fact that you've got business interruption there may not necessarily mean you're covered if the proximate cause is the flood.

David Bushby
Well Colin I want to get you involved in this next topic: what actually is a flood?

You've got these definitional thing between a flash flood and normal flooding, and Bill Shorten coming out loudly demanding that the industry comes up with a standardised definition of flood. Can you run us through that issue and is there any merit in trying to come up with one definition for all?

Colin Smith
I think if you put this simplistically David I think the big difference is really the difference between riverine flooding as it's been called, so rivers bursting their banks and causing flood damage, versus a flash flood where you either have just torrential rain which causes a flash flood, and/or you have water then coming up through the stormwater pipes and inundating properties that way. I think this is one of the contentious issues.

Where we are on this is not necessarily in accord with what other advisers and brokers would say – certainly not at the moment I understand the Insurers' Council or National Insurance Brokers' Association.

Let's put business to one side for the moment – the last discussion was really more about business people who may have a slightly more sophisticated level of knowledge. Looking at it from the average consumer's point of view, the concern that we have is that the average consumer just doesn't really understand the subject-matter.

This will really raise some eyebrows but I want to put it on the table: we need to find a way to call water damage water damage. I don't really care how it occurs unless it is a consequence of, for instance, poor maintenance of a property so the water gets in because the property was poorly maintained. If you think about what's recently happened in the floods it's water damage and it's come into the property from various sources. That's going to provide some real challenges if we get to that next step, but it would simplify it.

Really interestingly yesterday I came across a paper by PWC which was delivered in November 2010 before the floods calling for a government scheme based on precedents elsewhere in the world and in particular New Zealand, and of course we've had all these events since so there was a bit of serious thinking going on here.

My view is that I was around when this 1974 floods occurred as well and it just over a period of time people forget and governments forget, councils forget. Before you know it there's the population growth, and people are actually building in these areas.

I think there needs to be a plan where insurance is compulsory for floods and to do this it's no different from what we've seen in the terrorism scheme, where if you want terrorism cover then you have to go into the government reinsurance pool which I believe at the moment has about $2.5bn in it. My view is that we need to put the scheme together with the Government and the insurance companies working hand-in-hand.

How it would work in our vision is that the Government would provide a reinsurance pool for flood and, by the way, potentially other catastrophes, earthquake, cyclone – bushfire might be another one – because the insurance industry ultimately may find it difficult if climate change is real to continue to provide this cover economically.

Let's take it a step further. If we set up this pool then we would advocate that if you want to issue a home insurance policy in Australia you have to provide flood cover, it's compulsory, and the flood has a definition that has been mutually agreed between insurers and the Government and set down in law. Again as I say simplistically I'd love to see it as water damage with a few provisos. In that situation what then happens is that a person buys the policy, they have the cover, the flood occurs. What can happen in the interim is if an insurer does not want to provide the flood cover per se in that region they go to the Government reinsurance pool and they pay a premium and pass it onto the consumer. The Government has to then take a role in that region being charged a certain amount of money and then I think the next step is that because what happens inevitably is the Government reinsurance pool will be selected against for obvious flood exposure and/or other perils the Government will then have to start getting serious about risk management in flood-prone areas.

I think that has a fantastic swing back into the consumer because we are solving the problems of misunderstandings about what flood really is and at the same time we're also saying to Government "do you want people to live in known flood-prone areas, do you want to provide them with insurance or alternatively would you prefer just to wait to see what happens next time and ask the taxpayers for a levy and for a donation?" For me this is a completely unacceptable outcome.

Andrew Mair
Can I just jump in on the flood issue in terms of the definition.

I think a couple of years ago some of you may recall that the industry through the ICA tried to work with the various stakeholders to come up with a common definition of flood and it was actually the ACCC that ultimately put a stop to that, so it certainly is not a new issue, and it's clearly had a lot of profile lately.

The definition is not going to help the people that have been impacted as in the most recent events. It will certainly potentially prevent future confusion and that's probably worth thinking about, but I don't think it's fair to say that the industry has not done anything or imply that the industry hasn't done anything about it.

I think they've certainly tried, because every time something like this happens it becomes a very very emotional issue. I think it's going to take a lot of co-operation between Government, industry, all levels of industry and all levels of government to come up with an economical and viable solution that's palatable to everybody.

Colin Smith
But if you look Andrew at the precedent with a terrorism pool, Wayne Swan is the person who has to decide who gets paid and also decide what terrorism actually means.

From our perspective I accept what you are saying and I’m not being critical of the industry as such but as you know 1974 was the last flood, we've had a lot of events since then and from the consumers' perspective (and I'm an adviser and broker so I'm very much in this industry space) I believe that there isn't enough certainty from a consumer's perspective and that's because in a normal competitive environment different insurance companies are entitled to offer cover on varying basis and they are advised by different law firms as to how those words should stack up.

Andrew Mair
And they've also got access to different data and things like that that allowed them to price more confidently.

