This chapter considers the response of the insurance industry to the 2019-20 bushfires, the insurance losses associated with the fires and natural perils generally, and discusses the impact that the unaffordability of insurance can have on disaster preparedness, and ways that insurance affordability may be improved.
The chapter presents the views of various insurers on climate change mitigation and emissions reduction. Consideration is given to calls from the industry for greater Commonwealth government support for investment in mitigation infrastructure and for removal by the states and territories of duties and emergency service levies.
The chapter also considers the impact of severe and catastrophic weather events on the financial stability of the insurance industry, which is necessary for the industry to continue to contribute to the economic and social well‑being of the country as climate change drives more frequent and more damaging severe weather events.
The cost of natural disasters
The rising economic cost of natural disasters, including bushfires, has been acknowledged by insurers, the broader financial sector and the Commonwealth Government.
In a recent Menzies Research Centre policy paper (Menzies policy paper) commissioned by the Insurance Australia Group (IAG), it was noted that the economic costs of disasters was increasing. The policy paper noted that, particularly since 2000, there had been an upwards trend in natural disaster costs. For example:
In 2013, the total economic costs of natural disasters in Australia was estimated to average around $6.3 billion per year. By 2015, that the cost had risen to $9.6 billion with the inclusion of social impacts of disasters. By 2017, the cost of natural disasters had risen to $18.2 billion per year, equivalent to 1.2% of GDP, and was forecast to grow by 3.4 per cent per rising to $39 billion by 2050 per year in real terms, even without considering the future impact of climate change. These rising costs reflect increased population growth, the increasing density of infrastructure and continuing migration to more vulnerable parts of the country.
Economic performance of general insurers
In the March quarter of 2020, the Australian general insurance industry suffered its largest combined net loss after tax in recent memory. In addition, the financial performance of Australia’s general insurers has become very volatile from year to year.
Each quarter, the Australian Prudential Regulatory Authority (APRA) requires all general insurers to report their financial performance and APRA publishes the detailed financial performance data on its website.
Financial performance data for the March 2020 quarter reveals that the general insurance industry suffered combined net after tax losses of $1.011 billion. These losses were largely the result of combined and concurrent severe weather events in eastern Australia—the summer bushfires, hailstorms in January and an east coast storm event in February. Among other submitters and witnesses, IAG put compelling evidence before the committee that these severe weather events were driven by climate change.
By comparison, in the March 2019 quarter, which included an Insurance Council of Australia declared insurance catastrophe associated with devastating floods in North Queensland, all APRA‑mandated reporting general insurers reported combined net profits after tax of $601 million.
The four general insurers who appeared at the public hearing on 10 July 2020—IAG, Suncorp Group Limited, QBE Australia and Allianz Australia Limited—are an oligopoly controlling around 75 per cent of Australia’s general insurance market. Between them, they suffered combined net after tax losses on their general insurance lines of $721 million in the March 2020 quarter. IAG alone lost $400 million. By comparison, in the March 2019 quarter the four companies reported combined net profits after tax on their general insurance lines of $207 million.
The most recent quarter during which there were no insurance catastrophes declared by the Insurance Council of Australia, and which was unaffected by the COVID-19 pandemic, was the June quarter of 2019. In that quarter, the four major general insurers reported combined net after tax profits of $822 million.
The difference in the financial performance of the four major general insurers between a good quarter and a bad quarter can be nearly $2 billion. The recent financial performance of Australia’s major general insurers puts in stark relief the impact of climate change‑driven severe weather on their profitability and financial stability.
Insurance claims made following the 2019–20 bushfires
Tens of thousands of insurance claims have been made as a result of the
2019–20 bushfire season. A number of insurance companies provided statistics to the committee, highlighting the significant volume of lodged claims.
The Insurance Council of Australia (ICA) advised that, as of 23 August 2020, there were 38 416 claims lodged, of which 68 per cent were domestic, and 32 per cent commercial. The estimated value of these claims was $2.328 billion (with 62 per cent of this value being domestic, and 38 per cent commercial).
On 27 August, the ICA issued a news release, with updated information on claims relating to the 2019–20 bushfires. The ICA advised that the following claims had been closed:
83.5 per cent of 9389 home building claims;
93.7 per cent of 14 237 contents claims;
88.5 per cent of 1613 domestic motor vehicle claims and 90.5 per cent of 1332 commercial vehicle claims; and
81 per cent of 8737 commercial property claims and 81 per cent of 1285 business interruption claims.
The role of insurance in natural disasters
The insurance industry has a critical role to play in bushfire preparedness and response, climate change risk management and building community resilience.
Whether a policy holder is adequately insured can be a matter of life and death. In a 2010 report, the Senate Select Committee on Agricultural and Related Industries noted that a property owner's level of confidence in their insurance status could impact their decision-making during a bushfire event, and have significant impact on the risk to their lives. The report observed that:
Insurance is an integral part of bushfire risk management, not because it protects assets from being destroyed by fire, but because it has an important effect on the risks people are prepared to take to defend their properties. By providing property owners with the knowledge that their assets will be replaced in the event they are destroyed in a bushfire, adequate insurance cover encourages people to take sensible choices about self-protection in the critical moments of a bushfire disaster.
Other benefits of adequate insurance have also been considered. For example, during a January 2020 conference, the Organisation for Economic Co-operation and Development (OECD) considered adaptation to a changing climate in the management of wildfires. The key role of insurance in addressing wildfire risk was discussed, and it was concluded that:
Insurance and other risk transfer mechanisms can both limit the financial exposure to wildfire risks and encourage preventative action. Governments and insurance regulators and supervisors will need to ensure that insurers continue to be able to play this role in the context of increasing wildfire risk.
