Appendix F - Natural Disaster Relief and Recovery Arrangements (NDRRA) Review of Local

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Contents

1Executive Summary

1.1Our Scope

1.2Our Approach and Methodology

1.3Our Findings

1.3.1Who Performed the Independent Assessment?

1.3.2Current Insurance Arrangements

1.3.3State Funding Arrangements

1.3.4Risk Profile by EPA

1.3.5Natural Disaster Exposure

1.3.6Past Claims Experience and NDRRA Support

1.3.7Capital Management Policy

1.4Conclusions and Recommendations

1.5Reliances and Limitations

2Introduction

2.1Natural Disaster Relief and Recovery Arrangements (NDRRA)

2.2State Funding Arrangements (SFA)

2.3Local Governments’ Submissions

2.4General Approach and Methodology

3Australian Capital Territory (ACT)

3.1Who Performed the Independent Assessment?

4New South Wales (NSW)

4.1Who Performed the Independent Assessment?

4.2Current Insurance arrangements

4.3State Funding Arrangements

4.4Declared Assets

4.5Natural Disaster Experience

4.6Claims History and Past NDRRA Support

4.7Capital Management

4.8Conclusion

4.9Recommendations

5Victoria (VIC)

5.1Who Performed the Independent Assessment?

5.2Current Insurance Arrangements

5.3State Funding Arrangements

5.4Declared Assets

5.5Natural Disaster Experience

5.6Claims History and Past NDRRA Support

5.7Capital Management

5.8Conclusion

5.9Recommendations

6Queensland (QLD)

6.1Who Performed the Independent Assessment?

6.2Current Insurance Arrangements

6.3State Funding Arrangements

6.4Declared Assets

6.5Natural Disaster Experience

6.6Claims History and Past NDRRA Support

6.7Capital Management

6.8Conclusion

6.9Recommendations

7South Australia (SA)

7.1Who Performed the Independent Assessment?

7.2Current Insurance Arrangements

7.3State Funding Arrangements

7.4Declared Assets

7.5Natural Disaster Experience

7.6Claims History and Past NDRRA Support

7.7Capital Management

7.8Conclusion

7.9Recommendations

8Western Australia (WA)

8.1Who Performed the Independent Assessment?

8.2Current Insurance arrangements

8.3State Funding Arrangements

8.4Declared Assets

8.5Natural Disaster Experience

8.6Claims History and Past NDRRA Support

8.7Capital Management

8.8Conclusion

8.9Recommendations

9Tasmania (TAS)

9.1Who Performed the Independent Assessment?

9.2Current Insurance arrangements

9.3State Funding Arrangements

9.4Declared Assets

9.5Natural Disaster Experience

9.6Claims History and Past NDRRA Support

9.7Capital Management

9.8Conclusion

9.9Recommendations

10Northern Territory (NT)

10.1Who Performed the Independent Assessment?

10.2Current Insurance arrangements

10.3State Funding Arrangements

10.4Declared Assets

10.5Natural Disaster Experience

10.6Claims History and Past NDRRA Support

10.7Capital Management

10.8Conclusion

10.9Recommendations

Appendix A Guide to Submission Requirements – clause 4.6 of Natural Disaster Relief and Recovery Arrangements (NDRRA) Determination 2011

Appendix B Best Practice Submission Template

B.1Executive Summary

B.2Checklist of Data Provided

B.3Exposure Information

B.4Claims History and Past NDRRA Support

B.5Current Insurance Arrangements

1Executive Summary

1.1Our Scope

The Department of Finance and Deregulation (Finance) has agreed to undertake an independent review of local governments’ insurance arrangements (the Review) in accordance with Guideline 5/2011 of theNatural Disaster Relief and Recovery Arrangements (NDRRA) Determination 2011 (Determination). KPMG Actuarial Pty Ltd (KPMG) hasbeen engaged by Finance to perform the Commonwealth review on the local governments’submissions on behalf of Finance.

This review is integrally related to the independent review of state and territory (State)insurance arrangements (States’ submissions). The outcome of the review of the States’ submissions is set out in a document entitled “Natural Disaster Relief and Recovery arrangements (NDRRA) – Review of States’ Submissions” dated 6March2012. This document is set out as Appendix C in the report, “Review of the Insurance arrangements of State and Territory Governments under the Natural Disaster Relief and Recovery Arrangements Determination 2011 – Phase 1 Report” by Finance, dated March 2012. We also note the related addendum document entitled “Natural Disaster Relief and Recovery Arrangements (NDRRA), Addendum to the Review of States’ Submissions” dated 29 August 2012 which is an integral part of the States’ submission review.

Based on the local governments’ submissions, KPMG has been asked to respond to the following questions, providing supporting argument and analysis as required:

• Have the local governments through individual or collective action explored an appropriate range of insurance options available to them?
• Have the local governments assessed these options on a cost-benefit basis?
• Have the local governments put in place insurance arrangements which are cost effective for both the State and the Commonwealth?
• Have the local governments adequately met their obligation to minimise the financial exposure borne by taxpayers (both State and Commonwealth)? and
• Has the submission provided evidence of the items above?

