How ARPC’s Terrorism Insurance Pool operates
The pool was established on 1 July 2003 to provide eligible insurance contracts with terrorism cover for any Declared Terrorist Incident (DTI). Eligible insurance contracts are defined in the Terrorism Insurance Act 2003 (TI Act) and further refined through regulation.
The Minister, in consultation with the Attorney- General, determines whether a terrorist incident has occurred in Australia. They do so through the application of a consistent definition of terrorism, one used across Australian Government legislation, which draws on the meaning of a terrorist act contained in the Criminal Code. Once the Minister is satisfied that a terrorist act has occurred, the Minister must announce a DTI under section 6 of the TI Act. Upon that declaration, the provision of the TI Act in respect of eligible terrorism losses becomes effective and renders terrorism insurance exclusion clauses in eligible contracts of insurance invalid.
Under the TI Act, insurers have three options in respect of providing terrorism insurance coverage for a DTI. They can:
- carry the underwritten risk of terrorism losses following a DTI, or
- reinsure the risk through the commercial reinsurance market, by entering into a reinsurance contract and paying terrorism reinsurance premiums, or
- reinsure the risk with ARPC by entering into a reinsurance contract and paying terrorism reinsurance premiums.
If an insurer chooses to reinsure the risk of claims for eligible terrorism losses following a DTI with ARPC, they do so by entering into a reinsurance contract and paying reinsurance premiums to ARPC. In most major economies similar arrangements exist, with some government involvement through terrorism reinsurance pools.
Commercial businesses that are insured with ARPC’s insurer customers and which hold eligible insurance policies are covered by the Pool in the event of a DTI. Insurers are required to meet claims in accordance with the other terms and conditions of individual policies.
Pool coverage excludes loss or liability arising from the hazardous properties of nuclear fuel, material or waste. Pool coverage also excludes residential property not identified as eligible property. Farms can obtain cover if they hold insurance against business interruption.
Insurer and industry retentions (deductibles or excesses) apply before claiming against the pool. Claims against the pool will be met once an individual insurer’s retention is exhausted. In this way, and in line with good risk management practices, the pool requires insurers to retain the first portion of any loss.
ARPC’s pool of retained earnings is used to pay claims up to the agreed private retrocession deductible ($225 million for the 2021 calendar year). Above this point, an additional $3.475 billion of claims are funded by the retrocession program with global reinsurers.
Once retrocession is exhausted, claims are paid by the Commonwealth guarantee. These claims may have a reduction percentage applied if claims in this layer exceed the $10 billion limit of the Commonwealth guarantee as legislated in the TI Act. If insurance companies are not reinsured with ARPC, then they are liable for the cost of claims resulting from the DTI on all eligible policies up to their pre-existing policy limits with no reduction percentage applied.
The pool funding capacity is the total value of the pool, which as at 30 June 2021 totalled $13.7 billion. The pool’s benefits include efficient pooling of risk for terrorism catastrophe, particularly when capacity is limited and prices are high (which occurred following the terrorist attacks in the United States of America on 11 September 2001). Since then, ARPC has begun the gradual transfer of risk back to the global reinsurance market in line with incremental increases in global terrorism insurance capacity, thus reducing reliance on the Commonwealth guarantee in the event of a DTI.
In 2021, ARPC reduced the retrocession deductible by a further $25 million to be $225 million. This provides ARPC with more capital to reinstate the pool in the event of a DTI and is in accordance with the recommendations from the recent ANAO report.
Background to the pool
Significant commercial and financial issues resulted from insurance and reinsurance companies’ withdrawal of coverage for terrorism risk following the events of 11 September 2001. With a large pool of assets uninsured for terrorism risk, financiers and investors faced uncertainty, which could have resulted in adverse economic circumstances, delayed commencement of investment projects and altered portfolio management decisions going forward. For these reasons, the Government’s response was to create the TI Act, which attracted bipartisan support.
In July 2003, the TI Act stipulated a pool that provided terrorism cover on eligible insurance contracts (the pool) and established the Australian Reinsurance Pool Corporation (ARPC) to administer it.
ARPC’s functions of corporation under section 10 of the TI Act are:
- to provide insurance cover for eligible terrorism losses (whether by entering into contracts or by other means); and
- any other functions that are prescribed by the regulations.
The activities that ARPC undertakes to support the functions of corporation include:
- maintaining, to the greatest extent possible, private sector involvement
- appropriately pricing and compensating the Australian Government for risk transferred to it
- allowing for the re-emergence of commercial markets for terrorism risk cover, and
- responding to global solutions.
The total capacity of the pool at 30 June 2021 stood at $13.7 billion including all sources of funding.
