The general insurance sector in Australia is highly engaged with natural disaster trends, with 100% of general insurers polled in a climate survey taking steps to better understand the risks, Mr Geoff Summerhayes, an executive board member of the Australian Prudential Regulation Authority (APRA), has said.
A growing proportion of insurers were undertaking financial and scenario analysis and disclosing climate-related risks, he noted.
The new normal?
APRA’s interest in issues around natural disasters and climate-related risks is obvious, said Mr Summerhayes.
Climate-related events have a material impact on the general insurance industry’s financial position, he stressed. For example, Australia’s general insurers, at last count, faced paying out A$5.4bn ($3.8bn) from almost 300,000 claims related to last summer’s bushfires, floods and hailstorms. He pointed out that the economic damage caused by natural disasters typically far exceeds insured losses – what is known in insurance circles as the “protection gap”.
Mr Summerhayes said, “With support from the government, Australia’s financial sector and the broader economy are sufficiently strong and well-prepared to absorb and bounce back, even taking COVID-19 into account. But that resilience would be continually tested should last summer’s experience become the new normal. Alarmingly, the clear message from Australian and global scientific experts suggests this may be the case.”
Nevertheless, insurers have two other things in their favour as they face the prospect of higher claims costs from more intense and frequent natural disasters in coming years: an increasingly sophisticated ability to measure the risk faced by individual policyholders, and the fact that general insurance contracts are typically renewed annually.
These factors give general insurers much greater ability than most financial institutions to identify and avoid the highest risks by raising premiums or declining to offer cover. This might be good for insurers – at least in the short term – but it’s bad news for policyholders, and economic activity more broadly.
APRA’s biggest concern when it comes to the impact of climate-related risks on insurance is therefore not the prospect of an insurer becoming insolvent – it’s the possibility that general insurance might become unaffordable or even unavailable in parts of Australia.
Without access to appropriate general insurance, households and businesses would be less confident to invest or take financial risks in vulnerable parts of the country. Communities would take longer to recover in the aftermath of disasters, and more of the financial burden of recovery would fall on governments and – by extension – taxpayers. With its mandate to protect the soundness of financial institutions and broader financial stability, APRA is understandably keen to avoid such a scenario coming to pass, Mr Summerhayes said.
Residents of northern Australia know that this is not some hypothetical conundrum; it’s already happening. Since 2007, average home building insurance premiums have risen there by more than 178% for home insurance, and 122% for combined home and contents insurance. As a result, the Australian Competition and Consumer Commission (ACCC) has warned that household and strata insurance in the north is becoming unaffordable, which helps to explain why the rate of households without insurance there is almost double the rest of the country.
“Buy now or pay more later”
In contemplating how to tackle insurance affordability, Mr Summerhayes said, the most effective way is through greater investment in mitigation to protect homes, businesses and infrastructure from damage. “There may be other approaches that serve, for example, to subsidise the cost of insurance, but on their own they will ultimately be less effective because don’t lower the risk and may reduce the incentive to mitigate it.”
He said, “There is no doubt that some physical mitigation measures, such as flood levees or sea walls, can be expensive, however the billions spent each year cleaning up from disasters suggests the money is there – it’s just being spent after the damage is done. There is a lot of merit in the Productivity Commission’s assessment that paying for mitigation is far cheaper than paying for post-event remediation, and enduring the subsequent economic repercussions.”
He warned against waiting to build resilience, saying, “But, as with the transition to the low carbon economy, someone will ultimately pay, and waiting to act will only lead to higher costs in the long run.”
“We either buy now or we pay more later.”