Australia: Is the water any clearer?
Treasury releases ‘Flood Insurance’ discussion paper

Treasury releases 'Flood Insurance' discussion paper

Treasury released its eagerly awaited discussion paper yesterday, Reforming Flood Insurance – Clearing the Waters (the paper), seeking to address some of the issues arising out of the recent storms and flooding in Queensland and Victoria.

However, it remains to be seen whether the proposals will clear the muddy waters in respect of flood insurance in Australia.

Earlier this month, gadens lawyers addressed flood related issues arising in the context of commercial policies (click here).  In this update we focus on household insurance contracts and the two Treasury proposals designed to deliver greater clarity.

Clearing the waters?

The paper forms part of an overall program aimed at systemic change, putting in place a standard definition of 'flood' for use in insurance policies (proposal 1) and a requirement for insurers to produce a short 'key facts' statement that summarises the cover under insurance policies (proposal 2).

Proposal 1

The variation in usage of the term 'flood' and 'flooding' in policies is a potential source of confusion for many consumers.  The different approaches and definitions allegedly make product comparison difficult and can lead to underinsurance for flood risk.  Accordingly, the paper puts forward the following 'standard definition of flood' under proposal 1: 

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

1. any lake, or any river, creek or other natural watercourse, whether or not altered or modified; or
2. any reservoir,canal, or dam.

According to the paper,

The definition would be associated with rules which provide that insurance contracts of the relevant class... must not include the term 'flood' or 'flooding', except in association with the proposed standard definition. That restriction would also prevent those contracts from including compound phrases based on 'flood' (for example, 'flash flood' and 'accidental flooding').

The paper seeks consultative responses from across the industry and everyone affected by these floods – every insurance policyholder.

Proposal 2

Information about the terms and conditions of general insurance policies is required to be provided [1] in the form of a Product Disclosure Statement (PDS) in a 'clear, concise and effective' manner.

The broad objective of a PDS is to help consumers to compare the key elements of financial products so that they can check whether the products meet their needs and make informed choices.  The paper asserts that concerns have been raised by stakeholders that the PDS rules for general insurance are not as effective as they could be.  This is connected to the length and complexity of PDSs and the variations in presentation.

Proposal 2 involves requiring issuers of home buildings/contents insurance policies, in addition to the PDS, to offer consumers a short statement (one A4 page in length) containing a set of key facts about the policy.  

It is proposed that the contents and format of the key facts statement would be prescribed to some extent, and each insurer would need to create a key facts statement for its policies that accorded with the requirements.  The paper provides a draft sample of such a statement.

Will visibility improve?

Despite the potential 'greater clarity' associated with a standard definition for 'flood', the reality is that policies may still exclude cover where the damage or loss is directly or indirectly caused by flood as defined.  Therefore, regardless of how flood is ultimately defined, if the policy contains the permitted exclusion, damage or loss arising out of 'flood' remains an uninsured exposure.  In such circumstances, the fact that a standard definition was used is of dubious comfort.

The proposed definition does not significantly differ from those already employed in many policies.  Such exclusions have been given broad application, applying where rainfall was unable to enter a watercourse because it was already flooded. [2]  It is questionable whether a consumer would expect this breadth of application of the standard definition.

In addition, issues associated with concurrent causes are not addressed.  If losses are caused by 'concurrent effective or proximate causes' (one of which was covered by the policy, and the other, excluded), the application of the principle first identified in Wayne Tank & Pump Co Ltd v Employers Liability Assurance Corp Ltd [1974] QB 57 applies.

The principle laid down in Wayne Tank means that if a loss has two or more proximate causes and at least one cause is excluded from cover, the insurer is not liable.  It is consumers' understandable unfamiliarity with this concept and problems where damage is caused by storm and flood water that has arguably caused the most concern.

The waters remain murky...the government as underwriter?

The government proposes that the key facts statement would summarise what events are covered by the policy and that the standard flood definition will prevent general insurance contracts from including compound phrases based on 'flood' (for example, 'flash flood' and 'accidental flooding').

While this may make for a more informed consumer market, there is some scope for arguing that the government is attempting to act as an underwriter by mandating policy terms.  Treasury's proposals may very well educate, but they may also constrain other solutions, such as a compulsory natural disaster insurance scheme run by the government.

One possible method of implementation is to amend the terms of standard cover under the Insurance Contracts Act1984.  However, the paper notes that section 35 of the Insurance Contracts Act would then allow insurers to opt-out of the definition provided they 'clearly informed' insureds of the derogation from standard cover.  The implication is that Treasury would prefer a mandatory definition with no provision for opting out.  

Proposal 2, while its aims are laudable, is also potentially problematic in that there is underlying complexity in the defined terms/phrases used.  Merely referring to one word items such as 'Impact', 'Flood' or 'Riot' is unlikely to leave insureds any wiser, but may discourage them from reading the full PDS where such terms are defined and explained.  In order to fully understand the cover, the PDS/policy is still required.

Submissions on the paper are due by 13 May 2011 and developments in this space will continue to be closely monitored by all stakeholders.

[1] by a combination of the Insurance Contracts Act 1984 and the Corporations Act 2001.

[2]See Hams v CGU Insurance Ltd [2002] NSWSC 273; Prosser& Anor v AMP General Insurance Ltd [2003] NTSC 80; Eastern Suburbs Leagues Club v Royal & Sun Alliance [2003] QSC 413; Elilade Pty Ltd v Nonpareil Pty Ltd (2002) 124 FCR 1

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