Contracts of insurance covered by the Pool are those that provide insurance for:
- loss of, or damage to, eligible property that is owned by the insured
- business interruption and consequential loss arising from:
- loss of, or damage to, eligible property – that is owned or occupied by the insured, or
- inability to use eligible property, or part of eligible property, that is owned or occupied by the insured, and
- liability of the insured that arises out of the insured being the owner or occupier of eligible property.
Eligible property is property located in Australia comprising:
- buildings (including fixtures) or other structures or works on, in or under land (roads, tunnels, dams and pipelines are examples of eligible property)
- tangible property located in, or on, such property, and
- property prescribed by regulation.
Among the pool’s exclusions are:
- loss or liability arising from the hazardous properties of nuclear fuel, material or waste
- residential property or the contents of residential property where the building, or a group of buildings on a single strata policy, has a sum insured less than $50 million
- farms, unless they hold insurance against business interruption
- life insurance policies that fall within the meaning of section 9 of the Life Insurance Act 1995, and
- contracts of insurance to the extent that they provide cover for loss arising from computer crime.
Pool funding capacity
As at 30 June 2021, ARPC provided insurers with an annual claims funding capacity of $13.7 billion in reinsurance capacity, comprising funding of ARPC’s retrocession deductible, the retrocession program and the Commonwealth guarantee. Since 2009, ARPC has placed an annual retrocession program, purchasing more than $3 billion capacity through more than 70 reinsurers rated A- or better by Standard & Poor’s or AM Best, many of which are located overseas.
Terrorism claims against the pool are funded in a layered order:
- policyholder deductible (the excess or retention stated in the underlying policy)
- insurer retention (retention stated in ARPC’s reinsurance agreement with insurer customers) up to a maximum industry retention (total retention from all insurer customers involved in one calendar year)
- a $225 million ARPC retrocession deductible
- retrocession capacity of $3.475 billion and
- a Commonwealth guarantee of up to $10 billion.
A reduction percentage must be specified if the Minister considers that, in the absence of a reduction percentage, the total amounts paid or payable by the Australian Government under section 35 of the TI Act (including amounts not related to the act or acts specified in the declaration) would be more than $10 billion.
By notice in the Australian Government Gazette, the Minister may vary the reduction percentage, but only by making it smaller and the percentage may be varied more than once. Once the reduction percentage is applied, insurers covered by ARPC would have no liability for any costs above their retention (regardless of sums insured) and eligible policyholders would receive a reduced claim payment from their insurer. After the reduction percentage figure announcement, the Australian Government can decide to revise this figure (only to decrease it) which would increase claim payments to policyholders.
If an insurer is not reinsured with ARPC, that insurer is liable for the full costs of a DTI claim. They will not be protected by the reduction percentage and must pay claims to the limit of the policy sum insured, subject to the policy terms and conditions.
How the pool is administered
ARPC’s premium and investment income is used to:
- fund its operations and build a reserve to meet future claims
- pay retrocession premiums
- pay any fees and dividends to the Australian Government for the provision of the Commonwealth guarantee.
The premium charged by ARPC for reinsurance is determined by Ministerial Direction. The tier rates charged by ARPC are shown below.
The premium tiers have been set by postcode, having regard to the population density in a postcode area. Tier and broad geographical location illustrates the breakdown of the three premium tiers and the broad geographical location to which they relate.
Reinsurance premiums payable by insurer customers to ARPC are calculated as a percentage of the premium processed by the insurer for eligible insurance contracts. The pool provides for tier rates to be adjusted following a claim on the pool, enabling ARPC to meet its outstanding claims liabilities and rebuild the claims reserve within an acceptable timeframe.
ARPC’s retrocession program continues to provide the following benefits:
- increases overall pool capacity
- positions the Commonwealth further away from the risk of terrorism losses under the pool
- reduces the likelihood that a reduction percentage will be required
- facilitates inflow of foreign funds to rebuild Australian assets following a terrorism incident, and
- encourages the return of the commercial terrorism insurance and reinsurance market for Australian risks.
The retrocession program renews on 1 January each year. The 2021 placement of $3.475 billion includes $2.57 billion of capacity written on a multi-year agreement to reduce pricing volatility for ARPC and its retrocessionaires. The multi-year agreement allows adjustment if ARPC’s portfolio changes by more than 10 per cent year-on-year or cancellation if ARPC’s audited forecast premium income reduces by 10 per cent or more.
There are currently 73 participants in the retrocession program drawn from the Australian market and from the Lloyds, European, Bermudian, USA and Asian markets. Retrocession program counterparty credit rating CY 2021 illustrates the split of retrocessionaires by their Standard & Poor’s and/or AM Best credit rating.
The 2021 $3.475 billion (2020: $3.45 billion) retrocession program was placed in five layers in excess of $225 million (2020: $250 million). Losses which exceed the retrocession program are covered by the Commonwealth guarantee.
