The recovery effort has begun, but confusion over what really happened during the Australian floods and the scale of the damage could mean reinsurers end up paying out more than they need to

Reinsurers have been hit hard by recent catastrophic events in Australia. The country’s east coast was hit by heavy rainfall and flooding during late December and early January, which caused widespread damage and loss of life.

It was the most expensive natural disaster in Australian history, according to Aon Benfield, but loss estimates vary wildly. As the clean-up begins, some market analysts believe that the uncertainty surrounding the exact cost of repairs and nature of the losses could mean reinsurers end up making unnecessarily high payouts.

The Insurance Council of Australia’s (ICA) initial insured loss estimate for the flooding was A$150m ($151.6m), following more than 4,300 claims. By 11 February, however, it raised the estimate to A$2bn, following more than 43,700 claims. The bill is expected to rise further in the coming months.

Even (re)insurers themselves are unsure of the true extent of the damage. German reinsurer Munich Re estimated in its 2010 full-year profit update that insured losses for the market would range between A$4bn and A$5bn, but US insurer Chubb suggested that the figure could reach A$10bn.

Another major area of uncertainty for reinsurers is the definition of an “event” in Australian insurance policies. The ICA classified the December and January natural disasters as four separate events – Lockyer Valley, Toowoomba, rural Queensland and Victoria. This does not include Cyclone Yasi, a category 4 storm that hit beleaguered Queensland on 2 February.

RMS chief researcher Robert Muir-Wood says that because there is no consistency over definitions, reinsurance policy thresholds are murky. “Like a lot of flood events, it’s very messy and I am sure there will be some litigation over whether things should or should not have been included in what really appears to be a two-events reinsurance recovery process,” he says.

He warns that reinsurers need to be alert to the uncertainty over definitions. “They need to make sure they don’t feel losses are being added together that are inappropriate for the same reinsurance recovery,” he says.

Aon Benfield meteorologist Steve Bowen is concerned that the ICA is creating further confusion with its post-event figure updates. “It is releasing this data within one release,” he says. “It is not breaking it down into the catastrophes it declared. That adds even more confusion. What exactly goes where?”

Even the definition of a flood is unclear in Australian insurance policies. In 2008, the ICA had its definition of ‘flood’ rejected as “anti-competitive” by government consumer watchdog the Australian Competition and Consumer Commission, and no further definitions have been submitted.

An ICA spokesman says MP for Maribyrnong in Victoria Bill Shorten is now pushing the government to clearly define ‘flood’, adding: “The good thing to come from this disaster is that the industry wants it defined and we now have a minister who does too.”

According to Muir-Wood, most policies cover flash flooding but not river flooding, leaving hundreds of thousands of people without coverage from the overflow of the Brisbane River. He says: “People are upset about this and these floods have become much politicised.”

He is concerned that this level of government and public backlash will force insurers to pay claims that are not strictly covered – a move he says will leave reinsurers vulnerable to higher claims. “Insurers will be caught in the middle. If they pay for things they aren’t meant to, reinsurers may well deny recoveries for those costs.”

Reactive measures

In late January, Australian prime minister Julia Gillard announced a A$5.6bn funding package for flood rebuilding, including a one-off levy on Australian taxpayers.

Swiss Re’s head of Australia and New Zealand operations Mark Senkevics told a local radio station that cat bonds were more appropriate: “We’d like to see some form of insurance rather than a levy after the event,” he said.

But Muir-Wood strongly disagrees. “People drop cat bonds into conversation because they are alternatives, but it doesn’t make sense that they would neatly fit into what the levels of risk here. They are quite expensive and I don’t think there is a capacity shortfall there at the moment. The danger of cat bonds is they are designed to give you protection against a 100-year event, but no protection whatsoever against a 50-year event. Actually, this event is not even a 100-year event, so it wouldn’t have been covered.”

There is one positive that Muir-Wood believes will emerge from this series of events: Australia will be forced to clearly define the parameters of policies, ensuring there is no confusion in future.

But that definition will come at a price. “The challenge is, while they are being asked to come up with a broader definition that doesn’t exclude river floods, there isn’t an understanding that those in flood zones will have to pay a much higher technical rate for the risk. That debate hasn’t gotten very far yet.” GR