Insurance premiums and affordability – how can we curb the cycle of loss and costs?

The emergence of environmental issues such as global warming and climate change have triggered a dramatic global shift, including in Australia, where natural disaster losses continue to accumulate.

Given the copious losses, reinsurance companies are increasingly under pressure as they underwrite the riskiest portion of insurers’ portfolios.

As a result, the need to recapitalise may lead to a continuation of the current hard market as both reinsurance and insurance companies transfer their costs to their customers and in turn, premium prices continue to increase.

This concern was raised in a 2022 study published by Fitch, Commercial Insurance: Past the Market Peak. It stated that commercial insurance premiums have increased consecutively for seventeen quarters, citing high claims volumes, substantial underwriting losses and the COVID-19 pandemic.

Now well into the second quarter of 2023, we can observe the predicted cycle in the market, with several media sources (including Insurance News.com, The West Australian and the Sydney Morning Herald), pointing to IAG’s decision to increase premiums, citing a “massive influx of disaster payout claims, inflationary pressures and rising reinsurance costs”.

Suncorp has since followed suit, also citing “the need to recuperate loss margins as the reason for increasing prices”.

Recession looming

Should insurers continue to follow IAG and Suncorp’s example, we could soon see a domino effect impacting the incomes of consumers and businesses.

UNSW Business School’s Michael Sherris identifies these challenges as systematic risks. Systematic risks, or market risks, are those risks associated with an entire market segment.

In contrast with unsystematic risks, or risks that can be mitigated through diversification, the nature of systematic risk is unpredictable, hence it is impossible to avoid. Even through an extensive process of diversification and hedging, there will still be some form of risk retained in the portfolio.

In the event of a steep decline in insurance affordability, low-income earners and small businesses stand to be the biggest losers. Rising insurance premiums coupled with the rising cost of living due to recent continuous interest rate hikes could even lead the economy into a recessionary period.

As a result, more vulnerable stakeholders may end up falling behind on their insurance premiums, in the hope that the worst “won’t happen to them”. The idea of self-insuring their properties and premises can be terrifying, consequently putting them in a very precarious position.

Vulnerable stakeholders

According to a recent study by the Institute of Actuaries of Australia in August 2022, “vulnerable households” are mainly older individuals who are renting homes and have a lower savings ratio.

Additionally, people whose homes are situated in flood and fire prone areas are forced to shell out almost seven times their annual gross household incomes on insurance compared to “base households” who only spend about one week of their gross household income on coverage.

Where they are forced to choose between putting food on the table, a daily necessity, or coughing up a huge sum to pay for various insurance policies, households are faced with an opportunity cost.

In my opinion, most are likely to pick the former. The continuous increase in interest rates since May, 2022, (Cash Rate Target | RBA) has created a compounding effect on the economy.

Also, the response lag, or time gap between the implementation and effect of the current contractionary monetary policy, has indirectly hit businesses and consumers. As a result, consumers and businesses are now feeling a rise in the cost of living before the economic cycle has smoothed out.

Whether regulatory authorities adopt a monetary or fiscal policy stance, changes in interest or tax rates with the intention of curbing inflationary or deflationary cycles will have a direct impact on the economy.

Insurance options decrease

Meanwhile, insurers have been forced to remediate, to reduce risk so that certain products can be continued, or exit products completely.

As early as October 2020, research from the Australian Industry Group found that the global insurance hard market is causing a lack of insurance options, as many insurance companies are reluctant to provide coverage for the risks that have been presenting.

Hence, some businesses are pushed to either pay an exorbitant insurance premium or risk being under insured or not insured at all. According to the 2020 Australian Small Business and Family Enterprise Ombudsman’s Insurance Inquiry Report, small businesses are more likely to have their businesses shut due to the inability to invest in risk management, or the allocation of their annual funding and budget for increasing insurance premiums.

Of course, businesses have the option to reduce their insurance premium by increasing their deductibles. A higher deductible payment allows businesses to absorb some risk from the insurer.

However, this may not be the best option for businesses, as they would need pay a larger excess to make a claim. In the event of the need to lodge multiple claims at once, choosing higher deductibles may turn out far worse for a business in terms of its cash flow.

Between a rock and a hard place

For insurance brokers, operating in such a hard market driven by factors they can’t control is always challenging. With the increase in sanctions and various exclusions applied by insurers, brokers must spend more time reviewing numerous endorsements and wordings to ensure that their clients have adequate insurance cover.

Given some businesses choose to be more price-focused in this climate, a difficult conversation is often required. On the one hand, the broker wishes to serve the client with adequate coverage, while on the other, the client leans towards a cheaper, less optimal option. 

Adding to the challenge is the often low level of financial literacy in the community, including within businesses, and the resulting lack of awareness of the importance of risk mitigation strategies. Poor financial decision-making over the long term is the likely unfortunate outcome.

One case in point is highlighted in a recent InsuranceNews.com article, which tells of hotel owners unable to obtain a full claim payout when their premises was damaged by fire because of an underinsurance clause.

