- Flood risk management in Australia
The prevalence of flood risk in Australia
The frequency and intensity of floods is increasing
3.1Floods are a historically common natural event in Australia. They are essential to the functioning of many Australian ecosystems, driving biodiversity through the distribution of seeds and nutrients, the refilling of aquifers and wetlands, and stimulating population booms of native fauna. A changing climate, combined with urbanisation and development, have altered these naturally occurring floods.
3.2Rising sea levels and ocean temperatures are driving more frequent and intense rainfall events. This is leading to more frequent and more powerful floods, causing more extreme impacts to the communities living in flood-prone areas and the natural ecosystems that inhabit them.
3.3These impacts are expected to worsen as the effects of climate change are realised. Munich Re’s Managing Director, Scott Hawkins, shared his observations and concerns when he told the Committee:
Climate change is increasing both the frequency and the intensity of extreme weather events. These are now occurring in areas not previously exposed. Over the past 10 years, global losses from natural disasters have been well above the long-term average…Unfortunately, there is no reason to believe that the trend of ever-increasing losses from such events will stop or even revert any time soon, because the effects of climate change will continue to develop and in many areas are likely to get worse over time.
3.4The CSIRO and Bureau of Meteorology stated in the 2022 State of the Climate report that ‘It is expected that extreme rainfall will increase in Australia with climate change’. Further stating in the ‘future climate’ part of the report that in coming decades Australia is projected to experience:
More intense short-duration heavy rainfall events, even in regions where the average rainfall decreases or stays the same. This will lead to a complex mix of effects on streamflow, and associated flood and erosion risks, including increased risk of small-scale flash flooding.
3.5Urban and other development is also considered one of the key drivers contributing to the increasing severity of floods. Australia has a high proportion of its population located in city centres and in areas more prone to floods (such as along big rivers) and these centres are growing. According to the CSIRO, the International Panel on Climate Change has projected that the compounding impacts of climate change and urban development will make cities, built-up urban areas, and small catchments particularly vulnerable especially to flash floods following heavy rainfall events. Several reports published by Swiss Re also state that ongoing urbanisation, population growth, inadequate flood protection infrastructure and increased soil sealing will add to an increase in flood-related insured losses, stating:
Over the last 20 years, the increase in soil sealing in Australia’s five biggest cities has been the main contributor to a 7% increase in annual expected losses from floods.
3.6In some areas, development which has changed the natural flow of water, causing it to be redirected into areas not previously susceptible to flooding, has also contributed to more severe flooding. Examples provided to the inquiry include the construction of high roads, buildings and other surface altering infrastructure, preventing water from draining away or being absorbed as it usually would.
Increasing exposure of residential and community assets to flood
3.7In addition to the increasing frequency and severity of flood events – there has been considerable growth in the value of residential, commercial and community infrastructure in areas of high risk. This has been the result of decisions made by all levels of government over decades.
3.8In its submission, the Insurance Council of Australia (ICA) quotes Governor Macquarie in 1817 in relation to Australia’s long-term planning challenges, describing flood damage as ‘the inevitable consequences of [settlers’]…wilful and wayward habit of placing their Residences and Stock Yards within the reach of floods.’ This quote reflects the fact that poor planning decisions have been made in Australia for over 200 years. While true, relying on this quote is tone deaf in the face of the shocking evidence heard by the Committee of failure and neglect on the part of insurers. The fact that poor planning decisions have been made in the past does highlight that we need to make better planning decisions moving forward. But these past planning errors in no way take away from the reasonable expectation of people affected by those decisions that they will be provided suitable support by insurers now and going forward.
The increasing cost of floods in Australia
3.9The combined effect of increasingly frequent and severe floods and the building of more infrastructure in at risk areas has driven up the damage associated with flood events.
3.10Flood events have accounted for more than 54 per cent of losses from declared insurance events in the last five years. The rebuild costs after each of the 2022 floods were higher than expected as inflation, driven by disruptions in global supply chains and lingering effects from the pandemic, and increasing asset values meant replacement costs rose rapidly. Shortages in skilled labour pushed costs even higher. Evidence provided to the inquiry indicates that inflation, time taken to complete projects, and delays in commencement required insurers and policyholders taking cash settlements to factor in an increase of up to 20 per cent of the rebuild cost. This factor of increase was corroborated by the Australian Financial Complaints Authority (AFCA) who suggested that ‘it [cash settlements] be uplifted by between 10 and 20 per cent to protect against the transfer of the risk to the complainant to have to do the works themselves, particularly if they're generally not building experts’.
3.11In recognition of the high and growing costs of disasters in Australia, there have been attempts to determine the future costs of floods to the economy. In a 2021 report prepared for the Australian Business Roundtable for Disaster Resilience and Safer Communities, Deloitte projected that in 2060 economic costs from floods would fall between $30.7 billion annually (under a low emissions scenario) and $40.2 billion (under a high emissions scenario). In both cases, Queensland is expected to incur the largest increase in costs, followed by New South Wales, with the largest increases in population centres located on major rivers.
