Underinsurance, false affordability, and increasing risk: the perils of climate-related disasters in Australian communities

The flood has been called unprecedented, record-breaking, and historical. These adjectives have been getting a lot of use lately, and feels like there is a once in a 100-year event every other week.  

The 2019 Costs of Climate Change report found that the average risk from extreme weather and climate change to properties is projected to rise to “$91 billion per year in 2050 and $117 billion per year in 2100” annually.

The problem will get worse, and without a plan for coordinating global decarbonisation, the situation will get even worse. This means that climate-related disasters will cause things like insurance premiums for people in hotspots to rise.

The ACCC’s first insurance monitoring report paints a bleak picture for Northern Australia, and the premiums don’t look good for business:

The average premium in 2021-22 for residential combined buildings and contents insurance:

Northern Australia: $2,370

Rest of Australia: $1,350

The average strata insurance premium over the same period:

 Northern Australia: $5,740

 Rest of Australia: $2,940

Lecturer in management, accounting and training at North Regional TAFE and Institute of Public Accountants member, Joel Schreiber, is from the Pilbara region in Western Australia. Schreiber said that “house insurance is costing an average of $4,000 a year in the Pilbara which is causing us to underinsure.”

Schreiber also said that “small businesses are suffering a lot”, and that the cost of insurance and replacements will continue to mount on top of all the other costs of doing business.

Why?

Simply put, insurance companies are managing their own financial risk that arises through the provision of premiums in areas deemed to be at heightened exposure for floods and other climate-related disasters.

Victorian Nationals leader Peter Walsh claims that in some cases, insurers are considering limiting their coverage in these areas to mitigate the risk.

If multiple insurance companies withdraw from these markets, it will have dangerous implications because competition is vital for reducing premiums in Victoria, and by extension, other flood affected regions across the country.  As we know, if premiums rise, so will rates of underinsurance.

In 2020, a study from the Actuaries Institute found that the level of risk does not always correlate with the ability to pay insurance (i.e., residents with beachfront properties). However, the most grave “social concern arises where higher premiums occur in communities where there is less flexibility to absorb higher costs.”

The report also explores the perceived value of insurance, stating that “in many cases, the policyholder’s understanding of risk, and how the insurance policy responds are low, but can improve after a natural disaster or claim.”

Connecting these dots during, or at the conclusion of a disaster, is too late, and could leave homeowners and business owners with nothing. Underinsurance can also be unintentional, and it often occurs when someone finds another insurance product at a cheaper price.

However, it’s usually cheaper because it does not offer the same level of coverage, and the policyholder only realises they’re not fully covered when they try to make a claim. The Actuary Institute report refers to this as “false affordability.” 

Policy solution:

In 1961, Karl Borch described reinsurance as a decision that a “company will forego as part of its expected profits in order to reduce the possibility of inconvenient losses.” Today, the national policy solution to this insurance crisis is being delivered by the Australian Reinsurance Pool Corporation.  

While the program is currently voluntary, large insurers must join the pool by the end of this year. Meanwhile, smaller insurers have until the end of 2024. In theory, rather than passing the cost onto policyholders, insurance companies will “transfer their risk to the reinsurance pool, which is backed by a $10 billion Government guarantee.”

One apparent limitation of the solution is that the scope of the reinsurance pool is ‘cyclones and related flooding.’ According to the Bureau of Meteorology, heavy rainfall is the most frequent cause of both riverine and flash flooding. However, the pool will only cover claims made for damage that occurs within 48 hours of the Bureau of Meteorology observing the conclusion of an official cyclone event.

The initial effectiveness of the reinsurance pool will be revealed in the next ACCC insurance monitoring report, although the full extent of its success will not be known until after 2025, once all insurers have been involved in the scheme.

The ongoing risk of underinsurance:

Imagine that you own a small gift shop in an area that is prone to cyclones and flooding, and you’ve been through three floods in eight years. Every time you race to get your most valuable products onto higher ground, safe from the floodwaters, the next flood happens, damaging the building, your stock, and most of the town too.

The people in the town that were fully insured lodge their insurance claims, and relocate someplace else. Meanwhile, you, and everyone else that’s underinsured, are on your own without the money to rebuild. If it weren’t for crowdfunding and government support, the town would probably become an ‘instant ghetto.’

Most people want to believe that the government and the community will come to the rescue. However, the increasing threat from multiple climate-related weather events will limit the capacity for same level of support in the future. Reducing the rate of underinsurance is vital for avoiding a catastrophic scenario, and let’s hope that the reinsurance pool is reinforced with sandbags.