Fire, Flood and ENSO – Is it time to community rate Cat Risk?

CSIRO released research this week suggesting climate change will exacerbate the El Nino Southern Oscillation (ENSO) in the next decade, 40 years earlier than expected, bringing drier El Nino years to Australia and wetter La Ninas. The catastrophic fire and floods that have plagued Australia for the past five years look to become the norm, rather than the exception.

Climate Impact on Australian Insurance Premiums

The impact on insurance premiums is predictable – in the face of increasing climate risks, entrenched inflation and a historically tough Reinsurance market, property premiums will continue their inexorable increase.

These increases won’t be uniform, however. Where once insurers would apply a uniform rate for catastrophe claims across a state, inadvertently spreading the price of risk broadly across their customers, we have gradually moved to smaller and smaller zones until – after significant industry investment in geocoding, satellite imagery, LIDAR and other technology – sophisticated insurers (including Hutch) now price catastrophe risk for each individual property.

Neighbouring properties may receive radically different prices because of their elevation, flood exposure, exposure to prevailing wind, proximity to bush, slope of land and location in so-called “hail corridors”.

Further, sophisticated insurers – and lenders – are also using climate models to profile how climate change will impact a location’s long-term cat risk, the so-called “climate risk”.

Perfect Pricing or Perfect Storm?

This granularity of pricing should improve an insurer’s results, but does change the social usefulness of insurance. More precise pricing of risk means those that live in the most cat-exposed locations will pay the most premium; this sounds appropriate until one considers that cat risk disproportionately impacts the vulnerable, which means that insurers are charging their most needful customers the highest rates. In economic terminology, this is regressive, taking a larger proportion of the poor’s earnings than of the wealthy. It results in unaffordable premiums.

Large parts of Northern Australia are already economically uninsurable. Whilst insurance might be theoretically available, local consumers simply can’t afford it. And at the beginning of 2023 the media is reporting the same issue across the flood-impacted East Coast.

Insurance is a remarkably undervalued invention. It enables credit, which in turn enables development. Without it, banks will not lend, investors will not invest, and individuals and companies therefore cannot build housing, businesses or infrastructure. So it is in society’s interest to ensure it remains available. But as climate risk renders swathes of the country uninsurable, lenders will withdraw and they will become un-investable. Ultimately those towns and the productive industries they support will die.

Community Rating: Proven and Tested

In health insurance, Australia determined years ago that those most in need should not be priced out of the market, and introduced community rating. Is it time to consider addressing climate risk in the same way?

The underlying mechanisms exist to accomplish this. The proven legal structures and precedents in private health can be repurposed. The ARPC and its nascent cyclone reinsurance pool could be expanded with a mandate to spread the cost of climate risk across the market consistently.

It would be a sea change, and the detail involved would be boggling, but it is tried and tested in the most human part of the market. The size of the prize would be worth the effort – negligible increases for most of the many would result in dramatic savings for those who most need them, effectively “saving” whole regions whose long-term climate risk profile makes them conventionally uninsurable.

Combined with removing the inane regressive taxes that blight the industry (NSW ESL being particularly invidious), and a more strategic approach to investment in resilience and infrastructure, this would be a game changer for insurance affordability and would help drive a more prosperous, safer, stronger Australia.

Could it be done? Would it work? We'd love to hear your opinions. Join the discussion