3.12Residential and other development, particularly development in flood prone areas, will contribute to the increase in potential costs of floods. Currently, most of the costs associated with floods are attributed to a small proportion of properties in Australia. The National Flood Insurance Database (NFID) informs insurers on the number of properties at risk of varying levels of flooding across Australia. The NFID currently indicates that 4.4 per cent of properties nationally are exposed to a 1 per cent, 2 per cent or 5 per cent Annual Exceedance Probability (AEP) (also known as 1-in-100, 1-in-50 and 1-in-20 year floods respectively).
3.13The 2022 floods, as well as subsequent floods in the years since, have contributed to the evidence suggesting more frequent and severe flood events. This has, in turn, caused several areas to have their flood risk ratings adjusted. Many properties on or near flood-prone areas are being reassessed as having a higher flood risk once recent historical and flood prediction models have been incorporated into the assessment.
3.14Mitigation infrastructure such as levies and channels can help reduce the damage and consequently the costs of floods, however the Committee heard that with rising sea levels, mitigation infrastructure may also be subject to decreased risk ratings over time. The Emergency Management Adviser for the City of Launceston identified diminishing risk related to its flood levee system:
Further, if the impact of climate change is considered, insurance from a flood risk perspective becomes even more vital. From 2006 to 2090, protection from the flood levee system decreases its effectiveness from a 0.5 per cent AEP to a two per cent AEP, which is primarily driven by climate change impacts of sea level rise and more extreme rainfall events and changes in hydraulic modelling.
3.15Insurers have begun to price in the increased costs to rebuild and repair homes and the increasing risks to properties in flood prone areas. This is leading to higher premiums, with the greatest increases felt by people living in assessed high-risk areas. Some policies increased so sharply following the floods that it suggested insurers may have been using higher premiums as a way of formally offering coverage while know that it would not be accepted. More detail on these increases is detailed in Chapter 9.
Australia’s flood risk management approach
Division of Government responsibilities
3.16Under Australia’s constitutional arrangements, state and territory governments have primary responsibility for emergency management within their jurisdiction, that is, they manage the first responders to a flood event. States and territories also have responsibility for laws, standards and policies governing flood mitigation, land planning and the management of floodplains.
3.17Local governments are typically delegated responsibility by state governments for the planning and implementation of flood risk mitigation, as well as the operation of many flood risk mitigation assets in their Local Government Area. In doing so, the local governments must have regard for regulations set regarding the factors above.
3.18The Australian Government provides support to states and territories when coordinated assistance is requested and provides national security capabilities to prepare for and respond to events determined to be of national significance. The Australian Government also provides financial assistance to people who have been adversely affected by floods, either directly or through joint funding with state and territory governments.
3.19There are several frameworks, strategies and plans guiding the national arrangements for disaster management each covering the different phases of disaster management. These include:
- the National Disaster Risk Reduction Framework (NDRRF), the Australian Disaster Preparedness Framework (ADPF) and the National Strategy for Disaster Resilience (NSDR) - which provide a national approach to mitigation, adaption and improved resilience to disaster risk; and
- the Disaster Recovery Funding Arrangements (DRFA) – which supports the provision of funding for recovery following disasters of a certain scale.
- The Australian Government and state and territory governments also have their own disaster management frameworks which integrate and implement these national frameworks and strategies. The Australian Government Crisis Management Framework (AGCMF) describes the standing arrangements for the Australian Government’s response to all crises, including natural disasters.
The current approach to flood risk management
3.21Following the Royal Commission into National Natural Disaster Arrangements in 2020, which called for a national approach to disaster recovery and for the Australian Government to play a greater role in relation to natural disasters on a national scale, all levels of government have made concerted efforts to achieve a more integrated approach to flood risk management. Australian Emergency Management Ministers endorsed the Second National Action Plan in August 2023, providing direction to achieve disaster risk reduction across all sectors, for governments, industries, communities and individuals.
3.22Signalling that disaster resilience has become a priority for the Australian Government, the National Emergency Management Agency (NEMA) was created in 2022 to coordinate and align national capability to prepare for and respond to all natural disasters, including floods.
3.23The Australian Government has also established new services, including the Australian Institute for Disaster Resilience and the Australian Climate Service, to leverage the data, information and capabilities of agencies such as the Bureau of Meteorology, CSIRO, Geoscience Australia and the Australian Bureau of Statistics.
3.24Additional funding has also been provided over the medium term for mitigation projects and collaborative work, such as that being undertaken by the Hazards Insurance Partnership (HIP), to identify and implement policy solutions that reduce risk and also reduce insurance costs, with particular regard given to further investment in catchment areas with the highest risk of flooding.
3.25Following the 2022 major floods, the NSW Government established the NSW Reconstruction Authority to help communities impacted by the floods and any future disasters to recover faster, and conduct critical planning and preparation activities to reduce the impact of future disasters. This model was based on the Queensland Reconstruction Authority (established following the 2011 floods), was tasked with a similar program for recovery and resilience building by the Queensland Government.
