Do We Need a Third Fund?

If you always do what you’ve always done, you’ll always get what you’ve always got.

This article leads on from my earlier article on Making your Scheme Competitive to Insurers and the idea I present today stems from a discussion I had with a developer client in WA. They have a $100+ million building in northern WA that went through a Category 5 cyclone. When I asked about the extent of the damage, he said ‘all we lost was the front doors and a few shade cloths’. The insurance premium for this property was in the order of $1 million a year!….. so it got me thinking ….. if the damage to that type of property was fairly minor in the highest level storm, why are they paying such a high premium?

Three years ago at the National Conference I raised my concept of a “Property Replacement Fund” (PRF) where contributions act as alternate or augmented insurance during disasters.

It made sense to me that if owners contributed to their own PRF the balance will increase over time and make their scheme more competitive, and an acceptable risk to insurers with the insurance risk appropriately shared between lot owners and the insurer. The first call on money for any damage to property would be paid out of the PRF.

Actuaries will be able to carry out simple calculations and with a reasonable balance in a PRF, the owners should be offered a lower premium because of the lower risk and lower administration costs for insurers.

As we know, owners have unlimited liability, and legislation states that they must have insurance. Currently a significant number of properties cannot get insurance.

I am not an outright expert in insurance matters, but I am an expert on risk, and the PRF concept provides a structure for owners who cannot obtain insurance to deposit potential premiums into their own scheme’s PRF.

Some people may say that this will reduce premiums and as a result would reduce the money available for insurers to pay out claims, and commissions for strata managers. However, currently, there are significant numbers of properties that cannot get insurance at all and as a result there is no money available. 100% of nothing is still nothing.

Considerations and Cautions

While offering significant benefits in areas prone to disasters like flooding and cyclones, careful consideration of the usual legal, financial, operational, and ethical challenges is crucial. My preference is for the basic parameters to be determined, change the legislation, and adjust as the concept develops. Better rashness than inertia.

Benefits

• Community-based solution: A self-funding PRF fosters collective responsibility and shared risk management.
• Increased market value: Properties with a good PRF balance would attract a higher price.
• Insurance affordability: A PRF could offer relief from high premiums.
• Potential cost savings: A PRF would make a scheme more attractive to an insurer.

Challenges

• Regulatory compliance: Establishing a PRF will require legislative changes with inherent complexity.
• Disbursement processes: Defining clear criteria for accessing PRF funds and establishing a fair, transparent, and impartial disbursement process i.e. Tribunal.
• Dispute resolution: Potential conflicts around eligibility, disbursement amount, and reconstruction decisions necessitate a robust but simple dispute resolution mechanism.
• Financial planning and management: Accurately predicting future disaster costs and appropriate contribution rates.
• Investment of funds: Prudent investment strategies to ensure adequate growth and liquidity while minimising risk.

Key Considerations

• Mandatory vs. voluntary participation: Should participation in the PRF be mandatory for all lot owners or optional; or simply mandatory for schemes that have been refused cover.
• Contribution rates: Determined how and by who? Will they be fixed, variable, or risk-based? Or a simple, x% of the current valuation (sliding scale for larger schemes).
• Investment strategy: Investment guidelines for secure and profitable growth of the PRF.
• Disbursement criteria: Specific criteria to trigger access to PRF funds, and how amounts are determined.
• Governance and oversight: External oversight mechanisms for fund access i.e. Tribunal.

Conclusion

A PRF offers a potentially attractive alternative for schemes that cannot obtain insurance, and to reduce high insurance premiums in disaster-prone areas.

Without this PRF in place there may be an incentive for owners to simply state that they “tried” to get insurance, couldn’t and therefore spend that money on other things to the detriment of the collective mind of their strata scheme.

Wal Dobrow has been instrumental in having legislation changed in numerous matters, including the Common Property Memorandum (which he wrote), the basis of compensation for Strata Termination in NSW, and use of the Land and Environment Court; Leasehold Strata; Valuers carrying out Unit Entitlements in NSW; mandatory Professional Indemnity for real estate agents; the Valuer’s Certificate for all new strata schemes in NSW, amongst other things.