Commonwealth Numbered Regulations - Explanatory Statements

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INSURANCE CONTRACT AMENDMENT REGULATIONS 2002 (NO. 3) 2002 NO. 273

EXPLANATORY STATEMENT

STATUTORY RULES 2002 No. 273

Issued by authority of the Parliamentary Secretary to the Treasurer

Insurance Contracts Act 1984

Insurance Contract Amendment Regulations 2002 (No. 3)

Section 78 of the Insurance Contracts Act 1984 (the Act) provides that the Governor-General may make regulations prescribing matters required or permitted by the Act to be prescribed, or necessary or convenient to be prescribed for carrying out or giving effect to the Act.

Paragraph 9(4)(b) of the Act allows regulations to prescribe a provision of a contract of insurance that authorises or permits the insurer to vary or cancel insurance cover for risks related to war or terrorism. The effect of this is that the restrictions on insurers varying or cancelling insurance cover (as set out in sections 53 and 63 of the Act) do not apply to the prescribed provision.

The purpose of the Regulations is to prescribe contract provisions for extended coverage endorsement (aviation liabilities) which allow insurers to vary or cancel cover for war and terrorism risks.

Following the terrorist attacks in the US on 11 September 2001, the availability of insurance covering risk of war and terrorism in the aviation industry contracted sharply. In Australia, sections 53 and 63 of the Act meant that insurers could not unilaterally vary or cancel war or terrorism risk insurance cover following September 11.

While this initially helped to maintain such cover, overseas insurers, who provide the bulk of aviation war and terrorism risk insurance, made it known that they were not prepared to continue offering such insurance unless they could vary or cancel the cover at short notice, given that risk factors may change rapidly.

An amendment to the Act was therefore made by the Insurance and Aviation Liability Legislation Amendment Act 2002 to insert new subsection 9(4) into the Act, including the regulation-making power in paragraph 9(4)(b) described above.

The Regulations will encourage insurers to resume offering cover for risks related to war and terrorism in the aviation sector.

The Regulations commenced on gazettal.

REGULATION IMPACT STATEMENT

Policy objective

The Australian aviation industry (airlines, airports and service providers) is currently facing major difficulties obtaining sufficient third party aviation war and terrorism risk insurance (principally for damage caused on the ground). In most part, this is a result of the insurance industry taking a highly conservative approach to aviation insurance since the events of 11 September 2001.

Much of the problem centres on that fact that overseas-based insurers, on which the Australian aviation industry depends for much of its insurance, is no longer prepared, in the changed circumstances post-11 September, to offer sufficient cover. The problems being faced by the Australian aviation industry are identical to those being faced by their counterparts in other countries around the world and the solutions being pursued by the Australian Government are also mirrored elsewhere.

There are, however, some specific issues which are restricting access for the Australian industry to the limited amount of cover that is available on world markets.

The international insurance market is concerned with certain provisions of the Insurance Contracts Act 1984 (the IC Act) which restricts the unilateral cancellation (section 63) or variation (section 53) of a contract of insurance by an insurer.

The immediate response of international underwriters to the terrorist attacks was, in accord with standard clauses in contracts, to give 7 days notice of cancellation of aviation war risk cover. Although Australian firms were also affected by this global response, contracts had to be re-instated when sections 53 and 63 of the IC Act were brought to the attention of insurers. This, of course, provided only temporary relief for Australian firms - the international market simply refused to renew such contracts when they fell due.

Commercial cover has started to return as the industry re-evaluates risks and premiums - and competitive forces begin to re-assert themselves. However, international underwriters have not been prepared to provide coverage to Australian firms whilst the IC Act prohibits them from taking action to protect their interests in the event of another major incident.

Action is therefore required to encourage insurers to resume offering insurance cover for the aviation industry for risks related to war and terrorism. An important element in this is allowing insurers to vary or cancel such cover at short notice.

Implementation options

The following options have been considered:

Option 1. Do nothing.

This would mean that third party war and terrorism risk insurance would remain non-variable and non-cancellable in Australia, thus providing a continued measure of protection to Australian firms. However, it has become apparent that international insurance providers will not renew existing contracts as they fall due, thus depriving Australian aviation firms of access to the little cover that has returned to the market. In the longer term this will impact severely on the aviation industry.

Option 2. Make a regulation to exempt third party aviation war and terrorism risk insurance from section 53 of the IC Act (which restricts variation of contracts), thus assisting Australian airports and other affected parties to purchase war risk 'write back' cover from the global market.

This option was initially seen as an intermediate step, which would allow insurance providers to vary certain contracts, thus possibly assisting some parts of the Australian industry gain access to better cover. However, doubts have been expressed whether the regulation-making power in section 53 is broad enough to solve the problem. In particular, the section allows the regulations to declare a "class" of contracts as exempt from the requirements of section 53. The doubt surrounds the question of whether 'write back' cover is a distinct class of contract, or merely part of the larger aviation insurance contract. In any event, section 53 relates only to variation of contracts, but not to cancellation, so a regulation under this section would provide only a partial solution.