3.26Two pilot programs were also established in 2022 to support eligible homeowners in south-east Queensland and the Northern Rivers region of NSW to retrofit or raise their homes to make them more disaster resilient or to apply for a voluntary buy-back of their home and relocate elsewhere. The Resilient Homes Fund has $741 million in funding provided jointly by the Queensland and Australian Government. The similar Resilient Homes Program comprises $700 million in funds from the NSW and Australian Governments and a further $100 million funded by the NSW Government for the Resilient Lands Program to relocate eligible residents to flood-safe land.
3.27Many Local Governments in Queensland and NSW affected by recent floods have also been quick to invest in better, more up-to-date flood mapping to understand the flood risks in different areas, improve decision-making by Councils, and make this information available to other stakeholders. This work has been undertaken with some (but varying) levels of financial support from State Governments. In Victoria, flood mapping has been undertaken by water catchment authorities.
3.28While there has been a general acknowledgement of the need to improve the quality of flood mapping and modelling, it is important to note that the quality of modelling varies considerably, in no small part as a result of the varying resourcing of councils. Without funding assistance from other levels of government, small regional councils in particular struggle to undertake rigorous modelling. This issue will only become more pronounced as organisations attempt to supplement their modelling with climate modelling to determine the possible trajectory of flood risk over the medium and longer-term.
The role of insurance in a well-functioning economy
3.29Risk management is highly complex in modern societies. The task of risk management is shared between the public sector, the private sector and households. To the extent that government is involved, it involves all three levels of government in Australia. Arguably, risk management lies at the heart of the modern welfare state.
3.30Risk management takes three main forms: risk pooling; risk reduction; and risk allocation. All three of these are used in relation to floods in Australia.
3.31Risk pooling is the most commonly used means of flood risk management. It is largely undertaken by the private sector through highly regulated insurance and reinsurance companies and mutuals. Most households, companies and community/not-for-profit organisations purchase insurance that partially or fully covers their flood risk. Insurers pool these funds to pay out claims after events. Some local government entities also purchase insurance, although in recent years many have faced higher premiums, higher excesses and an unwillingness on the part of insurers to cover some assets.
3.32While the majority of household and organisational risks are pooled it is important to note that a growing number of risks are not being pooled. This is resulting in partial or non-coverage for a growing number of households and businesses. During the Committee’s investigations, even some large businesses are having to self-insure large parts of their operations after the 2022 floods. This trend is also reflected in local governments having to self-insure a growing proportion of their assets. This is partly due to affordability issues (for example, excesses being raised by reinsurers) and is partly due to insurers excluding certain asset classes (for example, underground pipes).
3.33Under- or non-insurance will often result in individuals or households relying for assistance on family, friends and community. This will often involve assistance not just in relation to the immediate losses arising from the disaster – but the financial, and psychological disruption caused as individuals and families adjust, often over very long periods of time.
3.34Home, contents and business insurance provides people and their communities with the financial resilience to recover more quickly from the shock of a natural disaster. Without insurance, people would be expected to cover the risk of natural disasters themselves, either by sacrificing savings, taking out loans, or relying on government aid. Higher levels of uninsurance in a community will slow recovery, sometimes for years.
3.35When people find themselves in the position of having to cover a significant, unforeseen event for which they are uninsured, they are more likely to rely on coping mechanisms that can have enduring consequences to recover. This could include diverting saved funds from critical spending on healthcare, food and education towards measures like making their home a safe place to live again. A return to normal spending becomes increasingly unlikely as the frequency of similar events increases. For these reasons, higher exposure to uninsured risks, including to natural disasters, has been shown to be one of the main causes of poverty and is certainly detrimental to wellbeing.
3.36Risk mitigation reduces the likelihood of future floods impacting on an area. Mitigation occurs at both the community level (which is largely the responsibility of government) and the household level. At the community level, mitigation could take the form of a levee, improved stormwater management or water storage (for example, increased dam capacity). Community mitigation is typically funded by one or more levels of governments. Even local government has invested in some large and impactful mitigation projects such as the Roma and Launceston levees. Both of these materially reduced flooding risks for population centres and resulted in premium reductions. Other forms of community level mitigation that don’t include physical infrastructure include improved flood modelling and disaster planning.
3.37Household level mitigation can include raising homes or businesses, installing water resistant flooring or improving the protection of non-water-resistant assets such as computer equipment. A significant problem in relation to household level mitigation is that insurers often don’t efficiently or fairly pass on premium reductions after the household or businesses have made the investment.
3.38Some forms of household level mitigation are funded by the public sector. Examples include house buy-backs and subsidised household resilience (for example, raisings).
3.39Risk allocation is the least obvious policy tool, but it is fundamentally important in how risk is managed in modern, complex societies. For example, limited liability has underpinned capital accumulation and allocation within modern economies and is, at its heart, a risk allocation mechanism. In the case of natural disasters, ex post risk allocation occurs where one entity takes on some or all of the risk of another. This often occurs after natural disasters where the government provides income support to individuals, businesses or communities, particularly those with little or no insurance. Sometimes the scope of this assistance is set out in policy documents in advance. However, this is often not clearly defined, other than a broad expectation that after a particularly bad disaster government will step in and provide support. On many occasions the generosity of the post-disaster assistance is determined on a case-by-case basis based on the severity of the incident, the needs of the community and overarching budget constraints of the government involved. This can create considerable uncertainty for uninsured individuals and communities.