It is important to note the above questions relate solely to the insurance arrangements of the local governments. No comment is made in respect of other aspects of risk management orrisk mitigation and any conclusions or comments on the local governments’ insurance arrangements do not infer comment or conclusion on any other aspect of risk mitigation.

As agreed with Finance, the following matters are considered to be outside the scope:

• All analysis will be performed on the information available. No modelling will be performed by KPMG to ascertain the required information.
• KPMG will not specify recommendations on the following matters:

−The equity of funding between the local governments under the Determination; and

−The appropriateness and effectiveness of the Determination.

• KPMG will not make comments on policy matters.
• Ongoing impact of natural disaster events to date, i.e. potential NDRRA expenditure and support in 2012 and 2013. It is noted, however, that given the impact of natural disasters in 2011 and the pattern of related expenditure, these are expected to be material and reinforce the conclusions presented.

As agreed with Finance, this Report concentrates on the insurance arrangements of local governments owned assets. Items that are commercial in confidence from local governments’ submissions have not been included in this Report in accordance with Clause 4.6.2 of the Determination.

1.2Our Approach and Methodology

Similar to the review of the States’ submissions, the local governments’review shows wide interpretation and different treatments by the local governments in respect of both mandatory and optional elements of the submission. In addition, the local governments’ submissions generally provided less detailed information due to the number of local governments in Australia and the lack of a central register of information, in particular for assets, in each of the States. This lack of consistency and detail is a limiting factor for quantitative examination.

In the States’ submissions, we prepared a ‘best practice’ submission template which draws on the strengths of each submission. This template sets out the information and key supporting evidence expected to support the independent assessment, including the format and breadth of the opinion provided. From that, we have examined whether the submission meets the review requirements, specifically the questions we have been asked to respond to as set out in the “Our Scope” section of this Report. We have adopted the same approach for the local governments’ submissions. However, some areas of the “best practice” submission template have been adopted with a more qualitative and “fluid” perspective due to the large number (approximately 571) of local governments within the State and across Australia. Each of the local governments operates independently of each other, have different risk profiles within the State, and different approaches to insurance arrangements and risk management practices.

1.3Our Findings

The first round of submissions sets out a positive starting point for the ongoing review of the Commonwealth’s interaction with the local governments in respect of natural disaster relief under the NDRRA.

Overall, with respect to our scope of services requested by Finance, our findings on the Review of the local governments’ submissions are similar to that in the States’ submissions. A summary of the local governments’ submissions, presenting the following factors is set out in the section below using the following structure:

• Who performed the Assessment?
• Current insurance arrangements
• State Natural Disaster Recovery and Relief funding to Local Governments
• Risk profile by declared values of Essential Public Assets (EPA)
• Exposure to natural disaster
• Past claims experiences and NDRRA support
• Capital management approach / assess to other capital
• Risk management

1.3.1Who Performed the Independent Assessment?

A specialist (generally an actuary) performed the assessments for four of the six Australian States. The results of the assessment are either included in the State submission or a separate report is issued. For the remaining States, the assessment was performed by the local governments’ mutual pool and State Treasury respectively.

Under the two approaches, the amount of information provided in the submission is generally less than that in the States’ submission. This is more likely due to the following reasons:

• The large number of local governments within the State and across Australia. There are approximately 571 local governments across Australia with 381 of them in NSW, VIC and QLD. The collation of information across the State, in particular the larger States, needs a high level of collaboration and effort.
• Each of the local governments operates independent to each other and possibly the State and differs in risk exposures, approach to insurance arrangements (if not self insurance through a mutual pool) and risk management.

1.3.2Current Insurance Arrangements

Table 1 summarises that the local government insurance arrangements within each State.

Table 1 – Insurance Arrangements Adopted by the Local Governments

All of the local governments within each of the States have elected to transfer risks to the insurance markets. The table above summarises that the local governments’ insurance arrangements within each State are either self insurance through a mutual pool or commercial insurance arrangements.

We note:

• Self insurance pools are not insurance. They are schemes where participatinglocal governments within the State pool their risks into a mutual and collectively self insure to a pre-defined retention. Above the self-insured retention, external reinsurance arrangements are purchased at a cost. The mutual is funded through annual contributions from the members (i.e. the participating local governments)

If there is a mutual set up in the State, not all local governments will participate in the scheme. Larger local governments may find external insurance arrangements more cost effective.

Based on the local governments’ submissions:

−For NSW, VIC and WA, the majority of the local governments self insure through the mutual pools. The remaining local governments independently arrange their insurance arrangements through the commercial market.

−All local governments in SA are self insured through the mutual, LGAAMF. For QLD, TAS and NT, the local governments independently arrange their insurance arrangements through the commercial market. For NT, the dominant insurer of the local government assets is the Territory Insurance Office (TIO) which is owned by the NT Government.

• Under both types of insurance arrangements, the local governments retain a fixed dollar amount of the losses of a claim through the deductible. The retained loss is generally quite low, ranging between $5,000 and $20,000 per claim. This reflects insurance designed to address the local governments’ concern of the impact of large losses and frequency of the “run of the mill” claims on their annual budget. Given that these insurances also respond to natural disasters, the NDRRA exposures are reduced but we note that the management of natural disasters and NDRRA exposures does not appear to be the key driver of insurance design.

