A Federal Treasury consultation paper on the Government-backed reinsurance pool for northern Australia has asked for feedback on whether insurer participation should be mandatory and how cyclone-related flood should be defined.

The consultation paper released today seeks input on how much risk should be ceded to the pool, which is intended to lower the cost of cover for household, strata and small business properties when it comes into effect in July next year.

The paper proposes options for defining “cyclone-related flooding”, given it’s currently not distinguished from “regular” flooding and questions if storm surge should be included, even though it’s not in the existing definition.

“Coastal properties in northern Australia are particularly vulnerable to storm surges and are also more likely to be in the highest cyclone risk category,” it notes.

A definition for small business needs to be determined, and issues explored over complexities in capturing SME property cover when policies are often sold as packages with add-on components.

“The reinsurance pool may require a detailed breakdown of risk premiums between cyclones, cyclone-related floods, and other perils,” the paper says. “This may require additional work and improved system capabilities on the part of insurers.”

The pool, backed by a $10 billion annually reinstated guarantee, will be designed to provide a reduced reinsurance premium per property, with higher risk properties receiving higher discounts.

The design should mean underwriters are able to reinsure risks at a lower cost than in the private market as the pool would forgo a commercial profit margin and the government guarantee would mean that it wouldn’t have to ensure enough cash is on hand to cover such rare events as a 1-in-100 year cyclone.

The paper says it would be to the advantage of insurers to switch as soon as practicable so they can offer more competitive premiums to customers, and they could otherwise risk losing market share.

“Providing sufficient lead time for insurers to plan and undertake the transition is important,” it says.

Whether the reinsurance pool should have an exit date, such as the Flood Re pool in the UK which is set to end in 2039, is also part of the discussion.

The paper asks for feedback on the type of monitoring required to ensure reinsurance savings are passed through to policyholders and on how it can encourage mitigation and avoid leading to increased risk taking.

“By reducing reinsurance costs for high-risk properties, there is a risk that the reinsurance pool may encourage new construction in high-risk areas or to a standard that is vulnerable to cyclones and related flood damage,” it says. “The Taskforce will consider options to address this, such as limiting eligibility.”

The paper asks for feedback on potential interactions between the existing terrorism pool and the new cyclone and related flood damage pool, given the Australia Reinsurance Pool Corporation’s mandate is being extended so it administers both operations.

The taskforce is seeking feedback by June 18. The paper is available here.