3.40Risk management in general - Access to affordable insurance is also critical for a well-functioning economy and society more generally. It allows people to take seemingly ordinary risks that they might otherwise choose not to take. People can purchase homes without fear that years of savings could be forgone in the event of a fire or flood. Financial institutions are also more willing to lend and, in Australia, home loan providers often require homeowners to hold a suitable home insurance policy for the duration of the mortgage. It also allows people to confidently invest in and operate businesses that have higher risks, enabling markets to exist where it would be too high-risk without insurance.
3.41The World Bank found that insurance, through its risk management role, plays a key role in underpinning economic stability and growth:
The insurance activity, both as a provider of risk transfer and indemnification and as an institutional investor, may contribute to economic growth in the following ways (i) promoting financial stability, (ii) facilitating trade and commerce (the most ancient insurance activity), (iii) mobilizing domestic savings, (iv) allowing different risks to be managed more efficiently encouraging the accumulation of new capital, (v) fostering a more efficient allocation of domestic capital, and (vi) helping to reduce or mitigate losses.
3.42The importance of having a reliable, accessible insurance market in Australia was emphasised by insurers throughout this inquiry, with QBE’s submission affirming:
Insurance is fundamental to our economy, giving people and businesses the protection and confidence to grow and prosper. It plays a significant role in managing the financial impact of natural disasters, contributing to resilience and recovery and lessening the financial burden for governments, communities and individuals. Protecting the integrity and stability of insurance markets and ensuring the long-term sustainability of the industry is crucial.
Why flood insurance is difficult for insurers to provide
3.43There are two aspects of floods that make them difficult for private insurance to deal with. First, as natural disasters that sometimes cover very large areas, they involve, to at least a degree, “non-diversifiable risks.” Second, at the more local level, flood risk is often highly concentrated, with very high pockets of risk which, if priced at an actuarially fair level, would result in unaffordable premiums.
3.44Pooling and diversifiable risks -In general terms, insurance transfers some or all of a risk from an individual, business or other entity to an insurer in exchange for payment (called a premium). As part of this transaction, a contract is agreed by both parties that if an (included) event were to occur in the future, the insurer will compensate them for the loss, usually through a like-for-like replacement or a cash amount of equivalent value.
3.45Unlike individuals, insurers can take on the risks of unforeseen events that would be too large for an individual to cover. By covering a range of risks that encompass a wide geographical area, insurers can pool their policies and effectively diversify their risk. Risk pooling relies on the idea that only a few policyholders will be impacted by a risk at any given time. If all policyholders were to experience the same event, at the same time, there is no guarantee that the insurer could cover all the losses. As non-disaster risks are independent, it is unlikely that these risks will occur simultaneously and impact the insurers’ ability to pay the policyholder.
3.46Natural disasters, however, are often incompatible with the ideal criteria for insurability, and floods are particularly problematic. This “non-diversifiable” characteristic of natural disasters, particularly large ones, makes them difficult for insurers to manage. There are two key ways in which individual insurance companies manage the non-diversifiable risk associated with large natural disasters. First, they spread that risk across different regions. This is often effective, particularly for large national and international insurers, although in 2022 this strategy was limited in effectiveness in that floods occurred across most of the nation. The second is to purchase reinsurance. While global reinsurance markets are highly liquid and able to take on large risks, the price charged to Australian insurers has increased materially over recent years which has placed upward pressure on Australian home and contents premiums.
3.47Insurers’ primary concern with insuring floods is that they are not an independent risk but rather spatially correlated, meaning that if one person is affected by a flood, more than likely many people are affected. The severe losses associated with significant or catastrophic floods could very well be greater than the premiums obtained for that year. For this reason, insurers may have additional measures in place to ensure their continued stability, including by holding a minimum amount of capital, or by transferring some of this risk to global firms by taking out their own insurance policies, known as reinsurance.
3.48Reinsurance allows risks, including non-disaster risks, across many insurance companies to be pooled and diversified globally, helping to smooth the volatility of payouts associated with locally correlated events. Reinsurance arrangements vary across insurers and policy lines, but typically include the insurer taking out either proportional reinsurance, where a proportion of every risk and premium is shared between the insurer and reinsurer, or taking out excess of loss reinsurance, where losses above a certain threshold for an event are transferred to the reinsurance market. To further diversify risk, insurers commonly split coverage for different policy lines between more than one reinsurer.
3.49Concentrated flood risks - Floods do not occur randomly or in isolation, they are, to a certain extent, a known risk for areas close to rivers, the coastline and other watercourses. As the impacts of climate change are realised, floods will become less random and more expected in these locations. Compared to fires and other hazards, there are large numbers of households exposed to very high risks of flooding (1 in 20 or more frequent). Actuarially priced premiums for houses in this situation will typically be unaffordable. It is estimated that, in 2022, nearly 230,000 homes were exposed to a 1-in-20 risk of flooding or higher (about 1.5percent of properties), and nearly 675,000 (about 4.4percent) to a 1-in-100 risk or higher.It is highly likely that this number is growing. This challenge was referred to in the 2011 Natural Disaster Insurance Review (NDIR):
All natural disasters present a challenge for insurers. Since each event typically affects a large number of policyholders at once, a single natural disaster can have a very large impact on insurers exposed to the risk. This challenge, however, does not prevent insurers from offering cover for most natural disasters in all home insurance policies. And, in large part, insurers are able to cover these natural disasters at affordable premiums.