The Menzies policy paper outlined the benefits of insurance for individuals, the community, government and the economy, including:
managing risk efficiently by allowing it to be shared or transferred;
encouraging those who are insured to reduce the threat of loss through risk‑weighted premiums;
reducing the demand on governments to meet the cost of rebuilding after disaster strikes;
promoting financial stability by pooling the cost of risk and spreading it over time;
mobilising domestic savings;
facilitating trade and commerce through risk mitigation; and
supporting economic growth through the efficient allocation of capital and the development of financial services.
Non-insurance and underinsurance
The issue of lack of insurance and underinsurance is longstanding, and has a direct impact on the ability of the community to respond to and prepare for future natural disasters.
The National Insurance Brokers Association (NIBA) defined underinsurance as occurring when the sum insured 'is insufficient to enable full replacement of the damaged or destroyed property', or a commercial business. The NIBA also noted that underinsurance often only comes to light following a large-scale insurable event, such as the 2019–20 bushfires, and the rate of underinsurance was very difficult to estimate nation‑wide.
Representatives of the ICA informed the committee that, particularly in New South Wales (NSW), there were concerns about a high level of underinsurance. Early investigations by the ICA suggested that 'perhaps 10 or 11 per cent of properties that were a total loss may not have been insured'. The ICA later informed the committee of the difficulties in determining the rate of non‑insurance, stating that:
In order to accurately calculate the number of properties lost who did not have insurance, it is first necessary to have an accurate list of all properties lost (insured and non‑insured) ... However, in the absence of an accurate list of all properties destroyed from state governments, it is not possible to identify those that were not covered [at] the time of the loss.
The July 2018 findings of the Australian Capital Territory (ACT) Longitudinal Survey on Climate Change revealed 'low rates of insurance for extreme weather events'. Regarding the 2019-20 bushfire seasons, the Eurobodalla Shire Council observed the lack of sufficient insurance in their area:
It reported that up to one third of people are not insured … The lack of insurance places increased pressure on governments, not for profit groups and the broader community to provide financial support to those impacted by natural disasters.
Approaches of insurance companies to climate change and climate‑related disaster mitigation
A research report released in March 2020 by the Climate Change Authority stated that climate change risks for properties and infrastructure was increasingly a consideration for banks and insurance companies. The report went on to state that:
… markets tend not to adequately recognise and price climate‑related risk because of a lack of information and short-termism in investment decision making. However, this is changing quickly as relevant tools become available and financial regulators divert more attention to the issue.
A number of insurance companies have taken some action to respond to the risks of climate change through their underwriting and investment policies. For example, in July 2019, Suncorp announced that it would phase out its investments and insurance exposure to thermal coal by 2025, following announcements of similar commitments by QBE Australia (QBE) and Allianz Australia (Allianz). This meant that 'all of the Australian based insurance companies have now effectively committed to removing coal from their investment portfolios'.
In addition, both IAG and Suncorp welcomed the passing of legislation in October 2019 to establish the Emergency Response Fund, which provides for an additional $50 million per year in Commonwealth mitigation funding, bringing 'total federal mitigation funding to $76.1 million per annum'.
In their submission to the committee, Suncorp indicated that it had 'long held grave fears over Australia's lack of resilience and lack of preparedness for natural disasters', and called for action to urgently address the resulting risks. In that light, Suncorp argued strongly for climate change mitigation:
With climate change increasing the risk of extreme physical and economic impacts of natural disasters, including the costs of recovery for governments and communities, bringing forward investment into mitigation of climate change and prevention of damage from future disasters is now urgent.
Further to its appearance before the committee, Suncorp pointed out that it accepted the international scientific consensus on climate change, and was:
… committed to playing [its] part in reducing emissions and preparing for the physical and economic impacts of climate change on our business, community, and across our value chain.
Suncorp would progress these aims through reducing its own emissions, supporting 'an orderly transition to a net-zero emissions economy', and through 'supporting growth through new and emerging opportunities' with positive environmental impacts.
Suncorp's representative, Mr Michael Miller, Executive General Manager, Motor, Property and Specialty Claims, noted that regarding climate change, '…what you're finding now is that it is starting to bite and it is starting to become very real' and that the organisation would consider whether the insurance 'should start to have a harder voice … in this area'.
At the 10 July public hearing, Mr Phuong Ly, Chief Underwriting Officer at QBE, informed the committee that QBE was reducing its exposure to carbon intensive industries, and was taking steps to address climate change concerns. Mr Ly advised that QBE:
… accept the science behind climate change and we support the Paris Agreement, as well as adopting all the recommendations from the climate change task force around financial disclosure. As a company, we have taken action to be carbon neutral, which we are now, and we have aspirations to be utilising fully renewable resources and energy for our energy requirements by 2025. We've also made decisions around underwriting and investment so that, hopefully, by 2030, we will reduce our involvement in heavy carbon industries.
Mr Ly went on to explain that insurance premiums were likely to go up 'in certain regions where we've had natural catastrophes'.
QBE offered its support for 'increased investment in measures to build community resilience', in particular for increased government funding of mitigation activities, as well as removal of government taxes which contribute to underinsurance.
Insurance Australia Group
IAG underwrites almost $12 billion of premiums per annum for more than 8.5 million customers, under brands including NRMA Insurance, CGU and SGIO, among others.
IAG commissioned the Menzies Policy Paper, delivered in April 2020. IAG had previously commissioned the Severe Weather in a Changing Climate report, the first edition of which was released in November 2019. The report explains 'how climate change is impacting the severity and frequency of extreme weather events…and what is likely to happen in the future'.
The report reflects on the actions necessary to protect Australian communities from natural disasters, stating that, along with reducing global greenhouse gas emissions:
Protecting communities also requires greater investment in resilience, adaptation, and mitigation planning – from governments, businesses, community organisations and individuals – to reduce the physical, economic and social recovery costs that follow a disaster.