Call for intervention

Given these unprecedented circumstances, whereby reinsurers, insurers, households and businesses are all negatively impacted, regulatory authorities could intervene further to ensure that the interests of all stakeholders are covered.

In my view, continuous increases in premiums and the inability to afford insurance for individuals and businesses could potentially lead to a market failure in the economy. Market failure occurs when an economy has failed to allocate resources efficiently in the absence of intervention.

The federal government of Australia is making swift changes to ensure that insurances for households and businesses are accessible.

During the last budget, it tabled an annual spend of $200 million, dubbed the Disaster Ready Fund. Nevertheless, in a recent article published by Insurance Business, the Royal Automobile Club of Queensland (RACQ), raises the concern that the government may not correctly prioritise the allocation of the funds.

In the article, the insurer’s spokesperson Josh Cooney urges that the funds be put to “shovel-ready projects” rather postponing their distribution until the final report on the government’s independent review of disaster funding arrangements comes out in 2024.

Cooney also points out that disaster prevention funding in Australia significantly lacks investment, with 97 per cent of funds spent on recovery.

A need for collaboration

Along with the need for funds, a lack of comprehensive data and information available to insurers makes it difficult for them to accurately incorporate any community mitigation strategies when assessing their risks.

Precautionary underwriting in the circumstances means that insurance premiums are likely to continue increasing. A lack of readily available information is also one of the factors that contributes to the inefficient allocation of resources.

For example, according to a 2021 report published by the Insurance Council of Australia (ICA), Climate change impact series: Tropical cyclones and future risks, key data gaps have prevented insurers from building an accurate picture of flood risk, especially during a changing climate.

Other ICA reports, published in May 2022, point to a lack of available of flood data due to “licensing issues”. Recommendations include a call for regulatory authorities to establish and maintain a reliable, quality assured database which is freely available and promotes an improvement in awareness and in turn, risk assessment processes.

In my view, the most ideal scenario would be to see regulatory authorities working together with insurers to identify and invest in vulnerable areas where resilience measures could be improved. Such initiatives could reduce the impact of potential disasters and cushion the economy from further economic losses.

According to InsuranceNEWS, insurance companies are suffering from previous and outstanding claim payouts amounting to almost $7 billion in insured losses.

Given a chance to recover, the resulting reduction in loss ratios could give more insurers the flexibility to offer lower premiums to households and businesses, in turn, enabling affordable insurance to become a reality for more consumers.

References

1. Yeates, Clancy. “Insurance Giant IAG Says Big Premium Rises to Continue.” The Sydney Morning Herald, 3 Feb. 2023, www.smh.com.au/business/banking-and-finance/insurance-giant-iag-cuts-guidance-after-hit-from-inflation-floods-20230203-p5chnl.html.
2. Sherris, M. (2022, September 19). How will businesses be affected by rising insurance premiums? [Review of How will businesses be affected by rising insurance premiums?]. https://www.businessthink.unsw.edu.au/articles/businesses-rising-insurance-premiums
3. Home insurance affordability and socioeconomic equity in a changing climate. (2022). https://actuaries.asn.au/Library/Opinion/2022/HIAGreenPaper.pdf
4. ‌www.aigroup.com.au. (2020). Business Insurance: Unaffordable or Unavailable? [online] Available at: https://www.aigroup.com.au/link/1d41218a066c43268094dcee02fc48e5.aspx
5. ‌Insurance Inquiry Report. (2020). Available at: https://www.asbfeo.gov.au/sites/default/files/2021-11/Final%20Insurance%20Report_0.pdf.
6. ‌Fitchratings.com. (2023). Available at: https://www.fitchratings.com/research/insurance/commercial-insurance-past-market-peak-22-03-2022
7. Institute, Actuaries. “Home Insurance Affordability and Socioeconomic Equity in a Changing Climate.” Actuaries Digital, 16 Aug. 2022, www.actuaries.digital/2022/08/17/home-insurance-affordability-and-socioeconomic-equity-in-a-changing-climate/.
8. Sections newslocal corporate regulatory & government life insurance the professional Insurtech International Analysis Breaking News. Insurance News. (n.d.). Retrieved March 31, 2023, from https://www.insurancenews.com.au/daily/underinsurance-clause-hits-hotel-fire-claim-payment
9. Olano, G. (2023) Racq urges spending of disaster funding on the "Right Priorities", Insurance Business Australia. Insurance Business. https://www.insurancebusinessmag.com/au/news/catastrophe/racq-urges-spending-of-disaster-funding-on-the-right-priorities-434831.aspx
10. Insurance Council of Australia. (n.d.). Climate change impact series: Tropical cyclones and future risks. https://insurancecouncil.com.au/wp-content/uploads/2021/12/2021Nov_Tropical-Cyclones-and-Future-Risks_final.pdf
11. Insurance Council of Australia. (n.d.). Climate Change Impact Series: Flooding and Future Risks. https://insurancecouncil.com.au/wp-content/uploads/2022/05/2202May_Flooding-and-Future-Risks_final.pdf
12. Claims totals from last year's floods continue to rise - Daily - Insurance News - insuranceNEWS.com.au