Flood, however, presents a unique challenge to insurers. Flood typically affects homes located close to a river or on a flood plain. As a result, the same homes are affected each time a river floods. … [W]hile the vast majority of homes are exposed to minimal flood risk, there is a small proportion of homes exposed to a high level of flood risk. … As a result of the very high premiums associated with high flood risk, insurers have often simply chosen to exclude flood cover from insurance policies.
3.50Uncertainties in flood modelling - The quality of flood modelling has improved over recent years, in relation to modelling undertaken by local government, water authorities and insurers themselves. This is due to higher quality and more granular underlying data and greater computational power to drive more accurate flood and climatic modelling. Insurers will often use local government flood maps as a starting point in their modelling, but will typically build on this with their own additional data and modelling – and also modelling and analysis undertaken by third parties (for example, actuaries).
3.51As with all modelling, different model designs, assumptions and calibrations can result in different outcomes. This is particularly the case for high-risk properties. At least some of the variation in pricing that occurs in the market can arise from differing assessments of risk across insurers.
3.52The challenge of private markets providing widely accessible flood insurance is exacerbated by data and modelling limitations that constrain insurers’ ability to price flood risk accurately. A paper by the Actuaries Institute’s Flood Working Group in 2008 noted that ‘Until recently, offering flood insurance has been considered “too hard” for most insurers’, as data deficiencies and modelling complexities make ‘a “perfect” pricing model…difficult, if not impossible, to achieve’:
…numerous models may exist that lead to very different outcomes. This is a particular problem for flood, compared to other perils, as there is a limited number of observed (and insured!) historical events that can be drawn on in calibrating models, and therefore a larger than usual number of assumptions are required in the modelling.
3.53These comments were echoed in Treasury’s 2011 Natural Disaster Insurance Review, which acknowledged that pricing flood risk is ‘a very inexact and approximate exercise’. Treasury’s subsequent consultation paper on flood insurance reform cautioned that such challenges encouraged insurers to be very conservative in flood cover and pricing decisions:
… it has generally only been the larger insurers with risk appetite and financial capacity, who have invested in underwriting systems to increase the availability of flood insurance. There are concerns that some insurers may be unable and/or unwilling to provide cover. Requiring all insurers to offer flood cover may result in some companies defensively pricing flood cover or simply ‘redlining’ flood prone areas.
3.54Asymmetric information - There are also issues with adverse selection and moral hazard. People that know their properties are likely to be flooded, are the most likely to want flood insurance cover (adverse selection). Insurers’ may be taking on an unacceptable level of risk if they are unaware of the flood risks of their insured properties and adjust their premiums accordingly. While information asymmetry has traditionally bedevilled insurance markets (for example, motor vehicle and life) where the insured has better information than the insurer, that situation may have flipped in the case of home and contents insurance over recent decades. Insurers now have extremely detailed, household land business level risk maps which means that they may have better information than the insured (and possibly than government and other stakeholders).
3.55Moral hazard may also be a factor in that people who feel secure in the knowledge they have flood insurance may also fail to take measures to reduce the damage to their properties. Insurers often deal with this problem through exclusions in the contract or may require certain rectification works to be undertaken by the policyholder before a claim will be processed.
3.56Despite the protection insurers receive from built up capital and the private reinsurance market, these are not free solutions to the problems associated with flood insurance. When insurance companies draw down on their capital, they must build it back up quickly to ensure they are prepared in the event of another natural disaster. Insurers also need to pay reinsurance firms for their cover. These costs flow through to policyholders through premiums, and with the increasing costs of damage from floods in Australia, these increased costs have contributed to higher premiums, especially for people that want to take out flood insurance that have a higher risk of flooding.
3.57Following the major floods of 2022, Australian insurers and global reinsurers have sought to collect more data to determine their level of exposure to flood risk through home and contents, commercial and other insurance lines. As a result, some insurers have stopped offering flood insurance, either as an inclusion in their policies or beyond a number of households the insurer is comfortable with, or insurers are raising premiums to better reflect the real risk underlying the policy.
3.58In Chapter 9, this report will look deeper at the issues contributing to higher premiums for flood prone properties and options for the Australian Government to consider to improve the availability and affordability of flood cover for these people. While these options are designed to provide some relief, they do not propose to allow people to ignore market signals, especially when those signals clearly indicate significant risk as floods become more frequent and severe.
