Despite increasing premiums, the profitability of home insurance has declined significantly with many insurers and underwriters making substantial losses, according to a discussion paper released by The Australian Institute, an independent public policy think tank. The Institute which has offices in Canberra, Hobart, Melbourne and Adelaide

The paper, titled “Premium price: The impact of climate change on insurance costs“, is written by The Australian Institute senior research fellow David Richardson; senior fellow and contributing editor Stephen Long and research director Rod Campbell.

The paper pointed out that data from the Australian Prudential Regulation Authority’s (APRA) show that profitability of housing insurance underwriting has been negative since 2019-20. This data shows that while much of Australia’s recent inflation has been driven by corporate profits, this does not appear to be the case for home insurers. These insurers have been hit by a combination of higher building replacement costs, climate-change driven CAT and higher reinsurance costs.

As insurers look to improve their profitability after years of losses on home and contents policies and to properly price for growing climate change risks, consumers are facing steep increases in premiums.

Home insurance premium increases

Between 2022 and 2023, the average home insurance premium in Australia rose by 14%, the biggest rise in a decade. This enormous average rise was driven by extremely high increases for homes in high-risk areas, such as flood zones.

Modelling from The McKell Institute estimated that the direct cost of natural disasters in Australia could reach A$35bn ($23bn) per year (in 2022 dollars) by mid-century, an average of more than A$2,500 per household per year. However, such averages hide more than they reveal. In areas at high risk of extreme weather events, insurance costs are multiples of national averages.

Premium increases across regions

In northern Western Australia, home and contents insurance costs on average A$4,395 per year, which is more than double the A$1,779 per year cost for Australians in the southern two thirds of the country. It is also significantly more than the A$3,069 that the average Australian household spends on electricity in a year. In the Northern Territory, average premiums are A$2,922, and in North Queensland A$2,918, roughly 60% higher than the rest of the country.

The high cost of home and building insurance in northern Australia has contributed to high rates of non-insurance, with about 20% of homes in northern Australia uninsured, nearly double the rate in the rest of the nation.

Recommendations

The paper said that the most obvious policy response is to address climate change, both mitigating its magnitude and adapting to its impacts.

Fossil fuel

Australia should end fossil fuel subsidies, place a moratorium on new fossil fuel developments, crack down on excessive use of offsets and pursue genuine decarbonisation and push for similar policies internationally. Far more investment and planning should go into climate adaptation. Since May 2022, the Federal Environment Minister has approved seven new coal mines or extensions, with 1.5bn tonnes of lifetime emissions.

Over the last two years, 250 gas wells have also been approved. The approval of these fossil fuel projects will make the cost of insurance even higher, regardless of where they are built, as they contribute to deteriorating climate conditions.

Fiscal and monetary policy

Beyond climate mitigation and adaptation, fiscal and monetary policy need to align to ensure inflation is managed with more than just the blunt instrument of rate rises, which would have no effect on insurance price increases, and many of the other factors driving inflation.

Specific policies to engage with the insurance market may be required but will need to be carefully calibrated and regularly reviewed.

In response to the high insurance costs in northern Australia, the Morrison Government created an A$10bn reinsurance fund to help underwrite the cost of natural disasters in cyclone-prone areas.

The Morrison Government’s reinsurance scheme has only had a modest effect because it subsidises insurance, but does not directly assist homeowners. Those already priced out of the market or unable to access insurance are not assisted at all.

High insurance premiums work as a market signal to deter new investment, even as they trap low-income households in hazardous zones. Government intervention, such as through the reinsurance scheme, blunts this market signal, so other solutions that consider adaptation policies such as building standards and climate-appropriate zoning are necessary.

As climate impacts become more severe, it seems likely that the existing cyclone reinsurance scheme will not be sufficient, and a range of insurance market interventions and wider housing policy initiatives may be required.

Separately, according to the Australian Reinsurance Pool Corporation, the government established a cyclone reinsurance pool that started operations on 1 July 2022. The pool is backed by an annually reinstated A$10bn government guarantee. Any shortfall in reserves built up over time by the pool will be paid for through the Government guarantee.

If the A$10bn guarantee is likely to be exceeded by a single cyclone event or series of cyclone events within a single year, the government will increase the guarantee to support the cyclone pool to meet all its obligations.