Insurers seek to balance short-term and long-term fixes to Australia’s affordability crisis

A four-week public enquiry took place during February, in which insurers were repeatedly asked why they took so long to respond to claims that were made following the floods that devastated large parts of Queensland, New South Wales, and Victoria during separate events in 2022.

Industry representatives accepted some of this criticism, but they said that they cannot tackle the insurance affordability crisis on their own.

“While insurers should rightly be scrutinised for things that did not go well through the 2022 floods, we hope this inquiry also provides a platform for a constructive conversation about some of the complex issues customers face in accessing affordable flood insurance,” said Richard Feledy, Managing Director of Allianz Australia.

The problem is that long-term solutions can be extremely costly and, according to Nicholas Scofield, Chief Corporate Officer of Allianz Australia, not always worth the effort. Scofield spoke to (Re)in Asia in a separate interview outside of the hearing.

A problem – and getting worse

According to the Insurance Council of Australia (ICA), the flooding that took place in Queensland and NSW during February 2022 was the costliest natural disaster in the country’s history, with insured losses amounting to AU$3.35bm. The Victoria flooding that subsequently took place in October resulted in a further AU$736m in claims, according to the ICA.

ICA data shows that 160,000 building insurance claims were made across four flooding events in 2022, with nearly 4% of these (6,000) yet to be closed.

The high level of losses that insurers have faced in Australia over the past few years, combined with the public criticism that they have endured, has made it all the more urgent to do something about the affordability of insurance in the country.

“Insurers are bound to be asking themselves whether it makes sense to still be in the market if they’re struggling to sell their products, and every time they do get claims they get hauled before a public inquiry?” said Sharanjit Paddam, Co-Head of Perils and Climate Practice at Finity Consulting.

Last year Paddam co-authored a report on behalf of the Actuaries Institute, published in August, which indicated that 12% of households in Australia are now “affordability stressed”, measured as those that spend more than one month’s worth of gross household income on home insurance.

“Insurers are bound to be asking themselves whether it makes sense to still be in the market if they’re struggling to sell their products.”

Sharanjit Paddam

Co-Head of Perils and Climate Practice at Finity Consulting

Since the report was published, some insurers – such as RACQ and Chubb – have withdrawn from certain areas of the market. This has increased pressure on government and industry to find a long-term solution to the problem.

The Actuaries Institute will publish an updated report on affordability stresses later in the year, probably around July or August.

Pools and parametrics

Scofield says that for the past 10 years Allianz it has been working on short-term fixes to the affordability crisis in Australia, such as by tailoring products to customers that find it hard to get hold of affordable insurance. The company was also one of the first firms to sign up to the government-sponsored cyclone reinsurance pool when it launched in early 2023.

Paddam warns, however, that such initiatives should be seen as short-term solutions only.

“These solutions can help address the acute problems we are experiencing right now and help provide a transitional arrangement, but they are not sustainable in the long run and will struggle in light of the mounting pressures that we face,” says Paddam.

While Australia’s cyclone reinsurance pool has made some difference to households that are highly vulnerable to these extreme weather events, there seems little evidence it has made a lasting difference to overall insurance affordability, as Scofield explains.

“The problem with the cyclone reinsurance pool is that it was set up without any government subsidy, which means that it has to internally generate money through not needing to make a profit and by charging market equivalent cyclone reinsurance premiums to insurers for all properties that are in the southern and inland areas of Queensland and Western Australia, where the risk of cyclone is very small,” says Scofield.

“But you can’t close the funding gap with just this kind of internal money-shuffling exercise. You need to put a government subsidy into the system.”

Scofield estimates that the impact on the premium that most households pay for insurance has been significantly under 10%. With rates rising an average of 20% across the board, according to Scofield, whatever small benefit households may have gained from the existence of the pool has been swallowed up by this rapid pace of price increases.

“But you can’t close the funding gap with just this kind of internal money-shuffling exercise. You need to put a government subsidy into the system.”

