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How ARPC’s Terrorism Insurance Scheme operates

The Scheme was established on 1 July 2003 to provide eligible insurance contracts with terrorism cover for any Declared Terrorist Incident (DTI). Eligible insurance contracts are defined in the Terrorism Insurance Act 2003 (TI Act) and further refined through regulation.

The Minister, in consultation with the Attorney-General, determines whether a terrorist incident has occurred in Australia. They do so through the application of a consistent definition of terrorism, one used across Australian Government legislation, which draws on the meaning of a terrorist act contained in the Criminal Code. Once the Minister is satisfied that a terrorist act has occurred, the Minister must announce a DTI under section 6 of the TI Act. Upon that declaration, the provision of the TI Act in respect of eligible terrorism losses becomes effective and renders terrorism insurance exclusion clauses in eligible contracts of insurance invalid.

Through ARPC terrorism insurance coverage (the Scheme), insurers have three options. They can:

  • carry the underwritten risk of terrorism losses following a DTI, or
  • reinsure the risk through the commercial reinsurance market, by entering into a reinsurance contract and, paying terrorism reinsurance premiums, or
  • reinsure the risk with ARPC by entering into a reinsurance contract and paying terrorism reinsurance premiums

If an insurer chooses to reinsure the risk of claims for eligible terrorism losses following a DTI with ARPC, they do so by entering into a reinsurance contract and paying reinsurance premiums to ARPC. In most major economies similar arrangements exist, with some government involvement through terrorism reinsurance pools.

Commercial businesses that are insured with ARPC’s insurer customers and which hold eligible insurance policies are covered by the Scheme in the event of a DTI. Insurers are required to meet claims in accordance with the other terms and conditions of individual policies.

Scheme coverage excludes loss or liability arising from the hazardous properties of nuclear fuel, material or waste. Scheme coverage also excludes residential property not identified as eligible property.
Farms can obtain cover if they hold insurance against business interruption.

Insurer and industry retentions (deductibles or excesses) apply before claiming against the Scheme. Claims against the Scheme will be met once an individual insurer’s retention is exhausted. In this way, and in line with good risk management practices, the Scheme requires insurers to retain the first portion of any loss.

ARPC’s pool of retained earnings is used to pay claims up to the agreed private retrocession deductible ($250 million for the 2020 calendar year). Above this point, an additional $3.45 billion of claims are funded by the retrocession program with global reinsurers.

Once retrocession is exhausted, claims are paid by the Commonwealth guarantee. These claims may have a reduction percentage applied if claims in this layer exceed the $10 billion limit of the Commonwealth guarantee as legislated in the TI Act. If insurance companies are not reinsured with ARPC, then they are liable for the cost of claims resulting from the DTI on all eligible policies up to their pre-existing policy limits with no reduction percentage applied.

The Scheme funding capacity is the total value of the Scheme, which as at 30 June 2020 totalled $13.7 billion. The Scheme’s benefits include efficient pooling of risk for terrorism catastrophe, particularly when capacity is limited and prices are high (which occurred following the terrorist attacks in the United States of America on 11 September 2001). Since then, ARPC has begun the gradual transfer of risk back to the global reinsurance market in line with incremental increases in global terrorism insurance capacity, thus reducing reliance on the Commonwealth guarantee in the event of a DTI.

In 2020, ARPC extended the top layer of retrocession by $100 million and reduced the deductible by $35 million. This expanded the Scheme size and further protected the Commonwealth guarantee.

Background to the Scheme

Significant commercial and financial issues resulted from insurance and reinsurance companies’ withdrawal of coverage for terrorism risk following the events of 11 September 2001. With a large pool of assets uninsured for terrorism risk, financiers and investors faced uncertainty, which could have resulted in adverse economic circumstances, delayed commencement of investment projects and altered portfolio management decisions going forward. For these reasons, the Government’s response was to create the TI Act, which attracted bipartisan support.