In response to questions on notice, IAG advised that it felt it was 'in a strong position to stress test our understanding and management' of climate change risks. The mechanisms to address these risks included:
the Board Charter including oversight of climate change and sustainability;
scenario planning, to 'understand the most significant likely impacts of climate change and related physical, transition and liability risks and opportunities'; and
research on both physical and transition risks.
IAG submitted to the committee that the government had a key role to play in emissions reduction policies, stating that:
To reduce the impacts of climate change, Governments need to ensure we have clear, considered and coordinated policies in place to reduce Australia's carbon emissions in line with our Paris Agreement targets. Additionally, Governments need to ensure a changing climate is accounted for when creating a strategy to mitigate, adapt and improve community resilience to natural perils.
At the committee's public hearing of 10 July 2020, IAG's representative, Mr Mark Leplastrier, Executive Manager, Natural Perils, noted that IAG was 'look[ing] at our targets around reducing emissions both in our own footprint and across our investment portfolios'.
Insurance Council of Australia
In June 2019, the ICA issued a public statement accepting the international scientific consensus on climate change presented by the International Panel on Climate Change and identifying the pressures it presents for the insurance sector and the wider Australian community. These pressures included:
changing physical risk, extreme weather patterns, and the need for new tools, modelling and investment to inform decision making, climate adaptation and mitigation;
the continued need for suitable and affordable insurance products to protect the community and businesses against perils;
a changing economy and the transition to a low carbon emissions economy, and
the need to ensure the solvency and stability of prudentially regulated entities.
The ICA has established a Climate Change Action Committee with the following mandates:
support the insurance industry to embed climate change issues and insights into decision making;
work with stakeholders to raise awareness of climate change and the impacts of climate change, manage risk and develop solutions including awareness of disaster preparedness in communities, and improve disaster response and recovery;
work with governments, regulators and other key stakeholders to promote action on climate change and other environmental issues; and
support industry disclosure of climate risks and opportunities.
It appeared to the committee that Allianz took a somewhat different approach to this issue than other insurance companies.
The Allianz submission to the inquiry recommended that the Commonwealth invest further in disaster mitigation and resilience. The submission went on to argue that the industry had 'long called for comprehensive measures to mitigate against the risk of extreme weather events', and that:
Mitigation and adaptation can help to protect the property against damage in the first place and make the property more resilient to damage. Allianz is supportive of a rebalancing of government funding that has a stronger focus on pre-disaster mitigation. At present, only 3 percent of natural disaster funding is spent on mitigation, whilst 97 percent is spent on post‑disaster recovery.
However, the company did not make any reference in its submission to climate change impacts on severe weather events, such as the summer bushfires, or to strong climate change mitigation through emissions reductions.
At the committee's public hearing on 10 July 2020, Allianz's Chief Corporate Affairs Officer, Mr Nicholas Scofield, noted that the organisation was unwilling to engage in what it characterised as a 'very polarised debate in Australia' around emissions reductions. Mr Scofield indicated that the increases to customer premiums could instead operate to offset the financial implications of extreme weather events.
The following exchange illustrates the position taken by Allianz:
Mr Scofield: I think it just comes down to the fact that emissions reduction is a very polarised debate in Australia. As insurers, we have taken the view that we don't want to put ourselves in the middle of a highly charged political debate. We'd rather just focus on what we see as the issues, the impact on us as insurers and our customers, and the things that we can advocate for that will directly deal with some of the issues that are arising. Essentially, it's around the impact of affordability driven by the increasing frequency and severity of natural weather events.
CHAIR: Taxation is a highly charged debate. What are your shareholders saying about this issue? It's an existential threat for the industry in some parts of Australia. You're losing very significant amounts of money, and it is difficult to price in over the medium-to-long term the sorts of premium increases that you're foreshadowing. That must be raising questions amongst your shareholders.
Mr Scofield: I don't think it's an issue in that sense, simply because we get to reprice every customer every year. We get to look at the premiums we need to charge and the amount of reinsurance we need to purchase to make sure our balance sheet and our shareholders are protected. There is a whole level of prudential regulation that ensures that as well. Ultimately, though, whether it's taxes, reinsurance price rises or our own premium adjustments relating to claims experience from weather events, only the customers can pay that.
Investing in disaster mitigation
Mitigation activities may be public, and carried out by governments (such as the introduction of revised building standards, land-use planning, hazard reduction burning and public warning systems), or may be private, and carried out by property owners (for example, installing home sprinklers, clearing land of vegetation and improved window and door seals).
The Australian Competition and Consumer Commission (ACCC) noted in a 2019 report that between 2009–10 and 2018–19, Australian government spending on mitigation through the National Partnership Agreements on Natural Disaster Resilience was 'approximately 2.1 per cent of total natural disaster relief funding'. The ACCC noted that this was 'considerably lower' than the US, where:
… the Hazard Mitigation Grant Program alone consists of 15 per cent of post disaster assistance funding, in addition to multiple pre-disaster mitigation funding programs.
A 2014 Productivity Commission inquiry found that Commonwealth Government mitigation spending was only three per cent of what it had spent post-disaster in recent years. The Australian National University (ANU) characterised this shortcoming as 'a long-standing situation that has been raised in a number of previous disaster management reviews and commissions of inquiry'.
A number of submitters also voiced their concerns about the inadequacy of Commonwealth Government funding for disaster mitigation, in the context of the increasing frequency and severity of extreme weather events. Submitters drew attention to the 2014 Productivity Commission inquiry, which found that 'governments overinvest in post‑disaster reconstruction and underinvest in mitigation that would limit the impact of natural disasters in the first place'.
