June 2008 - The Perfect Storm is Approaching
Insurers will continue to come under increasing pressure to provide reasonable returns to shareholders.
If they don’t, shareholders will look for alternative investment opportunities. To attract capital to the insurance market, it is self evident that insurers need to maintain profitability. The effects of the credit squeeze in the USA have had far reaching global effects and the insurance industry isn’t immune.
With climate change and global warming accepted as recognised phenomena, we can observe their impacts in the worldwide experience of large storms of ever-increasing ferocity. At the IOS conference in Melbourne last year, climate change experts spoke of possibly fewer storms for the northern half of Australia, but events of potentially greater magnitude. In Christchurch, the news was even less appealing – bigger storms and more frequent in occurrence.
We are still in the grip of a soft insurance market but insurance is a cyclical business. What happens when the cycle changes, as inevitably it will, and the market hardens?
Add to this scenario, the fact that value of assets exposed to extreme weather events is increasing as people shift to coastal regional for lifestyle benefits. This has been particularly noticeable in Queensland and northern NSW.
For insurers to maintain profits in a time of increasing storm-related activity and a rise in the incidence of claims and average claims cost, premium rates must inevitably rise, unless insurers contract their exposure in high-risk areas, increasing premiums in adversely affected regions mot a combination of both.
Concerns have been expressed that some insureds have pulled out of the market because they can no longer afford premiums. If premiums are to rise, which is probably inevitable, it seems likely that others will similarly no longer insure, perceiving that insurance is no longer a “luxury: they can afford.
With mortgage repayments, food and fuel process increasing, it’s hardly surprising. But are these people in a sector of the market that can afford to be without insurance? We see people with properties in flood-prone areas that are inundated regularly. In many cases, these people have limited capacity to bear the cost. If they are uninsured, where does the financial burden rest?
The overwhelming majority of Australians cannot afford to be uninsured or assume a self-managed risk. Insurers are entitled, like any corporation or business, to be profitable. If they aren’t, they will not remain in the market.
Risk-based premiums are necessary to maintain profitable outcomes for insurers. If we experience an increase in rates in the current economic environment, a decline in insurance take up, and an increase in the frequency and intensity of weather-related events are these conditions for the “perfect storm” for many insureds?
The alignment of influences may not occur in this insurance cycle but, if storm-related activity increases ad with it the corresponding cost to insurers, it is likely this scenario could present in the future.
We are observing an increasing incidence of underinsurance and the consequences this produces for insureds. It was particularly noticeable after Cyclone Larry. During times of crisis when people find themselves without insurance, or significantly underinsured, governments are called on to assist in providing financial relief. In effect, governments are subsidising the public for losses that might otherwise be better addressed by insurance.
Many governments in Australia use insurance as a revenue-raising mechanism. Given that natural market forces will see an increase in premiums, governments needs to consider easing the burden on policy holders. Instead of providing relief at the “calms end”, the question needs to be asked whether it might be wiser to encourage everyone to not only have insurance but adequate insurance by providing tax relief for premiums. That would assist in offsetting the costs of inevitable premium increases.
It is not in the community’s best interest for there to be an increase in the incidence of underinsurance or noninsurance. Where that happens, the community invariably ends up wearing the cost, one way or another.
Governments may need to provide incentives for people to be fully insured (as occurs with health insurance), rather than disincentives through multiple levels of taxation, as it now the case.
The threats and challenges of climate change will be with us for a long time. We need to ensure the insurance industry can meet its part of the challenge by maintaining its financial integrity.