Solutions to the disaster insurance gap used around the world
3.59Around the world, governments have established programs that seek to address the disaster insurance gap. These programs are often created to deal with one or more disasters responsible for the most damage to a region where insurers and reinsurers have deemed the disaster too risky to insure or will only insure in exchange for a premium that is unaffordable for most policyholders. Typically, government programs aim to increase the availability and affordability of disaster insurance either through the provision of insurance directly, or through reinsurance pools that transfer the risk from the private market to the government. Governments can help reduce premiums for policyholders, generally do not seek to achieve a profit and may be able to more effectively cross-subsidise the costs of the program.
3.60Some programs aim to cover only subsets of the population that are at the most risk from a disaster. For example, in the United States flood insurance is provided to the most high-risk communities through the National Flood Insurance Program (NFIP).
3.61Private insurance companies provide NFIP policies to participating communities, while the Federal Emergency Management Agency, which administers the NFIP and is responsible for underwriting the insurance coverage, assumes all of the risk for floods affecting policyholders and sets the rates charged for policies. Participating communities must meet certain conditions for enrolment, including that they adopt minimum floodplain management regulations. Additionally, anyone in a high-risk location with a mortgage through a government-backed lender is required to take out a flood insurance policy.
3.62Other countries have sought to implement similar programs, combining mandates for insurers to have disaster insurance included in their policies, and allowing them to charge surcharges to consumers, while also offering public reinsurance or a government-backed guarantee fund to protect the solvency of insurers from catastrophe-induced bankruptcy.
3.63For example, in Spain, insurers are required to include coverage for all natural disaster risks in general insurance policies. Insurance companies offset the risk by adding a surcharge to premiums and transferring risk to the public insurance consortium, Consorcio de Compensación de Seguros.
3.64France similarly mandates coverage for natural disasters, with premium surcharge rates set by the government, and the availability of the public reinsurance scheme, Caisse Centrale de Réassurance, protecting against catastrophe losses.
3.65New Zealand also mandates natural disaster insurance for some residential buildings whereby premiums are collected by private insurers and passed on to the Earthquake Commission to be held in a fund from which disaster insurance payouts are made when an event occurs.
3.66The United Kingdom (UK) has adopted Flood Re which requires all insurers that offer home insurance in the UK to pay a levy into the Flood Re Scheme which is used to cover the flood risks of home insurance policies. Insurers can choose to pass on the flood risk element of their policies to Flood Re for a fixed price. When a claim is made, the insurer will pay the claim and seek reimbursement from the fund.
3.67These programs are significant undertakings by any government. They usually require a dedicated organisation to work on the administration of the program, extensive data and modelling to ensure prices are fair, and monitoring following implementation to see whether the program is increasing insurance coverage while also not creating perverse incentives such as encouraging people to live in risky locations. The government also needs to be comfortable taking on the risk of a catastrophic event.
3.68There have also been a number of private sector innovations that have arisen in recent years. For example, there are start-ups that have begun offering parametric insurance to households, a solution which is primarily used in the reinsurance market.
3.69Parametric insurance is an index-based solution whereby a premium is paid in return for a specific payout if a pre-defined event occurs. A pre-agreed payout would be made if a parameter or index threshold is reached or exceeded, such as wind speeds during a hurricane, a certain level of magnitude of an earthquake, or rainfall levels and water heights of a flood. This solution has obvious benefits as it speeds up payments following a claim, removes the need for loss assessments on individual properties and reduces costs. However, they are not yet considered a viable option for households and businesses seeking full and comprehensive insurance cover. Currently, there is only one insurer offering parametric insurance for flood cover in Australia, French company, Descartes Underwriting. However, the Committee heard this cover can be ‘expensive’ and not necessarily feasible for people seeking flood cover.
Action taken by the Australian Government to address the disaster insurance gap in Australia
3.70The Australian Government has already taken steps to address the disaster insurance gap for cyclone and related flood damage in cyclone-prone areas. In 2022, the Australian Government sought to improve access and affordability of insurance by establishing the Cyclone Reinsurance Pool (Cyclone Pool), administered by the Australian Reinsurance Pool Corporation (ARPC). All general insurers are required to participate in the pool to maximise potential premium reductions. All large insurers have joined, and smaller insurers have until 31 December 2024. It is hoped that by introducing the pool, it will stimulate greater insurer participation in the northern Australian market. The Cyclone Pool is primarily focused on storm risk, but it also covers associated flooding occurring within a period of 48 hours after the storm event (known as the Cyclone Event Period). This time limit has been the subject of considerable discussion.
3.71Alongside the scheme’s introduction, the Australian Government directed the Australian Competition and Consumer Competition (ACCC) to collect data over 5 years to monitor the impact of the pool, assess whether savings from the pool are being passed through to policyholders, and see whether the pool is delivering on its intended outcomes. The ACCC’s second monitoring report for the year 2022-2023 in December 2023 indicated no significant price effects had flowed through to consumers during this period due to damage to property from tropical cyclones in 2022–23 being relatively limited and that most large insurers had joined the Pool around or after July 2023. The ACCC’s next report will analyse the impacts of the pool during the 2023-2024 period.
3.72The Australian Government has also more recently announced it will develop an integrated, cross-government approach to minimising the impacts of disasters on the community and help address insurance costs driven by more frequent and intense weather events. This work is to be undertaken by the Affordability and Natural Hazard Risk Reduction Taskforce.