Retrocession is placed on a calendar year basis from 1 January. The net retrocession premium expense incurred for the 12 months to 30 June 2021 totalled $64.9 million gross (compared with $62.8 million in 2019-20).
ARPC modelling capabilities
ARPC commissioned and specified the development of world class geospatial catastrophe modelling through its collaboration with both Geoscience Australia (GA), Australia’s public-sector geoscience organisation and Risk Frontiers.
Three-dimensional blast model
ARPC uses its insurer customers’ sum insured aggregate figures and building sum insured surveys in the three-dimensional (3D) blast model, developed in collaboration with GA. ARPC’s 3D geospatial blast model is intended to accurately analyse pressure waves and resulting damage from blasts in all Tier A locations.
The blast model includes the most built-up CBD areas of Sydney, Melbourne, Brisbane, Adelaide, Perth and Hobart with multi-location analysis conducted in those cities to review expected losses from different sized explosive charges.
ARPC, in collaboration with GA, maintains its capability to analyse exposure and potential damage from the release of a biological or chemical agent in Sydney and Melbourne CBDs. This capability draws on the expertise of several government agencies including GA, the Bureau of Meteorology, Defence Science and Technology Group and the Australian Federal Police, as well as external consultants.
ARPC regularly analyses various plume scenarios including mobile drone delivery systems of selected agents in Sydney and Melbourne.
GA forms an integral part of ARPC’s blast and plume analytical capability.
ARPC has entered a new three-year maintenance and development program for 2021-24 to keep both models current and to expand the model’s capability to include stochastic analysis in city locations.
ARPC continued to develop the geospatial two-dimensional (2D) blast model that incorporates some three-dimensional attributes covering all mainland locations in Australia and can estimate the business interruption from police exclusion zones applied to attack sites. This geospatial catastrophe model is based on the original 2D blast model developed by Risk Frontiers in 2007 and was commissioned in 2020.
Exposure risk management
A key Australian Government expectation is that ARPC will be able to advise the Minister of the estimated reinsured losses (under the Pool) in the event of a DTI. This estimate will be used to inform the calculation of an appropriate reduction percentage.
To address this issue, ARPC implemented a strategy to develop its capability to:
- analyse aggregate sum insured information
- estimate its probable losses in the event of a DTI, and
- provide evidence-based advice to the Minister on an appropriate reduction percentage.
Global terrorism reinsurance pools
Many foreign governments and insurance markets have introduced insurance pools with government participation. Some were created in response to the events of 9/11, while others were established in response to specific terrorist or war threats within each country.
Terrorism insurance pools are the global standard approach to providing cost effective reinsurance for terrorism catastrophe. There are 23 pools around the world offering similar arrangements. Terrorism reinsurance pools lists the international terrorism insurance pools in place today.
Insurer customer review program
ARPC undertakes insurer customer reviews on a regular basis. These reviews verify that insurer customers are meeting their obligations under ARPC’s reinsurance agreement. The following table details the number of reviews conducted over the past four years.
* Includes reviews on Lloyd’s syndicates
** Includes reviews on Singapore-based captive insurers
***The review of Lloyds` syndicates initially scheduled in May 2021 was deferred due to the ongoing impact of COVID-19 and border restriction
Insurer customer review trends
Most insurer customers were found to have high levels of compliance but there were some errors. In recent years, ARPC has observed and addressed the following types of errors in some reviews:
- out-of-date postcode tables
- back-calculation of gross written premium (GWP)
- terrorism exclusion clauses that are ambiguous or which could have unintended consequences
- incorrectly considering insurance contracts which contain a terrorism sub-limit to be ineligible under the TI Act
- not recognising pollution and contamination exclusions as terrorism exclusion clauses for the purposes of the TI Act
- incorrect calculation of premium that contains broker commission which results in over or under payment of premium
- incorrect calculation on premium that contains Withholding Tax (WHT) resulting in over or under payment of premium, and
- staff turnover within the insurer customer, leading to a lack of understanding of ARPC processes.
ARPC is committed to working with insurer customers to reduce the incidence of these issues.
Active insurer customers’ reinsurance agreements
ARPC’s active reinsurance agreements (or treaties) with insurer customers increased to 237 in 2020-21, compared to 227 in 2019/20.
The percentage split between each category is illustrated in Active client reinsurance agreements* below:
The Gross Written Premium (GWP) trend reported by insurer customers is measured by insurer customer type, premium by tier, premium by state and premium by business class.
Insurance premium report
The following tables show that GWP by tier, state and business class (between 2017 and 2021) has remained stable, with most premium generated from Tier B.
Insurance risk report by underwriting year shows that the annual change in ARPC premium revenue is directly related to changes in insurer customer premium rates, aggregate sum insured and ARPC premium rates. The overall growth is indicative of the market change in premiums for commercial risks over time, while the increase in premium as a percentage of insurer customer GWP shows the impact of the ARPC rate change implemented by Ministerial Direction in early 2016.