To this end, the NIBA was of the view that as the Disaster Recovery Funding Arrangements were disproportionately weighted to disaster recovery, there was 'little economic incentive for state, territory and local governments to invest in disaster mitigation'.
The 2014 Productivity Commission inquiry accordingly recommended that the Australian Government should gradually increase the amount of annual mitigation funding it provides to state and territory governments to $200 million annually.
As can be seen in the evidence above, throughout the committee's inquiry various insurance companies have urged the government to take action to enhance resilience to natural disasters and provide greater investment in disaster mitigation.
For example, IAG argued that in the absence of insurance:
… Governments would have a moral and economic responsibility to rebuild and restore communities should misfortune or disaster occur.
… we need all levels of government to take the lead and shift their focus from disaster recovery to mitigation. This cannot be a simple transfer of funds, but a coordinated strategy incorporating mitigation, adaptation, data, infrastructure and community resilience.
This call for government action and financial and other support was made consistently by the insurance industry in submissions and at the public hearing at which the four major insurers, the ICA and NIBA appeared.
ACCC Northern Australia Insurance Inquiry
The ACCC has been tasked with examining concerns about building, contents and strata insurance availability and affordability in northern Australia. The ACCC commenced the inquiry in 2017, after receiving instructions from the Treasurer to do so pursuant to subsection 95H(1) of the Competition and Consumer Act 2010.
In the inquiry's second interim report published in November 2019, the ACCC found that mitigation works could assist in insurance affordability for both individuals and communities. The ACCC observed that:
Mitigation works can increase the resilience of properties and reduce the risk of damage from a natural disaster event, which can lower the technical premium of the insured. In a competitive market, this will result in lower premiums in both the short and long term. Further, the premium reduction should be sustainable in the long run as the majority of mitigation works have a long lifespan… both private (household level) and public (community level) mitigation programs have been successful in reducing claims costs internationally.
The ACCC did point out, however, that 'it is important to note that even extensive mitigation works will not remove catastrophe risk entirely'. The ACCC further suggested that some insurers did not have automated systems in place to recognise mitigation activity by policy-holders, and that insurers may not pass the 'full benefit of the reduced risk on to consumers through lower premiums'.
The ACCC also made clear that insurance premiums, despite mitigation efforts, are unlikely to return to historic levels:
Mitigation will enable sustainable reductions in premiums for properties in high risk areas, but previous examples show that the reduction will not be enough to return premiums to historic lower levels.
Further, those most likely to be suffering from affordability pressures are least likely to be able to afford to undertake mitigation work which would decrease premiums.
The ACCC concluded that mitigation can improve insurance affordability and was of the view that government subsidies had the greatest potential to enable targeted affordability assistance. It further concluded that government-funded mitigation programs can help reduce the underlying risks facing residents in northern Australia. The ACCC also reaffirmed the general role of mitigation efforts:
Regardless of the extent of funding governments wish to provide to mitigation programs, the impact the program will have on the affordability of insurance will be enhanced if the mitigation works they fund are determined with reference to a robust assessment of costs and benefits.
Private mitigation works
It has also been proposed that some homes may need to undertake private mitigation works in order to increase their bushfire preparedness. The Australian Institute of Architects (AIA) stated in its submission that many of the homes destroyed in the 2019–20 bushfires were older homes built prior to current building regulations. The AIA pointed to research by SGS Economics and Planning which suggested that:
Australia-wide, some 2.2 million people live in high or extreme bushfire risk areas. This suggests a fundamental legacy issue of up to one million existing houses in bushfire prone areas currently with little or no bushfire protection.
The ICA advised that no Australian standards exist for retrofitting an older property, and as of September 2020 the ICA was engaged in discussions to establish guidance on 'retrofitting for bushfire risk to older property'. The ICA noted the variability in cost estimations for retrofitting, saying that:
Sum-insured estimation calculators, used to estimate the cost of a total rebuild, show that the additional costs involved for rebuilding in a high risk zone vary from $25K to $100K depending on the level of risk in the location and the age of the original property.
Given that the industry has indicated that mitigation infrastructure—including the retrofitting of homes for bushfire risk—may require government financial assistance, the committee will continue to pay close attention to this issue and will continue to engage with the industry in relation to the development of standards and costs.
It was argued that retrofitting and similar improvements need not necessarily by the sole responsibility of the homeowner. For example, the NIBA submitted that state and territory governments ought to provide funding in this area, to address the fact that existing buildings were falling further behind in their ability to withstand natural disasters. It was recommended by the NIBA that:
In order to bridge the gap between new and existing infrastructure … that state and territory governments provide grants to owners of non‑compliant infrastructure in bushfire-prone regions to undertake private mitigation works.
Similarly, the AIA submitted that alterations or additions to existing homes have become 'especially problematic in terms of meeting bushfire regulations' and recommended that government incentives and regulatory assistance be provided to support homeowners to upgrade their properties to enhanced safety levels.
IAG has argued for creating more incentives for property owners to conduct private mitigation works, given a general reluctance for home owners to invest in such works when they are required to bear the cost. IAG was of that view that:
… governments, insurers and business should work together to incentivise property owners to undertake mitigation works. Government could directly subsidise mitigation works; insurers then provide premium discounts according to the level of mitigation works and the building industry provides an expand range of cost-effective and acceptable retrofit options. The Queensland government's $20 million Household resilience program is an example of this in action. The program has seen premiums for those in the program reduce.
The NIBA submitted that in the past, both public and private mitigation programs have been effective in reducing risks and consequently lowering insurance premiums.
Regardless of whether the mitigations programs were public or private, the importance of mitigation efforts was highlighted by Mr Rob Whelan, Executive Director and Chief Executive Officer of the ICA. Mr Whelan explained that:
…if appropriate mitigation and prevention is not done, some parts of Australia may become uninsurable in the future.
