On average Australia spends A$1.58 billion dollars annually recovering from natural catastrophes. This is one reason why the report, Natural Disasters in Australia, from the Council of Australian Governments (COAG) found that insurance was an important factor in developing resilience in the Australian community. That was in 2002.
Almost a decade on, last December – just prior to Queensland's extensive flooding and a destructive cyclone – COAG reiterated the link between insurance cover and community resilience in the National Strategy for Disaster Resilience. Notably, there is still a general lack of both, says Michael Sherris, a professor of Actuarial Studies at the Australian School of Business.
About 50% of the households affected by the recent natural disasters along the Australia's east coast had no insurance or were significantly underinsured. One reason for that is the sheer cost of house and contents insurance. The price of premiums has been blown out by so-called "loaded costs". Although risk is an important factor determining prices, insurance policies are subject to goods and services tax, state government stamp duties and, in New South Wales and Victoria, fire services levies. According to the Australian Strategic Policy Institute report Sharing risk: Financing Australia's disaster resilience, all these additional costs loaded onto premiums can increase the cost to policyholders by as much as 123%. Figures from insurer Suncorp suggest that over a 20-year period, insurance charges have risen at twice the rate of the Consumer Price Index.
Imposts in the Line of Fire
"If consumers face high premiums, they buy less insurance or they don't update policies with the rising value of their belongings over time," says Sherris. This is exacerbated if consumers realise they are not actually paying for risk coverage in their policies, but to deliver against all those additional costs that have nothing much to do with protection against potential threats such as floods or storms.
"It is perfectly rational to underinsure if you face double the premium due to loading. Many people feel it's more economical to put their money into a savings account and just hope for the best," Sherris suggests. As a result, the level of private insurance penetration in Australia remains low compared with other countries in the Organisation for Economic Co-operation and Development. Almost one in four Australian residential properties does not have a building or contents policy.
Lack of insurance in many areas is not in the interest of government. By spreading risk across a larger group of people, insurance makes losses manageable. But if people feel it is not economical to buy appropriate cover, the state has to act as an "insurer of last resort" – and that also can be costly.
The government bill for flood relief and recovery contribution for the 2010/11 summer has been estimated to be more than A$5.6 billion, which has resulted in the federal government introducing a one-off flood levy to deal with the scale of its financial obligations. Yes, administrations need to provide disaster relief to assist in community recovery, argue Sherris and others, but public resources are limited. Incentives for individuals to self-manage their own risks are likely to be more effective than relying mainly on government support, they say. Therefore governments should have an interest in better coverage for citizens in a price-sensitive market and there's a case for reducing the cost loadings imposed on insurance customers.
It's not a new idea. In the report that followed Australia's Future Tax System Review, chaired by former Treasury chief Ken Henry, recommendation 79 (of the 138 made in the report) states: "Insurance products should be treated like most other services consumed within Australia and be subject to only one broad-based tax on consumption." Recommendation 55 reads: "Over time, a broad-based cash flow tax – applied on a destination basis – could be used to finance the abolition of other taxes, including payroll tax and inefficient state consumption taxes, such as insurance taxes." When the report was released in May 2010, the Insurance Council of Australia, National Insurance Brokers Association and major insurer Insurance Australia Group, wasted no time in issuing media releases welcoming the recommendations.
But in the months following the publication of the Henry report, the recommendations have largely gone ignored. "The real disappointment is that Henry recognised how Australian insurance taxes are leading to under-insurance or non-insurance, but the government only barely acknowledged that insurance taxes are amongst the most inefficient taxes levied in Australia," says Phil Lee, accounting firm Deloitte's partner for insurance tax.
In particular, the practice of charging home insurance with fire levies to finance fire brigades attracts critics, since the fire service is provided to everyone, but is funded only by the few who actually buy insurance. Following the Victorian bushfires in February 2009, a royal commission recommended abolition of the fire levy in favour of a mechanism by which all real estate owners paid for fire brigades via council rates. Such a property-based structure would lead to substantial savings in insurance costs for businesses and homeowners.
Should Everyone Pay?
After a financial year dominated by floods and cyclones, Sherris argues that insurance should be a key instrument to provide security from financial loss and the hardship of natural disasters. Climate change places new pressure on governments to create strategies that lead to a sustainable outcome for both citizens and the Treasury, Sherris points out. But what should be done exactly?
After the Victorian bushfires, some experts started discussing a compulsory home insurance similar to the legislated compulsory third party insurance policies, known as "green slips", for cars. The idea is that governments could collectively apply a levy to property owners in order to fund basic coverage. The levy, as part of the local council rates, could be applied at a consistent rate or adjusted according to a property's exposure to risk. But this would require the government to establish an entity to determine the specific risks and the levies due. However, many believe that mandatory insurance would be a step too far as this would milk the entire population for risks that only threaten a small part of the community.
According to the Natural Disaster Insurance Review (NDIR), there are only about 50,000 homes subject to high flood risk, less than 1% of Australia's estimated 6.2 million homes. Also, in the view of the NDIR, such a scheme would "would require new legislation and there would have to be a way to oblige insurers to provide cover to homeowners that they may decline in a voluntary market".
Alternatively, a national disaster insurance scheme could be established to create a common insurance pool for such events, similar to the natural catastrophe cover now provided by the New Zealand Earthquake Commission, which was set up in 1945. At a recent Institute of Actuaries of Australia conference, a comparable scheme for Australia was discussed in which the government, along with all insurance companies, would establish a common pool to cover losses from natural disasters. It would be run on insurance principles with premiums set by an advisory committee.
Until this advisory committee or some other risk review body is in place, Sherris and other experts contemplate the introduction of a mutual in the non-life insurance sector. A mutual would pool risks just as for-profit insurance companies do and share profit and loss, but it would face lower capital requirements from the regulator than publicly traded companies. The NDIR discussed such a common vehicle, with insurers participating and subsidised by the government, in regards to a Flood Insurance Pool. For homes beyond a pre-defined flood risk threshold "the price could be set at say 150 percent of the non-flood premium", the review suggested. Once again, it's a solution that would be so much more affordable without the duties, levies and taxes.