Should IAG and QBE shareholders worry about terrorism?
With the Sydney Siege still fresh in our minds, should insurers - and their investors - fear a major terrorist attack?
On December 15, the Sydney CBD went into lock-down when a gunman took 17 people hostage in the Lindt Cafe at Martin Place.
Was it terrorism or a rogue criminal? Over the coming weeks, Federal Treasurer Joe Hockey will decide. And whether the Sydney Siege is declared a 'terrorist incident' has wide-ranging implications for insurers such as IAG (ASX: IAG), QBE (ASX: QBE) and Suncorp (ASX: SUN).
Following the September 11 attacks, insurers started to introduce terrorism exclusion clauses. To curb the practice, the Terrorism Insurance Act 2003 formed the Australian Reinsurance Pool Corporation (ARPC), which enables insurers to recoup losses due to terrorism and the policyholder to remain covered for damage to premises, business disruption, etc.
The Act overrides terrorism exclusion clauses in insurance policies and requires insurers to meet eligible claims.
As ARPC's website puts it: “Claims against the scheme are met once an individual insurance company's risk retention is exhausted. ARPC's pool of retained earnings will meet claims until the agreed retrocession deductible is reached. Once retrocession is exhausted, claims will continue to be met by the Commonwealth guarantee. The total value of the scheme is $13.4 billion.”
Acts of terrorism with minimal economic fallout, as the Sydney Siege is most likely to be, wouldn't exceed the claims threshold needed for IAG and other insurers to receive payment from ARPC.
However, for catastrophic losses – say, if a nuclear bomb went off in Sydney – where the amount payable under the Commonwealth guarantee exceeds $10 billion, the Minister would also announce a 'reduction percentage' which reduces the amount payable by the insurer to the policyholder.
As far as terrorism is concerned, Australian insurers are largely shielded from catastrophic losses. Though we hope the ARPC scheme is never truly tested.