Australian Prudential Regulation Authority's supervision of the insurance industry
The Australian Prudential Regulation Authority (APRA) supervises prudential regulation of financial institutions across banking, insurance and superannuation. Under its legislation, APRA is tasked with protecting the interests of depositors, policyholders and superannuation fund members. APRA’s legislated mandate is to:
… protect the Australian Community by establishing and enforcing prudential standards and practices designed to ensure that, under all reasonable circumstances, financial promises made by institutions [APRA] supervises are met within a stable, efficient and competitive financial system.
Over recent years APRA has sought to ensure that regulated entities are actively seeking to understand and manage the financial risks of a changing climate. APRA observed that the 'effects of changing climate extend to all sectors of the economy', and that these effects 'pose financial risks, as well as provide new business opportunities, to all APRA-regulated entities'.
In a February 2020 letter to regulated entities, including general insurers, APRA emphasised that, given the diversity of business models, it 'has not been prescriptive as to how [managing the financial risks of climate change] should be done, nor imposed any particular constraints on specific sorts of business activity', instead opting to 'make sure that the effects on businesses from a changing climate—both direct and indirect—have been actively considered within entities' decision making'. APRA's stated goal was 'increasing industry resilience'.
In the same letter, APRA noted that the current situation required insurers to act now regarding the climate data deficit. APRA drew attention to its 2018 climate change survey, which highlighted that 'many large entities understand the financial risks and opportunities from a changing climate'. APRA went on to note, however, that:
… this work also highlighted the need to address the climate data deficit, to quantify the likely impact of the physical, transitional and liability risks of climate change and accurately assess and appropriately price these risks. … Effective action now on these fronts will promote strong understanding and management of the potential financial impacts of a changing climate on current and future business prospects, allowing well-managed entities to minimise costs and optimise benefits.
APRA observed that industry participants had requested further information on 'better industry practice in relation to climate‑related financial risks', and on regulatory expectations. In response, APRA advised of its intent to develop and consult on a climate change financial risk prudential practice guide (PPG). APRA stated that the PPG would:
… cover areas relevant to the prudent management of climate change financial risks, aligned with the recommendations of the TCFD, including aspects of governance, strategy, risk management, metrics and disclosure.
APRA also committed to developing a climate change financial risk vulnerability assessment. APRA noted that the vulnerability assessments would take into account the threat posed by climate change, and would require entities to estimate:
… the potential physical impacts of a changing climate, including extreme weather events, on their balance sheet, as well as the risks that may arise from the global transition to a low-carbon economy.
APRA advised in the February 2020 letter that it would coordinate this work with the Australian Securities and Investment Commission (ASIC), the Reserve Bank of Australia, via the Council of Financial Regulators, as well as seek input from the Commonwealth Scientific and Industrial Research Organisation (CSIRO), the Bureau of Meteorology, and international regulatory authorities.
APRA concluded its letter by noting that it would continue to engage with entities and support industry-led initiatives, to encourage coordination between industry and regulators. However, APRA warned that entities should take action, prior to any further advice from APRA. APRA was of the view that:
… entities should be proactive in taking steps to assess and mitigate climate change financial risks now, and not delay action until further guidance or scenario analysis from APRA is released.
Progress of the climate change prudential practice guide
APRA's February 2020 letter noted that it would consult on the draft PPG in mid‑2020, with a view to publish final guidance before the end of the year.
The committee sought an update from insurance entities as to the progress of the PPG. Suncorp explained that on 23 March 2020, APRA had advised that it had suspended work on various issues, including the PPG. Suncorp advised that APRA had:
… suspended the majority of its planned policy and supervision initiatives in response to COVID-19 – including the climate change financial risk vulnerability assessment. Suncorp is currently awaiting further advice from APRA on the revised timing of this assessment.
In August 2020, IAG further advised the committee that the vulnerability assessment 'hasn't been designed yet and APRA's initial focus is on authorised deposit-taking institutions (ADI) with no set timing for general insurance'.
Similar points were made by Allianz, which noted that APRA's initial focus was on ADI vulnerability assessments, which would be executed in 2021, 'with other industries including the general insurance industry to follow'.
The affordability of insurance
A number of submissions made to the inquiry called for improved affordability of and an increase in the uptake of insurance.
In its 2014 report into natural disaster funding arrangements, the Productivity Commission found that:
Australian insurance markets for natural disaster risk are generally working well, and pricing is increasingly risk reflective. However, this has resulted in increases in premiums and potentially underinsurance and non-insurance in high-risk areas.
The Practical Justice Initiative University of New South Wales (PJI) drew attention to research suggesting that under current insurance models, one in 20 homes would be uninsurable by the end of the century due to an increase in climate change induced weather extremes, which were boosting risk-based insurance premiums to unaffordable levels.
The PJI further observed that 'the insurance industry has—for more than a decade—been asking the Federal Government to increase spending on disaster‑mitigation' and that '[t]he government's continued failure to mitigate is directly linked to the uptick in the inability of some Australians to insure their homes'.
Submitters made the point that Australians were significantly uninsured and underinsured, and encouraged governments to implement measures that would improve the affordability and accessibility of insurance, including disaster mitigation and the removal of taxes and duties from property insurance policies.
Following the 2019–20 bushfire season, Emergency Leaders for Climate Action (ELCA) and the Climate Council issued its Final report of the National Bushfire and Climate Summit 2020. This report made a series of recommendations that were designed to 'increase the affordability and uptake of insurance for properties in disaster prone areas'.