Colin Smith
Absolutely, so all I'm really saying is the reinsurance pool that the Government creates enables every insurer to issue a policy with flood cover in it on a pre-agreed definition which everybody has agreed to, the Government signed off on and you have the opportunity as an insurance company to actually reinsure to the pool or not.

But you have to issue flood cover on that basis or don't issue the policy at all. This happens a lot in the US where they prescribe how the policy must be issued for certain issues like earthquake. We've had the National Flood Insurance Programme in the USA for some years, we've had New Zealand with its earthquake fund going back to, I think, 1970-odd from memory. France have got a similar arrangement, Switzerland's got another one and that seems to be sort of the trend around the world. One wonders whether the global warming situation is a real push on this.

So I'm really seeing at the moment, listening to the television, there just seems to be so much uncertainty about what flood actually means, and that can't be good. I don't know that we've got the perfect answer, I'm just really saying I think there is another way to look at this.

The one thing I would say and I will be happy to be quoted on this and have been every day the one thing we don't want is the Government trying to run insurance, because we already know what they are like at running these sorts of things, they virtually closed down every insurance office that was ever set up.

Andrew Mair
And I think depending on the specific peril your talking about there's only a relatively small amount of the population – even though these are big events, if you think about it from a housing point of view there's around 10 percent of places have a flood exposure and an even smaller percentage has a bush fire exposure – so it's about understanding the true magnitude of the issue and who actually has the exposure.

Colin Smith

Andrew Mair
And making those sorts of decisions about what's economic to provide, what should the community bear, and what should the individuals who are more exposed to that risk than others bear.

Fred Hawke
Colin's legislative solution would work.

I was involved in setting up the Terrorism Insurance Act in 2003 and the Australian Reinsurance Pool Corporation and that same principle could certainly be applied to floods and other natural disasters.

The real thing of course you've got to remember is that there's no such thing as a solution which is going to give everybody everything they want and this won't give consumers everything they want either.

One of the features of the Terrorism Reinsurance Pool is that in the event of a declared terrorist incident the Minister can also declare what he calls a reduction percentage and that would essentially reduce proportionately the liabilities of all of the insurers under the terrorism cover that they have to give under their policies so as to cap the liability of the statutory reinsurer at the amount of its assets, so that the general revenue is not hit and the pool doesn't go bankrupt, the pool can't go broke.

Now it may well be that in relation to a mandatory scheme giving everybody flood cover, there would have to be some adjustments, that not everybody would get a full indemnity necessarily, and that proportionate reduction might be applied on a sliding scale basis according to the profile of the area where the buildings taking place. That might be another way of addressing it.

David Bushby
Andrew I wanted to throw another point to you. You guys obviously have an operation in New Zealand as well and Colin had mentioned there was the scheme that's been operating there in relation to earthquakes since the 1970s. I guess we've got an example in hand right now – how is that scheme performing, has it worked, is it adequate or is too early to tell?

Andrew Mair
I think it's probably a little early to tell.

I think over an extended period of time it has served its purpose and I think with the earthquake issue in New Zealand they have far more of an issue about frequency. You hear some of the statistics about how many tremors and things they have every year over there, that's a far more likely event than and predictable, in the sense that they know that because they are sitting on fault lines that these things are going to happen.

What they don't know is when and the severity of them and because it's such a relatively small pool over there too I think insurers would find it difficult to be able to bear all that risk themselves. That's probably why the government there thought there was a role for them to step in and participate. Again on a global scale you know Australia is a very small populated country so those sorts of things you need to think through quite carefully before you go there.

David Bushby
Colin, considering the demographic or geographic difference that New Zealand has, will the scheme work in Australia and this instance?

Colin Smith
Well I think it will work better because we've got more critical mass, so we've got a bigger population to support the scheme. I think that's a really critical issue.

Just as a matter of interest I just checked my notes. The New Zealand Earthquake Authority started in 1945 and as at November before the most recent earthquakes it had $6bn in funds so it will be interesting to see how that's tested. You can imagine there's going to be a range of levies or whatever required but the Government is certainly going to have some work on its hands, but I think that the advantage we have in reality is that we've got a large spread of people compared with New Zealand, plus we also have far less areas in flood-prone situations than we do in non-flood-prone situations.

I think there's a real prospect that with the support of the Government we could pull the backup reinsurance pool off very successfully. In my view the insurers would continue to prosper because they would have that fall-back scenario, the consumer would prosper because they're be some inadvertent certainty over the definition of water damage as we'd like to call it. So I really don't see too many downsides in this as I sit here with a crystal ball.

David Bushby
Okay well look guys we're are way over time. I'm afraid I'm going to have wrap it up there, but some fantastic insights we will continue to keep a very close eye on this as it unfolds and some changes I'm sure will come through at some point.

We are out of time so I would like to thank you again Fred Hawke at Clayton Utz, Colin Smith, Strategic Insurance and Risk Solutions, and Andrew Mair, Executive General Manager (Intermediated Distribution), Vero.

David Bushby
And listeners thank you for tuning in. If you have any questions for Fred Hawke please send a message on [email protected].

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