Australia faces a massive insurance gap that leaves home and business owners increasingly vulnerable to either dealing with disasters without being fully insured or paying more for premiums even if they live thousands of kilometers from a disaster zone.
Everyday Australians are facing steep insurance premium rises and the number now seen as being under insurance stress has increased from 10 percent in 2022 to 15 percent last year. That leaves many people in vulnerable areas underinsured or uninsured and even those who can get insurance are paying much more.
That potential lack of insurance cover also has sobering ramifications for those seeking a mortgage and home ownership, especially in a world where climate-linked disasters are increasing. The potential solutions are complex and will require government action.
It’s a global problem that Australia knows too well. In 2022, when disastrous floods hit Queensland and NSW, the insured losses alone were more than $6 billion and about 48 percent of Australian losses were not covered by insurance.
Globally, a climate or extreme weather-related disaster has been recorded every day for the past 50 years, resulting in an average of 115 deaths and $202 million in losses. Aside from increasing concerns about how to pay for recovery, there are also issues about rebuilding to avoid future losses.
In advanced economies there is an assumption that insurance will pay for rebuilding, but a disaster insurance protection gap means many people in disasters are uninsured with no identified source of funds for recovery. The recent Los Angeles fires have been estimated to have cost up to $250 billion in economic losses, but only $40 billion was covered by insurance. There are already more than 60,000 insurance claims from Cyclone Alfred and associated flooding in March, so many people will wonder how much will be uninsured – and how that will affect the recovery.
Australia is not unusual in having a disaster insurance protection gap. The disaster insurance protection gap globally – which means there is no insurance money to help pay for recovery – is estimated to be about $1.8 trillion. Some of this gap arises from losses that are not typically insured, such as infrastructure and government-owned assets such as roads, while another part comes from lower-income countries that lack a robust insurance market.
And then new threats contribute to the gap – such as cyber risk – that are not yet sufficiently modeled or understood to form the basis of insurance policies.
However, as shown by the LA fires and Australian floods, the insurance protection gap is a growing problem in economies where most homeowners would once have been assumed to be insured. This assumption no longer holds true, with many people either underinsured or uninsured against the key risks they face.
There are three key reasons for this insurance gap. First, in risk-reflective pricing, insurers charge higher premiums to those properties that are likely to incur more losses. That is based on a combination of previous losses and proximity to or location in high-risk zones and means the higher premium reflects the potential for higher loss.
Second, insurance is a pooling mechanism, in which the premiums of the many pay for the losses of the few. As increasingly severe and frequent disasters cause multiple losses, more premium capital is needed to cover the “losses of the many.” Insurance companies buy a reinsurance policy on the global market, so as losses increase globally, the cost of reinsurance capital goes up around the world, creating a ripple effect.
Finally, climate uncertainty, sometimes called weather weirding or whiplash, increases insurance market volatility from unexpected losses. Uncertainty is associated with higher capital reserving by insurers and reinsurers to cover unexpected losses and is reflected in increased premiums.
The insurance protection gap means that global capital does not flow to rebuild homes in local economies after disasters. Without sufficient insurance, the burden for recovery falls disproportionately on those who lack sufficient insurance and are already financially and socially vulnerable. And being unable to get insurance means people probably won’t be able to get mortgages, which is a sobering thought given home ownership is a key source of Australian wealth.
The broader cost to society is also high, as government disaster funds cover costs like temporary housing and rebuilding.
Any approach to the insurance gap needs to be two-pronged, bridging both the financial gap and reducing the physical gap.
Government-legislated insurance mechanisms, known as protection gap entities, are needed to subsidize those at high risk to keep them in the insurance pool. They have operated in many countries for decades to help stabilize economic responses to disaster. The cyclone pool in Australia is an example, providing a guarantee that helps insurance companies offer policies.
Protection gap entities need to be compulsory to ensure the entire population can be covered and offer multi-peril protection that covers all key hazards. This approach in France, Spain and Switzerland ensures more than 85 percent of the population is insured while keeping prices relatively low. That effectively bridges the financial aspect of the protection gap.
The frequent criticism of protection gap entities is that they are unfair to those at lower risk or that by suppressing price signals about high-risk areas they allow people to rebuild in high-risk areas such as floodplains or cyclone or bushfire-prone regions.
These criticisms point to risk reduction as the other key requirement for reducing the protection gap. In the U.K., the entity related to flooding is working with insurers to ensure properties are rebuilt with increased flood resilience. The Swiss public sector insurance system goes further and includes a mix of preventative measures to try to limit losses during a disaster.
The overseas experience shows that any solution will be complex, requiring collaboration across all layers of government, targeted risk interventions and public-private collaboration to support the integration of insurance into the resilience ecosystem.
Australia is considering some measures and the insurance sector is calling for $30 billion investment in flood resilience. Both federal and some state governments are investing in resilient housing programs at different scales.
The tightly-defined cyclone reinsurance entity might be the basis for a wider pooling mechanism that helps add more weight to a system that integrates insurance and resilience measures.
Originally published under Creative Commons by 360info™.