A number of the recommendations of the report related to insurance and considered pricing, affordability and underinsurance. The recommendations included:
establishing an independent expert panel to review insurance affordability in Australia, 'having regard to the rising levels of financial difficulty and the worsening impacts of climate change';
the panel should work with the insurance industry, other jurisdictions and consumer groups to complete a comprehensive review of the impact of climate change on the provision of insurance;
exploring barriers to total replacement building insurance policies, and addressing these to make this type of insurance more attractive and widely available;
development of a standard for sum insured calculators, including modelling of climate risk and costs such as debris removal, demolition and other services—noting that transparency was particularly important to assist people living in areas of high climate risk;
supporting the recovery of some or all of the value that public infrastructure generates for private landowners;
requiring mortgage lenders, as part of the serviceability test, to include an insurance cost projection for the life of the mortgage, with climate change risk included; and
ensuring that insurance pricing is a fair and transparent reflection of the resilience of the property, so that people who build or invest in resilience measures are rewarded with lower insurance premiums.
The committee is generally supportive of the intent of the reforms suggested by ELCA and will continue to engage with ELCA, the industry and other stakeholders, including receiving further submissions and holding public hearings on the subject of insurance affordability in bushfire and other natural disaster‑prone regions.
Emergency services funding
Currently, the majority of state and territory governments fund their emergency services through a property-based levy. The exceptions to imposing a property-based levy are in the following jurisdictions:
NSW, which funds emergency services through insurance-based levies;
the Northern Territory, which funds services through consolidated revenue; and
Tasmania which funds emergency services through a combination of property and insurance-based levies.
Drawing on reporting by the ICA, QBE informed the committee that from 2007–08 to 2018–19, insurance taxation revenue collected by state and territory governments totalled $54.7 billion (the majority of which was in NSW, with $18.2 billion collected). It was forecast that an increase in the NSW emergency services levy would generate an additional $230 million in revenue between 2018–19 and 2021–22.
Further, Allianz estimated that for the 2019-20 financial year, the amount of revenue collected through state and Northern Territory duties and levies would be $5.833 billion.
During the inquiry, a number of insurance industry groups voiced concerns over the way emergency services were funded in those jurisdictions imposing an emergency services insurance‑based levy. The industry argued for lower levies, taxes and duties on insurance in order to increase its affordability.
Issues with insurance-based levies and taxes
The NIBA was of the view that insurance-based levies were 'inequitable', as they forced 'responsible property owners'—being those who have adequately insured their properties against loss—to shoulder the costs of funding the emergency services, rather than a fairer system based on property levies, which collectively fund state emergency services.
The NIBA went on to argue that the current insurance-based arrangements require the levying of emergency services levy, goods and services tax (GST), and stamp duty on top of the base premium, in that order. The NIBA suggested that the compounding of taxes caused a significant increase in premiums, which could have serious consequences for policyholders who may already struggle with insurance affordability. The NIBA concluded that:
Policy holders may be forced to reduce the sum insured value of their property or forego insurance entirely, leaving them open to significant financial liability if a disaster were to occur.
Similar views were put forward by Mr Robert Whelan, Chief Executive Officer and Executive Director of the ICA, who informed the committee that the NSW insurance-based levies for emergency services 'funds something in the order of 73 to 74 per cent of the total budget for that service by government'—totalling over $1.1 billion for the most recent financial year. Mr Whelan noted that when the levy was combined with premiums, GST and stamp duty, the effect was:
… quite substantial on individual policies, to the extent that close to 50 per cent of a premium charged in total to an insured person in New South Wales is taxation, and that can go up to as high as 70 per cent for businesses in certain areas as well.
Mr Whelan suggested that this could be the reason as to why underinsurance was a more prominent issue in NSW, compared with Victoria.
The Productivity Commission found in 2014 that 'taxes and levies significantly raise the cost of insurance and contribute to non-insurance and underinsurance' and recommended that 'state and territory taxes and levies on general insurance should be phased out and replaced with less distortionary taxes'.
This solution has been consistently argued for by the insurance sector. For example, in November 2019, the ICA submitted its comments to the NSW Review of Federal Financial Relations Discussion Paper, which repeated its argument that 'insurance-based taxes distort decision making and drive up the cost of insurance for consumers'. It also argued that the 2019–20 bushfire season provided an even stronger impetus for tax reform, and suggested that:
As the Federal and NSW Governments necessarily consider lessons in light of the current catastrophic bushfire season and the impact that climate change will have in making bushfire seasons longer and more severe, tax reform is a vital consideration for community resilience, risk management and ensuring that citizens can recover from a disaster.
The Menzies Policy Paper included the observation that the status quo in this area was discouraging individuals from insuring themselves, including at the federal level:
At present the Federal Government discourages people from insuring themselves by imposing the GST on insurance premiums. Some state governments also penalise self-reliance by imposing levies on insurance companies to fund fire brigades, a cost which is passed on through increased premiums.
The NIBA argued that improving affordability removed barriers to insurance and enabled more homeowners to appropriately manage their risks. Similarly, the Salvation Army was of the view that the shock to household budgets of insurance costs could be alleviated by abolishing insurance stamp duty in the states where it was still charged.
Insurers argued in their submissions for governments to remove taxes and levies on insurance premiums, arguing that they 'result in the perverse scenario that sees vulnerable Australians paying more in tax if they face greater risk' while also creating a greater fiscal burden for governments. The proposed reforms suggested by the industry included:
removing all taxes (including GST) and levies from disaster insurance, and making premiums fully tax-deductible;
removing the Emergency Services Levy from insurance in NSW, and ideally, abolishing it (and if not, the levy should be attached to local government rates as in Victoria); and
removing the Insurance Fire Levy from commercial insurance in Tasmania.
Committee views and recommendations
Evidence provided to the committee showed a very substantial volume of claims made as a result of the bushfires, for both residential and commercial properties and vehicles, and that the majority of these claims have been settled. The committee commends the industry for settling claims with speed, efficiency and compassion. There has been no evidence put before the committee at this stage of the inquiry to suggest that the claims handling processes of the insurers, their overall conduct and the associated support they have provided to bushfire‑affected communities has been anything other than exemplary.