In July 2003, the TI Act stipulated a scheme that provides terrorism cover on eligible insurance contracts (the Scheme) and established the Australian Reinsurance Pool Corporation (ARPC) to administer it.

ARPC’s functions of corporation under section 10 of the TI Act are:

a) to provide insurance cover for eligible terrorism losses (whether by entering into contracts or by other means); and

b) any other functions that are prescribed by the regulations.

The activities that ARPC undertakes to support the functions of corporation include:

  • maintaining, to the greatest extent possible, private sector involvement
  • appropriately pricing and compensating the Australian Government for risk transferred to it
  • allowing for the re-emergence of commercial markets for terrorism risk cover, and
  • responding to global solutions.​​

Scheme coverage

The total capacity of the Scheme at 30 June 2020 stood at $13.7 billion including all sources of funding (see Figure: ARPC funding layers for terrorism claims from all sources as at 30 June 2020 under Scheme funding capacity).

Contracts of insurance covered by the Scheme are those that provide insurance for:

  • loss of, or damage to, eligible property that is owned by the insured
  • business interruption and consequential loss arising from:
    • loss of, or damage to, eligible property – that is owned or occupied by the insured, or
    • inability to use eligible property, or part of eligible property, that is owned or occupied by the insured, and
  • liability of the insured that arises out of the insured being the owner or occupier of eligible property

Eligible property is property located in Australia comprising:

  • buildings (including fixtures) or other structures or works on, in or under land (roads, tunnels, dams and pipelines are examples of eligible property)
  • tangible property located in, or on, such property, and
  • property prescribed by regulation

Among the Scheme’s exclusions are:

  • loss or liability arising from the hazardous properties of nuclear fuel, material or waste
  • residential property or the contents of residential property where the building has a sum insured less than $50 million
  • farms, unless they hold insurance against business interruption
  • life insurance policies that fall within the meaning of section 9 of the Life Insurance Act 1995, and
  • contracts of insurance to the extent that they provide cover for loss arising from computer crime.​

Scheme funding capacity

As at 30 June 2020, ARPC provided insurers with an annual claims funding capacity of $13.7 billion in reinsurance capacity, comprising funding of ARPC’s retrocession deductible, the retrocession program and the Commonwealth guarantee. Since 2009, ARPC has placed an annual retrocession program, purchasing more than $3 billion capacity through more than 70 reinsurers rated A- or better by Standard & Poor’s or AM Best, many of which are located overseas.

ARPC funding layers for terrorism claims from all sources as at 30 June 2020 ARPC funding layers for terrorism claims from all sources as at 30 June 2020

Terrorism claims against the scheme are funded in a layered order:

  1. policyholder deductible (the excess or retention stated in the underlying policy)
  2. insurer retention (retention stated in ARPC’s reinsurance agreement with insurer customers) up to a maximum industry retention (total retention from all insurer customers involved in one event)
  3. a $250 million ARPC retrocession deductible
  4. retrocession capacity of $3.45 billion and
  5. a Commonwealth guarantee of up to $10 billion.

Reduction percentage

A reduction percentage must be specified if the Minister considers that, in the absence of a reduction percentage, the total amounts paid or payable by the Australian Government under section 35 of the TI Act (including amounts not related to the act or acts specified in the declaration) would be more than $10 billion.

By notice in the Australian Government Gazette, the Minister may vary the reduction percentage, but only by making it smaller and the percentage may be varied more than once. Once the reduction percentage is applied, insurers covered by ARPC would have no liability for any costs above their retention (regardless of sums insured) and eligible policyholders would receive a reduced claim payment from their insurer. After the reduction percentage figure announcement, the Australian Government can decide to revise this figure (only to decrease it) which would increase claim payments to policyholders.

If an insurer is not reinsured with ARPC, that insurer is liable for the full costs of a DTI claim. They will not be protected by the reduction percentage and must pay claims to the limit of the policy sum insured, subject to the policy terms and conditions.