The regulatory framework governing general insurers
3.73The general insurance industry is governed by a framework of legislation, self-regulatory codes, regulators and industry bodies.
The legislative framework and the role of regulators and authorities
3.74Retail general insurers must hold an Australian Financial Services Licence (AFSL) under the Corporations Act 2001. Among other things an AFSL comes with obligations for services to be provided to customers efficiently, honestly and fairly. Licensees must also have adequate arrangements in place to ensure staff are sufficiently trained and competent to provide their services, and that there are compensation arrangements and a dispute resolution system in place. This must include an internal dispute resolution process and membership of the AFCA for external dispute resolution.
3.75It is also an offence to conduct insurance business in Australia without the proper authority required by the Insurance Act 1973,which compels insurers to seek a licence from the Australian Prudential Regulation Authority (APRA) in order to provide general insurance products. It is through the Insurance Act, one of two Acts specifically regulating the general insurance industry, that insurers are prudentially regulated and subjected to supervision by APRA. General insurers are further regulated by standards issued by APRA, such as those requiring insurers to hold a minimum level of capital and requirements to report to APRA on insurers’ financial positions.
3.76The second piece of legislation specifically regulating general insurers is the Insurance Contracts Act 1984, which regulates the terms included in general insurance contracts and related insurer conduct, and for which the Australian Securities and Investments Commission (ASIC) is the regulator.
3.77The Insurance Contracts Act seeks to strike a fair balance between the interests of insurers and policyholders. It does this in part by having a duty of utmost good faith as an implied term applying to both the insurer and insured in insurance contracts, so that a breach of the duty can give rise to a claim for damages. The duty aims to ensure that each party to the insurance contract acts with fairness, decency and honesty.
3.78As part of its role, ASIC ensures that insurers provide insurance efficiently, honestly and fairly, handle complaints properly, and uphold their obligations to policyholders. ASIC is also responsible for contraventions of consumer law by general insurers under the Australian Securities and Investments Commission Act 2001 (the ASIC Act), which replicates protections under the Australian Consumer Law for financial services and products. ASIC can also issue regulatory guides that insurers must comply with, such as Regulatory Guide 271 Internal Dispute Resolution which explains what financial firms must do to have a compliant Internal Dispute Resolution system in place.
3.79Insurers are also subject to other whole-of-economy laws such as competition laws under the Competition and Consumer Act 2010, with the ACCC having a role in maintaining and promoting competition and taking action against insurers for contraventions of competition law. The ACCC can also be directed to inquire into and monitor prices in the insurance industry, as it was in 2017 when it was directed to inquire into the supply of insurance in northern Australia, and in 2022 when it was directed to monitor prices, costs and profits relating to the supply of insurance before and after the introduction of the Cyclone Pool.
3.80AFCA is authorised under the Corporations Act to deal with and resolve complaints by individuals or small business consumers made about their licensed financial sector firm, including general insurers. It operates as a not-for-profit and non-government organisation and is primarily funded by member firms in the industries it regulates.
3.81The AFCA scheme is overseen by ASIC and must comply with general considerations which are: accessibility; independence; fairness; accountability; efficiency and effectiveness. AFCA’s complaint resolution service is free to consumers and its decisions are binding on financial firm members. AFCA also has responsibilities to identify, resolve and report on systemic issues and serious contraventions of the law to ASIC. It supports separately funded, independent committees that monitor firms’ compliance, including with relevant industry codes.
The self-regulatory regime
3.82The ICA is the representative body for the Australian general insurance industry. Members of the ICA represent approximately 85 per cent of total premium income written by private sector general insurers, including reinsurers. The ICA’s roles include declaring ‘insurance events’, coordinating the industry’s response, conducting community consultations and collecting data. More generally, the ICA works with members, consumer groups and government on matters related to general insurance.
3.83First introduced in 1994, the 2020 General Insurance Code of Practice (the Code) is the principal voluntary self-regulatory document for the general insurance industry. The Code was created and is maintained by the ICA. All ICA members that offer products covered by the Code must subscribe to the Code and other industry participants are also encouraged to subscribe.
3.84The Code covers aspects of a consumer’s relationship with their insurer, including when a consumer buys insurance, makes a claim, is experiencing hardship, or makes a complaint. This includes timeframes for insurers to respond to claims, complaints and requests for information from customers. The Code also sets out the broad standards that general insurers must meet when providing services to their customers, including being open, fair and honest.
3.85The General Insurance Code Governance Committee (CGC) is an independent body that monitors compliance with the Code. The CGC is funded by industry, however, its operations are carried out by an independent secretariat that sits within AFCA. The CGC’s work includes examining insurers practices and recommending improvements to practices, identifying current and emerging industry-wide problems, monitoring the effectiveness of customer remediations and applying sanctions to insurers where necessary. The CGC also conducts inquiries and publishes its findings.
Flood insurance is a relatively recent phenomenon
Floods have historically been excluded from insurance policies
3.86The availability and affordability of flood insurance is, understandably, seen as a community and public policy challenge right now. However, historical context is important.