Climate change mitigation
The committee is of the view that the insurance industry has a vital role to play in responding to increasing climate risk and disaster mitigation.
The evidence presented to the committee indicates that insurers agree that the climate is changing and that mitigation is needed, and that there needs to be urgent action taken to address climate change risks. This is uncontroversial. Where the controversy seems to arise is the strength of the mitigation required and who should bear the cost.
There is disparity across the industry on this issue. For example, IAG appears to have most clearly acknowledged the impact of climate change on the insurance industry, and the need for urgent mitigation action. As IAG’s Severe Weather in Changing Climate report points out, limiting global temperature increases to the Paris Agreement target will only be achieved under ideal conditions with, among other actions, 'rapid and large scale political commitments to decarbonisation'.
On the other hand, Allianz seemed to suggest that its position is that it is not willing to engage with the public discussion around emissions reduction and the burden of a lack of domestic and international political will to take urgent action on emissions reductions will fall on policy holders through increased premiums.
Insurance industry advocacy in the political arena for government expenditure on mitigation infrastructure is not new. It can be traced back to at least the Canadian industry's advocacy in the 1990s for a 'national mitigation strategy', intended to stimulate public and private infrastructure spending which was designed to adapt buildings and construct infrastructure (such as flood levees) to make communities more resilient to severe weather damage. The proposition is that in circumstances or locations where there is no mitigation infrastructure and the risk of severe weather hazard is high enough, insurance will become unavailable, either as a result of unaffordable premiums or insurers simply withdrawing cover. To the extent that government funded mitigation infrastructure either reduces premiums or causes insurers to offer cover, the expenditure performs a risk pooling function by offering tangible ex ante protection in the form of a floodway or some other form of physical mitigation. The alternative is that in the absence of insurance, government carries all the risk by having to provide after-the-fact compensation in the event of damage caused by severe weather.
There is no doubt that governments should invest in mitigation infrastructure that reduces the risk of catastrophic damage caused by climate change‑driven severe weather events. However, these investments should not be seen as an either/or proposition relative to strong climate change mitigation offered by rapid emissions reductions and decarbonisation. The two should operate concurrently.
The committee agrees that government expenditure on mitigation infrastructure is both necessary and unavoidable given the growing risk posed by climate change driven severe weather. However, any proposed infrastructure expenditure would have to be subject to clear, transparent criteria and selection processes based around sound business cases, sound environmental cases, proven capacity to mitigate risk and consequently, increase the likelihood of reducing insurance premiums.
The committee will continue to engage with the insurance industry and other stakeholders throughout the remainder of this inquiry to explore funding models, assessment processes and the types of infrastructure that would make real contributions to Australia's stock of necessary mitigation infrastructure.
Affordability – taxes and levies on insurance policies
It is clear to the committee that it is critical that Australians, and particularly those located in bushfire-prone areas, have adequate and affordable insurance to ensure that they are not left destitute following events like the 2019‑20 bushfire season.
The committee is concerned at the level of taxation and levies imposed on insurance policies and can see some justification in imposing property‑based taxes and levies as an alternative. The committee acknowledges concerns raised about the rising cost of insurance premiums to which taxes and levies add a substantial portion.
However, the taxes and levies on insurance premiums are in the form of stamp duties and emergency services levies, which are imposed by the states and territories. The revenue that would be forgone and would need to be replaced is considerable, amounting to approximately $5.58 billion per annum. As demonstrated in the Australian Capital Territory (ACT), the move away from stamp duties towards broad-based property taxes is not a politically easy process. Implementation of taxation reform in the ACT faced sustained political opposition and criticism over a long period of time. It is not for this committee to recommend or advise the state and territory governments on the courses of action they might take in this regard. We would however encourage stakeholders including the insurance industry to continue to engage constructively with state and territory governments so that bipartisan proposals for reform can be reached.
The committee is concerned at the premium increases foreshadowed by insurers which gave evidence in the course of the inquiry thus far. The committee is particularly concerned at the evidence given by Allianz that it will expect policy-holders to shoulder the burden of increased severe and catastrophic weather risk through increased premiums.
The committee is not labouring under any illusions that the natural peril component of insurance premiums will increase over time under climate change, but we do not accept the proposition that policy-holders should carry the entire burden. This is particularly the case in circumstances where the industry is calling on taxpayers to make significant mitigation expenditures and forgo significant tax revenues, while the industry itself is not prepared to publicly engage with the strongest possible mitigation measure available—rapid emissions reductions and decarbonisation.
The committee is of the view that there is sufficient concern over the likelihood of significant premium increases in coming years, particularly given the absence of any certainty around what the contribution of climate change to the natural perils component of premiums will be in the short and medium term. Therefore, the committee considers that ACCC intervention in the form of price monitoring is warranted.
The committee recommends that under Part VIIA, Division 5 of the Competition and Consumer Act 2010, the Treasurer direct the Australian Competition and Consumer Commission to undertake monitoring of the prices, costs and profits relating to insurance premiums, with particular attention paid to the impact of climate change‑driven severe weather on the natural perils component of general insurance premiums.
Insurance industry financial volatility caused by severe weather
In September 2020, IAG released the second edition of its report, Severe Weather in a Changing Climate. In an important update to the November 2019 report, the second edition draws on the latest data connecting different extreme weather events and how multiple, connected events in close succession and even concurrent events may lead to more devastating consequences for communities than they have ever experienced.
