The Federal Government has cut a deal with independent senator Nick Xenophon to tighten controls on the states’ insurance requirements in return for his vote to pass its $1.8 billion flood levy.

Senator Xenophon says states which “fail to take out insurance or fail to set up other measures like a properly resourced disaster fund will have their access to federal disaster funds cut back in the future”.

“This is about sending a clear message to all state and territory governments that the days of gambling with other people’s money is over,” he said.

Prime Minister Julia Gillard says in a letter to Senator Xenophon that the Government “will amend the Natural Disaster Relief and Recovery Arrangements “to incorporate a new process under which the Commonwealth will be able to vary the level of Commonwealth support provided in response to state and territory disasters where a state or territory’s prudential arrangements are found to be not reasonably adequate”.

She says the states will have their insurance arrangements assessed by an “independent and appropriate specialist” such as their auditor-general, before a further review by the Federal Department of Finance and Deregulation and a final recommendation by the Attorney-General.

The deal with Senator Xenophon has angered Queensland’s Acting Premier, Paul Lucas, who says it is a “cave-in” that will be “a major kick in the guts to the taxpayers and ratepayers of Queensland, and a major win to overseas insurance companies”.

“The Federal Government itself doesn’t have natural disaster reinsurance – a decision made by the Howard government,” he said. “Will they now have to seek reinsurance, along with all the states, territories and local councils?”

Senator Xenophon – who insisted his support for the bill was dependent on the Government penalising states that didn’t have appropriate insurance cover – says it would be “extraordinary if the Commonwealth didn’t fall into line”.

The levy, originally intended to assist solely with the clean-up after the Queensland floods, was amended last week after independent MP Bob Katter secured a deal for some of the funds to flow to his electorate of Kennedy, which was devastated by Cyclone Yasi.