By Sophy Woodward, partner, Clayton Utz

The recent LA bushfires sent shockwaves through the insurance industry that will be felt around the world this year, with Victorian fires and Queensland floods causing further pain here in Australia.

Meanwhile, Peter Dutton and the Greens have both flagged government intervention in the insurance industry to curtail increasing premiums.      

While the interventions proposed are targeted at the plight of homeowners, the increased frequency and severity of extreme weather also has serious implications for Australian businesses, which government needs to address before it becomes a full-blown crisis.

The financial hit to insurers from natural disasters has directly affected consumers and businesses in the form of premium increases. The Coalition and Greens’ proposals for intervention will put further pressure on insurance companies and may not help ease the rising cost of living. But there are other ways government can intervene.  

Insurance affordability and accessibility is a significant issue for many Australian homeowners and businesses. Insurers are recalibrating their risk models to account for the growing threat of climate-related disasters, leading to significant adjustments across their portfolios. Since the Black Saturday bushfires, insurers have paid out almost $17 billion in natural disaster claims.

Insurers and reinsurers typically pool funds to cover their losses following a large-scale disaster, but these major events still lead to increased premiums for policyholders, regardless of whether they were affected. The Insurance Council of Australia says extreme weather has increased reinsurance premiums by up to 30%.

Broker Gallagher reports that a growing number of Australian businesses are experiencing difficulties securing commercial property insurance amid inflationary pressures, rising rebuilding costs and an uptick in extreme weather events. The industries most severely affected by rising property insurance premiums include energy, construction, infrastructure, commercial property and resources.

For businesses owning and operating assets that are particularly exposed to bushfire risk, property insurance is simply unavailable now. This has significant ramifications for Australia’s economy, especially the large-scale infrastructure projects needed to support the energy transition. These businesses are highly exposed to property damage and risk breaching licensing requirements or contractual obligations.

So, what needs to be done? Government could introduce cost reduction measures such as lowering insurance taxes and providing targeted subsidies. But subsidies are costly and hard to wind back once introduced, and most insurance taxes are levied at state government level. And there are no guarantees either would increase the availability of insurance and reduce premiums over the longer term without more fundamental risk mitigation and loss distribution measures. 

Ultimately, Australia needs targeted policy initiatives to reduce the risk and improve business resilience to natural disasters. The Hazards Insurance Partnership between the Australian government and the insurance industry, which aims to address insurance affordability and availability, is a good example. But although this is likely to have a positive long-term impact, it won’t resolve the short-term problem of insurance affordability.

The purpose of insurance is to spread risk by sharing the burden of losses with the wider community. Insurance companies are merely the mechanism through which this is achieved, and their social licence depends upon them doing so efficiently. But at present, the impact of natural disasters is more heavy on those homes and businesses that are most exposed.

A better solution may be to expand the cyclone reinsurance pool to include all natural disasters. This would significantly reduce the cost of reinsurance and give immediate relief to exposed policyholders by removing the reinsurance profit margin and substituting a government guarantee, the cost of which is less than reinsurers’ cost of capital. The government would not make a profit on the reinsurance, but the pool is required to set its rates and administer its reserves to break even over the long term. That preserves the price incentive for policyholders to mitigate their risks. 

This would enable insurers to offload the reinsurance of specific risks to the government-funded pool, so they can continue to cover higher-risk properties. In exchange for payment of a premium, the government provides reinsurance for eligible losses. Effectively, risks are shared across the entire Australian community. Participation in the pool is mandatory. This ensures the pool achieves the greatest possible premium reduction and enables it to operate cost-neutrally over time. 

The advantage of expanding the cyclone reinsurance pool is that the legal and actuarial structure has already been established. However, the pool will need to be fit for purpose across a much broader set of risks. The Australian Competition and Consumer Commission is already tasked with using its price monitoring powers to measure the pool’s impact on premiums. Expansion of the pool would see the remit of the ACCC increase, but this aligns with its existing regulatory responsibility for insurance.

Has the cyclone reinsurance pool been effective at reducing premiums? It’s early days. Large insurers weren't required to join the pool until December 31 2023 and small insurers were only required to join at the end of last year. But the ACCC has reported that premiums decreased for 27% of policies on properties in medium to high cyclone risk areas that were renewed after the insurer joined the pool.

The Coalition is proposing government intervention to help stem the rising cost of premiums. I’m proposing the same thing. But rather than putting pressure on insurance companies, a government-backed natural disaster reinsurance pool would support insurers in continuing to offer cover at an affordable cost and thereby ease pressure on Australian businesses and consumers. 

We can say with a high degree of confidence that it’s only a matter of time until Australia has another large-scale natural disaster. Government action now would provide much-needed reassurance, encourage economic activity and attract future investment.

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