3.87Historically, flood has not typically been part of home and contents insurance policies in Australia. For decades, industry concerns about the magnitude of exposures, a lack of consistent and reliable flood maps, the absence of mitigation and concerns about the ability of policyholders to afford flood cover, persistently kept insurers from offering coverage for flood.
3.88All levels of government and the insurance industry repeatedly reviewed the issues after almost every major flood event, largely in response to continued public dissatisfaction with a lack of available flood cover. Although several schemes were proposed over the years, each proposal was ultimately rejected, with governments citing concerns over costs and the appropriateness of government intervention.
3.89While the Australian Government introduced standard terms and conditions for prescribed general insurance contracts through the commencement of the Insurance Contracts Act and Insurance Contracts Regulations, which included flood as a peril (as well as fire, storm, earthquake, cyclone and actions of the sea), insurers were able to exclude any standard cover items and largely continued to exclude flood from their policies. It was not until after the Wollongong flood in 1998, that some insurers moved to extend their policies to include flash flooding or partial flood cover with sub limits.
3.90The creation of the NFID in 2007 by the ICA addressed some of the concerns held by insurers around the uncertainty of exposure. Combined with pressure from public backlash following floods in the Hunter and Central Coast region in 2007 and Queensland in 2008, more insurers began to offer flood cover. Suncorp introduced flood cover on a no opt-out basis for most of its home and contents policies, followed by Zurich offering flood cover as standard and Insurance Australia Group (IAG) offering flood cover on an opt-out basis under its NRMA brand. Following the Queensland floods in 2011, there was a substantial increase in flood coverage as part of home and contents and commercial insurance policies, with insurers offering for policyholders to opt-out if they didn’t want, or couldn’t afford, flood cover.
3.91Today, all major insurers offer flood cover as part of their home and contents and commercial policies, however the availability of insurance for high flood risk properties is decreasing.
3.92The high costs borne by insurers from the 2022 floods have made insurers aware of the need to manage their exposure to floods. Several insurers have reduced the maximum number of properties they will insure in certain locations. Insurers are now able to leverage more accurate, granular flood risk data to isolate higher risk properties. In doing so, they have been able to reduce their exposure by limiting the number of policies covered in an area and charging premiums that better reflect the real risk of the properties they do insure to future flood events. Consequently, many people occupying areas that flooded in 2022 have found they have been unable to renew their policies, or have been quoted premiums substantially higher than they paid previously.
3.93A third trend has also become apparent throughout the course of this inquiry: a decreasing number of insurers are choosing to provide insurance with flood cover as an opt-out option, and where this is offered, insurers are moving to exclude related cover such as rainwater runoff.
3.94The Committee noted that of the eight largest general insurers in Australia, Suncorp, QBE, Youi, Royal Automobile Club of Queensland Limited (RACQ), and Hollard provide flood cover as standard (meaning it is mandatory) in most or all of their home and contents policies.
3.95Suncorp offers an opt-out option for flood cover for its AAMI home insurance products for high-risk customers. Auto & General Insurance Company Limited (A&G) offers flood cover as an add-on option for home and contents policies for properties, including in high flood risk areas.
3.96Until recently, Allianz offered flood cover as part of relevant home and contents policies, with customers able to opt-out if they choose. However, in May 2024, Allianz announced changes to its home and contents (and landlords) policies to include flood cover as standard for all new customers and existing customers with a low to moderate flood risk. Allianz’s existing high flood risk customers with policies that do not have flood cover will be able to continue without flood cover, with flood cover exclusion also to include rainwater runoff. These changes will commence from late 2024.
3.97From early 2022, IAG changed its home and contents policies to bundle the inclusion or exclusion of storm surge and rainwater runoff with flood in most of their products. IAG’s popular product lines, NRMA and RACV, now offer opt-out for all three events in NSW, the ACT, Victoria and Tasmania where there is a higher risk of water inundation.
Committee comment
3.98The Committee understands that the preference by some insurers to include flood cover as standard in their home and contents policies is due to some of the issues examined as part of this inquiry, including the challenges experienced when there is a need to determine whether damage to a property was caused by flood or something else when a policy doesn’t include flood cover. Insurers were more likely to experience delays due to the required hydrology assessments, with claims susceptible to disputes over the cause of damage where policyholders had opted-out of flood cover. Throughout the inquiry, all insurers indicated they were aware of the issues associated with opting-out of flood cover and the insurers which held policies without flood cover during the 2022 floods were continuing to consider their response as this inquiry concluded.
3.99While removing opt-out for flood insurance may streamline those insurers’ claims handling processes following a flood, there is also a real prospect that hundreds of thousands of households will be unable to afford and access any insurance at all. The inability to take out any insurance to protect against non-disaster related risks would have flow on effects for households, including by locking them into uninsurable homes and exposing them to significant financial stress if the risk eventuates. It could also impact people’s access to finance, and put homeowners with mortgages in the difficult position of breaching their contract, as it is a requirement for owners to hold an insurance policy to take out a mortgage on a property.
3.100The Committee will consider the impacts of the current trends in insurance coverage further in Chapter 9, on the accessibility and affordability of flood insurance.