Nicholas Scofield

Chief Corporate Officer at Allianz Australia

Industry criticism of the cyclone reinsurance pool, widespread in the industry, has dampened enthusiasm for extending it other areas of insurance, such as flooding.

“Flooding is very localised. You either have severe flood risk or you don’t have flood risk. Very few people have low levels of flood risk,” says Paddam. “Therefore the challenge with designing a pool for flood risk is getting enough low-risk people into the pool in order to subsidise those people that are subject to high flood risk.”

There are also concerns about the long-term viability of parametric solutions, which link payouts to predefined triggers.

“Parametric solutions can offer a more efficient way of tailoring products so that they respond better to risk, but they’re still dealing primarily with the symptoms,” says Paddam. “If the risk is going up then the cost will continue to come up and fundamentally people will still be paying more for insurance.”

Longer-term solutions

This leaves industry and policymakers to look at longer-term solutions, which it is doing through the Hazard Insurance Partnership (HIP). HIP held its first meeting of the year on February 23. According to a note from the ICA, which participated in the meeting, “focus remained on the importance of data sharing to better understand Australia’s risk exposure and prioritise mitigation projects.”

“We first need to reduce the risk because this is the only way to actually reduce losses and losses are the main component of premiums.”

Roland Eckl

Chief Executive for Asia Pacific at Munich Re

Roland Eckl, Chief Executive for Asia Pacific at Munich Re, says: “We first need to reduce the risk because this is the only way to actually reduce losses and losses are the main component of premiums. We need to better adapt to the situation and increasingly invest in mitigation and resilience measures…. Other solutions merely redistribute the costs, but with more and stronger natural disasters, this is not a sustainable solution.”

Eckl says that houses are still being built in Australia in areas that are overly-exposed to extreme weather events. Moreover, building standards are still based on a timeframe when extreme whether was much less severe that it is now, he adds.

“We need to harness the information in the hands of (re)insurers and governments to ensure that we reduce the risk and to adapt building standard and planning laws to improve the situation for the future,” says Eckl.

Better modelling could help.

Moody’s RMS has already developed a number of models in Australia and is working to update them in line with the changing nat cat landscape.

“The high frequency of non-peak perils that we are seeing these days is creating significant earnings volatility, and that is not a very good situation for insurers to be in,” says Steffi Uhlemann-Elmer, Director of Product Management at RMS. “We have a series of new climate models that will help close the modelling gaps, the technology gaps and the correlation gaps between perils.”

Closing these gaps, says Uhlemann-Elmer, will provide better coverage of nat cat risks as the climate changes and have an important impact on insurance affordability – not just in Australia but all over the world.

“The high frequency of non-peak perils that we are seeing these days is creating significant earnings volatility, and that is not a very good situation for insurers to be in.”

Steffi Uhlemann-Elmer

Director of Product Management at RMS

A balance

But how far can things go?

Scofield says that while there has been a welcome shift in government policy over the past 18 months or so, since the Anthony Albanese government came to power, it simply isn’t possible to reduce risk to the extent to the extent that would comprehensively address flood cover affordability issues.

“Take flood for example. You can use levees and flood mitigation dams to reduce some of the risk, but there are areas where it is impractical to completely eliminate the exposure,” says Scofield.

He contrasts the cities of Brisbane in south Queensland and Sydney in New South Wales to illustrate his point.

While Sydney only has a dedicated water mitigation dam, Brisbane’s main dam is used partially for flood defence and partially for water supply. But, when Brisbane was hit by severe floods in 2011, the dam quickly reached full capacity and was unable to prevent large parts of the city being submerged by water.

“The moral to this story is that it is impossible to eliminate flood risk entirely in Brisbane. More could certainly be done but then it becomes a trade-off: how much will this cost and what proportion of flood risk properties will be taken out of the equation?” says Scofield.

It’s a balance, he says – and that’s why long-term solutions need to go hand in hand with the kinds of short-term innovations that Allianz, and others in industry, have been coming up with.