The low level of retained loss also reflects the high reliance on the credibility of their insurers and reinsurers. The risk of default should, in theory, be kept low through the Australian Prudential Regulatory Authority’s (APRA) capital regulatory requirements for Australian incorporated insurers and reinsurers. However, many of the reinsurers, particularly those participating in the higher layers of coverage, are not incorporated in Australia and are outside the jurisdiction of APRA’s regime. Default risk is therefore managed by the regulations of other regimes.

• It is noted in all submissions there are no discussions on the past efficacy of the reinsurance/insurance arrangements and the benefits (if any) to the NDRRA with respect to past events. Hence, it is difficult to draw a conclusion on the efficacy of any external insurance, reinsurance and/or captive arrangements and whether the local governments have met obligations under the NDRRA Determination to minimise financial exposures borne by taxpayers (at both State and Commonwealth levels) as the past claims experience provided in submissions are generally net of reinsurance recoveries with no visibility of the true gross expenditure.

1.3.3State Funding Arrangements

Under the Determination, financial assistance provided for restoration of EPA (a subset of Category B measure) is based on the classification of assets rather than the owner (State or local governments) of the assets. Hence, it is expected that the NDRRA expenditure and subsequent support provided in the financial year are based on a combined position of State and the local governments within the State.

However, compared with the State’s revenue, the revenue base of local governmentsare significantly smaller with limited access to additional capital. The local governments’ budget and financial viability are highly exposed to the impact of large losses and natural events. This is particularly true for those regional town centres which have a higher exposure to natural events. In the event of natural disaster, the financial assistance required by the local government needs to be immediate. The NDRRA financial assistance to the local governments under the current structure does not appear to address the immediate requirements as support is on a financial year basis and heavily influenced by the number of the events in the past two years (the allowable time limit for NDRRA support) and the impact of these events on the State as a whole.

Recognising this, all States with the exception of the NT, have a separate natural disaster funding arrangement between the State and the local governments within the State. (We refer to this structure as the State funding arrangements or SFA). The SFA are similar to NDRRA in concept but varyin terms of funding support. The level of funding support also varies between States. One other major difference is the SFAoperate on a per disaster basis as opposed to the cumulative payments in a financial year basis. The per disaster basis provides the local governments with immediate funding for the community to recover in the event of disaster. However, the difference in bases (per event and financial year) between NDRRA and the SFAcreates complexity and difficulty in tracking the cash-flows arising from a natural disaster and in predicting the outcome of future cash-flows of NDRRA.

Unlike NDRRA as set out in Determination, the availability of the State’s funding support through the SFAis not dependent on an assessment of the adequacy of the local governments’ insurance arrangements. Civil assets such as roads and bridges are generally not insured though the mutual pool and/or commercial insurance arrangements and flood events are either not covered or only covered to a lower sublimit. Hence, in the event of natural disasters, the SFAis clearly vital for the uninsured civil assets.

In summary,

• The SFAprovide default insurance across the States for local governments’ uninsured assets. This typically responds on a per event basis.
• NDRRA acts as the reinsurer of the SFAacross the States. This responds on a financial year expenditure basis.
• The reinsurance arrangement is an aggregate excess of loss arrangement with NDRRA’s first threshold as the retention.

1.3.4Risk Profile by EPA

Table 2 sets out the assets declared in the local governments’ submissions.

Table 2 – Assets declared in the Local Governments’ Submissions ($m)

The type of assets included in the submission, and key differences between submissions, are clarified below:

• For QLD, bridges are generally not insured with the exception of bridges in Brisbane.
• For SA, eighteen of the sixty-eight local governments elected to insure some of their infrastructure assets (excluding roads) within their mutual fund. These assets are subsequently reinsured with an external reinsurance provider.
• For NSW and SA, declared values of local governments’ owned underground pipes have not been provided in the submissions. These assets should be included within either storm water and/or water and sewer assets. Hence, for these States, the percentage of uninsured assets is higher than that shown in the table above.
• For WA, the percentage of local government assets which is uninsured is low. This is mainly because water and sewer assets are owned by the State and there is a high proportion of unsealed roads which are of significantly lower cost per kilometre.
• For NT, roads information was only provided with accuracy for six of the sixteen local governments. Hence, the percentage of uninsured assets should be higher than the 27% stated in the table above.

Civil Assets

Not all local government owned assets are insured through reinsurance or insurance. For civil assets, in particular roads, bridges, storm water, underground pipes and sewers, there is a common theme of non-insurance. In some States, flood cover is an extension and not a standard cover to the insurance policy.

Road assets generally contributes to a large proportion of the civil assets. It can also be noted from Table 2that road assets (with the exception of WA)range from approximately 30% to 66% of overall local government assets by asset values. This is significantly higher than that for the States which are approximately 20% to 30% of the overall State assets.

The proportion of roads owned by local governments by kilometres is also significantly higher, as observed in Table 3 below.

Table 3 – Road Assets by kilometres and cost per kilometres