Option 3. Make a regulation under the new paragraph 9(4)(b) of the IC Act, introduced by the Insurance and Aviation Liability Legislation Amendment Act 2002 (IALLA Act), to exempt third party aviation war and terrorism risk insurance from the restrictions on variation and cancellation in sections 53 and 63.

This is regarded as the best long-term solution. New paragraph 9(4)(b) of the IC Act introduces a new targetted regulation-making power which will allow the regulations to prescribe provisions in contracts of insurance that cover war or terrorism risk as exempt from the requirements of sections 53 and 63.

The regulation will prescribe certain parts of standard aviation clauses which write back insurance cover for war and terrorism as provisions to which sections 53 and 63 do not apply. Its effect will be to allow insurers to cancel or vary this written back cover if they choose. It will therefore place Australian aviation firms in the same position as the rest of the world, thus providing no reason why the global insurance market should discriminate against Australian industry.

Assessment of impacts

Impact group identification

The groups that will be impacted by the regulation will be participants in the aviation industry, including airlines, airports and service providers, as well as insurers. The wider public who use aviation services (eg. airline travellers) may also be indirectly affected by the regulation but, it is believed, in a positive way.

Analysis of costs/benefits

The IC Act provides protection to Australian business and consumers alike. However, the Act recognises that certain classes of insurance may require special treatment. For example, section 53 provides that regulations can declare that a contract included within a specified class of contracts is not subject to the prohibition on variation. Further, subsection 9(3) excludes from the cancellation restriction in section 63 (and other provisions) contracts of insurance against the risk of the loss of an aircraft, or damage to the hull of an aircraft, as a result of war. This provision was made in recognition of the fact that such insurance is only readily available on global markets and would probably not be available to Australian carriers if such insurance had to comply with the non-cancellation regime of the Act.

It is probably the case that the international insurance industry had not been aware of the relevance of the IC Act to their business in Australia until the effect of the restrictions in sections 53 (variation) and 63 (cancellation) were pointed out. Following the terrorist attacks in the United States on 11 September 2001, the full impact of these provisions became obvious, and the Australian aviation industry found it increasingly difficult to access what third party war risk insurance was available on the international market.

The regulation proposed in option 3 will assist in removing impediments to Australian aviation enterprises gaining full access to the international insurance market for third party war and terrorism risk insurance.

Both Treasury and the Department of Transport and Regional Services have consulted with the industry on the terms of the proposed regulation to ensure it is appropriately focussed on war and terrorism risk and does not inadvertently remove other desirable protections from the aviation industry.

While these changes will expose the aviation industry to the possibility of variation or cancellation of their insurances in the event of another major terrorist attack, it is the judgement of both Government and the industry that these moves are necessary in order for the Australian industry to have access to the global market.

It should be noted that any variation or cancellation will not operate retrospectively. That is, insureds in the aviation industry will be covered for war and terrorism risks up until such time as their insurance cover is varied or cancelled, and any claims arising out of war or terrorism events occurring before the variation or cancellation should be honoured by the insurer (provided they otherwise meet the requirements of the insurance contract).

For example, if a war or terrorism event occurs and as a result the insurer cancels the insurance cover for such events seven days later (as permitted under the regulation), the insured would still be covered in respect of the event that had occurred prior to the cancellation.

The 'cost' that the possibility of variation and/or cancellation of insurance imposes on the aviation industry is outweighed by the costs associated with the continuing lack of access for the aviation industry to adequate insurance cover for war and terrorism risks, which in the longer term will impact severely on their activities. It is likely to lead to increased costs for users of aviation services, especially airline travellers and, at the extreme, may even force the closure of airlines and/or aviation service providers.

Other issues - consultation

Affected participants in the Australian aviation and insurance industries have been consulted on the content of the regulation.

While there is support for the regulation from the aviation industry, some insurers feel that the regulation is not wide enough (eg. it will be relevant mainly to third party or liability insurance, but not to hull insurance, as the latter is not generally provided by the extended coverage endorsements which are to be prescribed by the regulation).

Nevertheless, in the wake of the events of 11 September 2001, it was mainly in the area of liability insurance (rather than hull insurance) that cover was withdrawn, and the Government's overall response has therefore been to focus on liability insurance.

Conclusion and recommended option

Option 3 (a regulation under paragraph 9(4)(b) of the IC Act) is the recommended option.

There would be considerable cost in the long run in doing nothing (option 1), in terms of the continuing lack of availability of adequate insurance coverage for war and terrorism risks. There are limitations in pursuing a regulation under section 53 of the IC Act (option 2). First , it would only be a partial solution (ie. would apply only to variation but not cancellation of contracts). Second, doubts have been expressed about the effect of a regulation under section 53, due to the particular wording of the regulation-making power in that section. It was mainly in recognition of the limitations in the regulation-making power in section 53 that paragraph 9(4)(b) was inserted into the IC Act.


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