Climate change widening the gap in home insurance affordability for Australian households

Date18th August 2022

Home insurance affordability in a changing climate

Over the last ten years, the Australian insurance industry has seen increasing losses from extreme weather-related events, even after allowing for inflation and exposure growth. 2022 has seen the highest ever flood loss, and hardening property reinsurance rates at the latest renewals are setting expectations that home insurance premiums will continue to rise. The Commonwealth has launched the Cyclone Reinsurance Pool in an effort to address insurance affordability in North Australia. All of this is raising the spectre of home insurance affordability and potential solutions.

In a recent green paper for the Actuaries Institute entitled Home insurance affordability and socioeconomic equity in a changing climate, Finity authors Sharanjit Paddam, Calise Liu and Saroop Philips have performed a detailed investigation into the current state of home insurance affordability in Australia and the potential implications of climate change.

The green paper considers a new measure of home insurance affordability: The Australian Actuaries Home Insurance Affordability (AAHIA) Index, calculated for each of the 10.1 million households in Australia as AAHIA Index = Annual Home Insurance Premium/Gross Annual Household Income (weeks), and aggregated at a Local Government Area (LGA) level.

The home insurance premium for each house was based on a combination of:

  • Natural perils risk at each address, estimated using Finity’s finperils models

  • Building and contents sum insured, estimated using Finity’s rebuild product

  • Attritional costs, insurer expenses and profit margins, and taxes, by calibrating to market premium levels estimated from Finity’s Finesse product

Gross household income was estimated based on census data and imputed down to individual household level in Finity’s Defin’d database.

By combining Finity’s models and data, the paper provides a strategic insight into this important challenge for the industry. Finity routinely provide similar views for banks and insurers looking to understand their exposure to affordability challenges and climate risk, and the green paper elevates this to a market-wide level.

The AAHIA index shows that the median household faces an insurance premium equal to about 1.1 weeks of gross income – an average premium of $1,534, an amount that seems likely to be affordable. However, 1 million (10%) of Australian households today face home insurance premiums of over four weeks of gross household income. These households are shown in red in Figure 1 below. While there is no clear definition of “unaffordable” these households are face extreme financial pressure to pay these premiums.
Source: Figure 1.1 - Australian Actuaries Home Insurance Affordability Index by percentile, pg. 6 Actuaries Institute Green Paper

The green paper describes this group subject to extreme affordability pressure as vulnerable – and notes that they face an average home insurance premium amounting to 7.4 weeks of gross income, with the remaining 90% of the population as base households, who face an average weekly premium of 1.0 weeks of income.

There is no public information available on whether or not people purchase home insurance, but the ACCC Inquiry in 2019 that found that 11% of the population do not purchase home insurance – aligning with approximately 10% of the population facing extreme pressure.

The results show that insurance affordability is affected by both the risk of extreme weather – as reflected in insurance premiums (Figure 2), and low incomes (Figure 3). These figures show a clear overlap between areas of high premiums and areas with low incomes. Perhaps this is not surprising as low-income households might only be able to afford housing in outer suburbs of cities or rural areas, which are exposed to bushfires, and are often in flood plains (e.g. West of Brisbane, or Western Sydney).
Source: Figure 4.3 – Mean annual home insurance premium by LGA – current, low and high emissions scenario ($2022 values), pg. 26 Actuaries Institute Green Paper
Source: Figure 4.8 – Average annual household income and current savings by LGA ($2022 values) – pg. 30 Actuaries Institute Green Paper

Combining these metrics gives us the AAHIA. Figure 4 shows the median AAHIA by LGA, which shows a familiar pattern of high or extreme affordability pressures in Northern Australia and inland NSW. In North-western WA, however, higher incomes associated with the mining boom at the time of the census, alleviate the pressure of high risk.
Source: Figure 5.2 – Median AAHIA as at 2022 and under low and high emission climate scenarios, pg. 33 Actuaries Institute Green Paper

Looking at the proportion of vulnerable households by LGA (Figure 5) shows a similar picture to the median, but emphasises that there are vulnerable households in every LGA. Affordability can be driven just by low income without above average risk.

Looking at the proportion of vulnerable households by LGA (Figure 5) shows a similar picture to the median, but emphasises that there are vulnerable households in every LGA. Affordability can be driven just by low income without above average risk.
Source: Figure 5.5 – Proportion of vulnerable households by LGA, pg. 34 Actuaries Institute Green Paper

Moving beyond geographic factors, Finity’s Defin’d product also provided us with insight on the socioeconomic characteristics of vulnerable householders compared to the rest of the population. Groups with socioeconomic disadvantage, including older or retired Australians, single parent families, and renters were over-represented in vulnerable households. Further analysis from Defin’d showed that vulnerable householders lived in areas with low socioeconomic status, had low insurance literacy and low savings.
Source: Figure 5.10 – Population characteristics of vulnerable and base households, pg. 37 Actuaries Institute Green Paper

The green paper also considered the impact of two climate scenarios – a low emissions scenario (based on IPCC AR5’s RCP2.6), and a high emissions scenario (RCP 8.5) at 2050, using advice provided by the Earth Systems and Climate Change Hub (a partnership of CSIRO, Bureau of Meteorology and UNSW) to the Climate Standards Measurement Initiative on the behaviour of extreme weather events.

Finity’s climate-adjusted finperils models provided new estimates of the home insurance premiums under these climate scenarios. Assuming no impact to gross impacts (i.e. excluding the potential impact of climate transition on employment and incomes), we recalculated the AAHIA.

The results showed a markedly different picture for the vulnerable households – which faced an average 20% increase in the AAHIA index under the high emissions scenario, to the base households that experienced very small increases. Under the scenarios considered, climate change did not affect everyone equally – already vulnerable household faced the greatest increase in risk and home insurance premiums.
Source: Figure 5.8 – Increase in median AAHIA under a high emissions scenario, pg. 36 Actuaries Institute Green Paper

The Green Paper makes a number of policy recommendations to address these issues, noting that many of the solutions come from outside insurance, and will require close collaboration between governments, insurers, banks and other stakeholders:

• Structural solutions to improve infrastructure resilience (such as levees, flood ways, and sea walls);

• Managed retreat from risk-prone areas;

• Better land use and planning and changes to building codes to allow for the impact of climate change over time, and to reduce development in high-risk areas;

• Nature-based solutions for improving resilience;

• Close consultation with First Nations Australians on more resilient ways of living within the Australian landscape;

• Options to subsidise insurance for low-income households to supplement the cyclone reinsurance pool;

• Improved data collection and availability on home insurance affordability as well as vulnerable assets, natural hazards and the impact of climate change; and

• Replacement of State stamp duty and levies with more equitable and efficient sources of revenue.

For insurers, the Green Paper demonstrates a method of considering the strategic risk of climate change – deploying Finity’s models and data assets to understand the limits of affordability on your home insurance portfolio and developing strategic responses to these risks and opportunities.

Banks will also be challenged by these results as requiring customers to obtain buildings insurance is the key control used to manage climate physical risk. If that insurance becomes unaffordable, then this control will likely fail and banks will be left with a substantially increased residual risk. Again, Finity deploys its models to help our banking clients understand the level of climate physical risk and the implications for credit risk for their residential lending portfolios. Through these insights we also assist banks in developing strategic approaches to the risks and opportunities from climate change.

For more information download the report here or contact Sharanjit Paddam.

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