* The premium revenue for the 2020-21 underwriting year of $258 million is the amount to 30 June 2021 as at 8 August 2021
** The 2020-21 risk reports are submitted into our RISe platform from July 2021 until September 2021. Therefore this information is not available as at 30 June 2021
Insurance risk report for 2019-20 by tier (as at 30 June 2020) shows the breakdown of premium income and sum insured by tier, indicating that ARPC’s exposure is mostly located within Tier B, followed by Tier C. This is consistent with ARPC’s portfolio being mainly ‘business package’ risks located in suburban areas followed by ISR policies covering major infrastructure in rural areas.
Insurance risk report for 2019-2020 by state, as at 30 June 2020 indicates that the vast majority of ARPC’s exposure is in New South Wales, Victoria and Queensland. Much of the premium income is derived from NSW, followed by Victoria, owing to the higher volume of risks located in Tier B.
Aggregate sum insured reports
ARPC’s reinsurance agreement requires each insurer customer to provide an annual aggregate sum insured report by 31 August each year. The report summarises the aggregate sums insured amounts at postcode level for all postcodes and at street address level for the five main central business district Tier A locations as at 30 June. The information is uploaded by insurer customers directly into ARPC’s RISe system, which enables ARPC to analyse the distribution of exposure risk across Australia. The analysis includes the ability to report aggregate sum insured exposures.
Aggregate sum insured amounts by tier, Percentage of aggregate sum insured held by tier 2019-2020 and Aggregate sum insured by tier 2019-2020 provide an overview of ARPC’s total exposure based on information provided by insurer customers as at 30 June 2020.
The exposure report by state allows ARPC to identify the correlation between state exposures and collected premiums and the relative size of assets in each state.
ARPC supports the Treasury with the 2021 Triennial Review
The Terrorism Insurance Act 2003 requires that a review be conducted at least once every three years to test whether market failure for terrorism insurance exists and therefore whether the Act should continue. Previous reviews have also been used as an opportunity to improve the pool.
Previous reviews completed in 2006, 2009, 2012, 2015 and 2018 each found there was insufficient terrorism insurance available commercially on reasonable terms, and concluded that the Act should continue in operation, subject to further review, in no more than three years.
The terms of reference for the 2021 Triennial Review comprise:
- whether there continues to be market failure in the private sector supply of terrorism insurance, and consequently whether there is a need for the Act to continue
- whether the governance, administration and resourcing of the pool remain appropriate, including interactions between the Cyclone Reinsurance Pool and the Terrorism Reinsurance Pool and
- whether the risk of cyber terrorism causing physical property damage should be included in the pool.
ARPC supports the review including connecting stakeholders to The Treasury if they wish to provide input into the Review.
As in previous years, The Treasury is responsible for undertaking the 2021 review and preparing a report for ARPC’s Minister, The Hon. Michael Sukkar MP, Assistant Treasurer, Minister for Housing and Minster for Homelessness, Social and Community Housing.
The 2021 Review is due to be presented to the Minister by 31 December 2021.
Cyclone reinsurance pool proposal
The Government would provide a $10 billion annually reinstated guarantee to ARPC in support of administering the cyclone reinsurance pool.
On 5 May 2021, the Australian Government announced that it intended to establish a reinsurance pool to cover cyclone and related flood damage to commence from 1 July 2022.
The policy is intended to improve the affordability and accessibility of insurance in cyclone-prone areas, predominantly located in northern Australia, and is a significant policy announcement for the insurance sector and for the residents and small businesses in those areas.
The cyclone reinsurance pool was announced at a media doorstop in Cairns, far north Queensland, on 4 May 2021, by The Hon. Scott Morrison MP, Prime Minister; The Hon. Michael Sukkar MP, Assistant Treasurer, Minister for Housing, Minister for Homelessness, Social and Community Housing; The Hon. Warren Entsch MP, Member for Leichhardt; and Mr. Phillip Thompson OAM, MP, Member for Herbert.
Further information can be found in the joint media release issued 4 May 2021 by The Hon. Scott Morrison MP, Prime Minister; The Hon. Josh Frydenberg MP, Treasurer; The Hon. David Littleproud, Minister for Agriculture, Drought and Emergency Management; and The Hon. Keith Pitt MP, Minister for Resources, Water and Northern Australia.
The joint media release containing the Prime Minister’s announcement can be found here: https://ministers.treasury.gov.au/ministers/michael-sukkar-2019/media-releases/more-affordable-access-insurance-northern-australians
In response to the Prime Minister’s announcement, ARPC issued a media release welcoming the cyclone reinsurance pool proposal and committed to supporting Treasury as it completes the detailed design of the pool.