The report finds that:
since the pre-industrial period (1850-1900), the average global mean temperature has already risen by more than 1 degree Celsius;
it is highly likely that this warming could reach 1.5 degrees Celsius this decade and 2 degrees Celsius by 2036;
accelerating change in average global mean temperature will substantially increase the frequency of many weather and climate extremes;
bushfire weather risk, including the most catastrophic types of fire weather conditions is expected to increase across most parts of Australia;
fire seasons will get longer and closer together thus reducing opportunities for fuel management and hazard reduction;
even the highest Bushfire Attack Level (BAL) construction specifications are not designed for catastrophic fire conditions and were not adequate for the 2019-20 fire season;
hail risk is already increasing;
the risk of giant hail events is expected to shift further south down the east coast and risk is expected to increase in Sydney, Canberra, Melbourne and to a lesser extent, Adelaide and Perth;
the entire region from the Hunter Valley to eastern Victoria will also likely experience increased hail risk;
there will be higher proportion of the most intense tropical cyclones and they will extend further south with risks increasing more rapidly in south‑east Queensland and north-east New South Wales;
increased temperatures will generate tropical cyclones with more energy and greater capacity to generate more rain over larger land areas, leading to increased risk of flooding and wind-driven rain damage; and
while there may be fewer east coast lows in winter and spring, there will be an increase in the number and intensity of the more damaging east coast lows that occur in summer and autumn (an example is the destructive east coast low storm event in February 2020 across Queensland and NSW which generated $958 million in insurance losses).
Most worryingly, the report found that extreme weather events that are connected in time and space exacerbate the impacts that would have occurred from separate events. The report concluded that:
Connected extremes can, therefore, lead to multiple extreme impacts upon Australian communities… Emerging research is showing the damage from connected extreme weather events is exacerbated by climate change.
While incremental increases in average temperatures or rainfall are cause for grave concern, it is changes in the severity and frequency of climate extremes that ought to keep insurance company executives awake at night. Research shows that extreme temperatures, catastrophic bushfires and extreme rainfall events behave differently from the way that average conditions will respond to climate change. This was evidenced by bushfires regularly creating their own weather during the last bushfire season and has serious consequences for the financial stability of the insurance industry.
Changes in the severity and frequency of extreme weather events affect the financial stability of insurers in three main ways. Changed weather patterns interfere with insurers' ability to predict future insured losses. It shortens return periods between extreme weather events, which shortens the time between insurers receiving premiums and paying out on policies, and it increases the amounts paid out under policies.
As long ago as 1997, under the auspices of the United Nations Environment Program (UNEP), insurance companies launched the UNEP Insurance Industry Initiative for the Environment which in 1999 published a paper discussing the implications of climate change for the insurance industry, which made the following observation:
Underwriting of property risk from natural hazards such as windstorm, flood and subsidence is based on the concept of 'return periods'. Return periods are generally calculated on observed events and historic claims costs. Rapidly changing climatic conditions will lead to difficulties in calculating return periods and to lagging premium adjustments.
According to Andrew Dlugolecki, who for 27 years held senior technical and operational posts with the UK insurance giant Aviva and has contributed to IPCC work on financial services, there are five important implications for insurers when return periods shrink:
Historical models of costs are inapplicable because the scale and frequency of severe weather events move beyond historical experience;
Risks are incorrectly rated because the probability of an extreme loss is assessed as too low;
Exposures are too high because the maximum probable loss is too low and a consequence is faulty reinsurance planning;
Claims handling capacity is too low because the scale of destruction in new extremes is beyond experience. Multiple, connected events may overwhelm recovery capacity; and
Credit ratings held by insurance firms are too generous because the probability of a serious, sustained depletion of capital is underestimated, thus exposing insurers to the risk of unrecoverable reinsurance.
The effects of shrinking return periods on Australian general insurers is evident in Figure 7.1 below, produced by the ICA, which charts various financial metrics using data reported to APRA by the general insurance industry between the first quarter of 2010 and the second quarter of 2020. The industry has experienced significant financial volatility since 2014, a period which has coincided with historically high numbers of ICA‑declared insurance catastrophes related to severe weather events.
Particularly volatile key metrics are net profit/loss after tax, underwriting result, investment income, return on net assets and net loss ratio.
Figure 7.1: General Insurance Industry Statistics
The committee holds serious concerns over the impact severe and catastrophic weather events, driven by climate change, can have on the financial stability and viability of the general insurance industry.
The committee understands the reason for APRA suspending its work with the industry, on ensuring the industry is sufficiently cognisant and prepared for the financial risks posed by climate change, due to the demands imposed by the COVID-19 pandemic.
However, there is a high probability that the recent financial volatility of the industry due to severe weather events will continue. The industry's preference for relatively weak mitigation action in the form of government expenditure on mitigation infrastructure and states and territories foregoing revenue as an affordability measure are only part of the solution to the threat posed to the industry by climate change. In the absence of the strong political will the industry acknowledges is necessary for rapid emissions reductions and decarbonisation, the committee is not persuaded that adequate steps are being taken to protect policy-holders from excessive premium increases and the industry from ongoing financial volatility and vulnerability. The availability and affordability of insurance are essential for economic development, the financial cohesion of society and peace of mind in a world that is experiencing rapidly increasing risks of natural peril.
The committee therefore believes that APRA should recommence the financial resilience measures it outlined to the industry in February 2020. In addition, APRA should undertake financial vulnerability stress testing of the insurance sector, in anticipation of worst‑case scenario severe weather events.
The committee recommends that the Australian Prudential Regulation Authority immediately recommence its work on the climate change‑related prudential practice and governance guide as it relates to the general insurance industry.
The committee recommends that the Australian Prudential Regulation Authority should, if it has not already done so, undertake financial vulnerability stress testing of the insurance sector, including consideration of capital adequacy in anticipation of worst case scenario severe weather events causing catastrophic insurance losses, either singly or in combination.