Climate change widens gap in home insurance affordability

A new report has indicated how climate change and extreme weather risks are impacting home insurance affordability in Australia.

In a recent green paper for the Actuaries Institute, Finity authors Sharanjit Paddam, Calise Liu and Saroop Philips used Finity models and data to investigate the correlation between climate change and insurance affordability, providing critical information for insurers, insureds and banks looking to understand their exposure. 

The report said the Australian insurance industry had seen increasing losses from extreme weather events over the last 10 years, even after allowing for inflation and exposure growth. Just this year, southeast Queensland (Qld) and northern New South Wales (NSW) experienced Australia's costliest flood and the third-costliest natural disaster.

For the latest green paper, the Finity authors considered 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 authors based the home insurance premium for each home 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; and
• Attritional costs, insurer expenses and profit margins, and taxes by calibrating to market premium levels estimates from Finity's Finesse product.

Additionally, the authors estimated the gross household income based on census data and imputed it to the individual household level in Finity's Defin'd database.

Read more: Climate change to intensify insurance affordability pressure

So, what are the findings? The AAHIA index showed 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. While there is no clear definition of “unaffordable,” these households face extreme financial pressure to pay these premiums.

The report further revealed that insurance affordability is affected by extreme weather risk (as reflected in insurance premiums) and 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,” the authors said.

Mozo research released this month highlighted that almost half (49%) of Australians believe their insurance premiums have been skyrocketing due to the impacts of climate change – intensifying insurance affordability pressure.

However, do not lose hope yet because the authors shared a few suggestions requiring the participation of insurers, banks, governments, 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 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 and 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.