A burning platform
Good afternoon, and thank you for the invitation to speak today about natural disaster resilience – the issue that is central to the mission of the Australia Business Roundtable. Thanks also to outgoing IAG CEO Peter Harmer for his introduction, and his leadership. I wish him well in the next stage of his life.
Let me start with a confession: much of this speech was written more than six months ago. I had been invited to speak at the Insurance Council of Australia’s (ICA’s) Annual Forum on the 18th of March. In previous years, I’d used the ICA event to speak about emerging financial risks. But with parts of the country still burning from the summer’s bushfire disaster, and other areas in Queensland and New South Wales cleaning up from severe flooding, it seemed impossible to avoid addressing the issue of natural disasters – risks that are as old as the continent itself. I prepared a speech focused on the need for greater investment in natural disaster mitigation to keep insurance affordable and accessible, especially for those in more disaster-prone parts of the country. As the severity of COVID-19 became apparent, the ICA cancelled its event, and that speech was never delivered.
Much has changed since March. Most dramatically, the world remains gripped by the greatest health and economic crisis most of us have experienced. Governments at all levels have needed to put their budgets into the red to support investment in the job market, keep businesses afloat and people in their homes. But the threat posed by bushfires, floods, cyclones and storms hasn’t gone away. The latest bushfire season is already upon us, while on Monday the Bureau of Meteorology issued its latest Tropical Cyclone outlook1 for the season starting in a fortnight. Amid predictions that natural disasters will become more frequent and intense into the future, the task of ensuring the community is prepared for these natural disasters is becoming more urgent.
In the face of this threat to financial stability and economic growth, we are now seeing investment in practical mitigation to protect vulnerable communities becoming the national priority it needs to be. Some of these measures are expensive, and there will be arguments over who should bear that cost. But, as with the transition to the low carbon economy, someone will ultimately pay, and waiting to act will only lead to higher costs in the long-run.
The new normal?
APRA’s interest in issues around natural disasters and climate-related risks is obvious. These events have a material impact on the industry’s financial position. For example, Australia’s general insurers, at last count, faced paying out $5.4 billion from almost 300,000 claims related to last summer’s bushfires, floods and hailstorms.2
We don’t all run an insurance company – like Peter – or regulate the industry – like me – but the sustainability of Australia’s general insurance industry matters to everyone. Nearly every business and household relies on insurance to protect them financially, to give them the confidence to invest, and to rebuild if disaster strikes. As the industry’s prudential regulator, APRA’s mandate is to ensure that every insurer has the financial means to pay all legitimate claims. Consequently, at the peak of last summer’s bushfire threat, as hundreds of weary and distraught Australians surveyed the ruins of their house, shop or farm, none needed to have any doubt about the financial capacity of their insurance company to cover the cost of repairs, replacement or rebuilding.
However, the economic damage caused by natural disasters typically far exceeds insured losses – what is known in insurance circles as the “protection gap”. Public infrastructure, such as roads, bridges, and electricity and water utilities, needs to be repaired or replaced. Businesses are badly disrupted and opportunities forgone. We also know from past experience that a significant number of affected households and businesses will either have no insurance or be underinsured, putting additional burden on governments as the insurers of last resort.
With support from the Government, Australia’s financial sector and the broader economy are sufficiently strong and well-prepared to absorb and bounce back, even taking COVID-19 into account. But that resilience would be continually tested should last summer’s experience become the new normal. Alarmingly, the clear message from Australian and global scientific experts suggests this may be the case. The Bureau of Meteorology says Australia’s climate has warmed just over 1 degree Celsius in recent decades, contributing to a long-term increase in extreme fire weather and the length of the fire season.3 The Australian Academy of Science warns the link between human-induced climate change and extreme weather is clear, and we must start preparing for a more dangerous future.4 The recently released report by IAG and the US-based National Center for Atmospheric Research forecasts a near future with a higher proportion of category 4 and 5 cyclones that extend further south into more heavily populated areas. The report also predicts a greater risk of flash-flooding, increasing coastal erosion from rising sea levels, and more destructive hailstorms.
Mind the gap
These trends are already being felt by general insurers, which are more directly exposed than other parts of the financial sector to natural disasters. Swiss Re has observed that climate change is leading to more flooding, torrential rains, prolonged drought and severe wildfires.5 Figures from another reinsurance giant (and Australian Business Roundtable member), Munich Re, show that the number of global insurance loss events from natural disasters has risen from 249 in 1980 to 848 last year, driven by a major and sustained rise in weather and hydrological events.6
APRA has been working with insurers for several years now to make sure they understand these trends, and are managing the risks. We know from APRA’s climate survey that the general insurance sector is highly engaged on this issue: 100 per cent of general insurers surveyed were taking steps to better understand the risks, and a growing proportion were undertaking financial and scenario analysis and disclosing climate-related risks.
Insurers have two other things in their favour as they face the prospect of higher claims costs from more intense and frequent natural disasters in coming years: an increasingly sophisticated ability to measure the risk faced by individual policyholders, and the fact that general insurance contracts are typically renewed annually. These factors give general insurers much greater ability than most financial institutions to identify and avoid the highest risks by raising premiums or declining to offer cover. This might be good for insurers – at least in the short term – but it’s bad news for policyholders, and economic activity more broadly. APRA’s biggest concern when it comes to the impact of climate-related risks on insurance is therefore not the prospect of an insurer becoming insolvent – it’s the possibility that general insurance might become unaffordable or even unavailable in parts of Australia.
Without access to appropriate general insurance, households and businesses would be less confident to invest or take financial risks in vulnerable parts of the country. Access to credit may be reduced, while credit risk for existing loans would rise. Communities would take longer to recover in the aftermath of disasters, and more of the financial burden of recovery would fall on governments and – by extension – taxpayers. For these reasons, countries with larger insurance protection gaps typically suffer more severe economic consequences after disasters, such as reduced productivity and higher debt levels. With its mandate to protect the soundness of financial institutions and broader financial stability, APRA is understandably keen to avoid such a scenario coming to pass.
Residents of northern Australia know that this is not some hypothetical conundrum; it’s already happening. Since 2007, average home building insurance premiums have risen there by more than 178 per cent for home insurance, and 122 per cent for combined home and contents insurance.7 As a result, the Australian Competition and Consumer Commission (ACCC) has warned that household and strata insurance in the north is becoming unaffordable, which helps to explain why the rate of households without insurance there is almost double the rest of the country.8
The reason for the soaring premiums in Australia’s north is simple – the cost of claims keeps rising, driven chiefly by storms and cyclones. According to data from the Insurance Council of Australia, 42 per cent of policyholders north of the Tropic of Capricorn are exposed to both cyclone and flooding; and another quarter are exposed to cyclones only. Rebuilding costs are also markedly higher than the southern capitals: 6 per cent higher in Townsville, 45 per cent higher in Port Hedland and 80 per cent higher in Darwin.9
Not only are premiums rising in the north faster than the rest of the country, insurers are often losing money in these markets10, resulting in a growing reluctance among some insurers, especially smaller operators, to offer cover in high-risk areas. The prospect of more extreme weather, rising sea levels, and hotter, drier conditions suggests the protection gap will not only expand in the north, it will spread to other parts of the country.
The root of the problem
In contemplating how to tackle insurance affordability, we need to go back to basics and consider what an insurance premium is. Whether in general, life or private health insurance, a premium is effectively a measure of financial risk. It’s a calculation of the potential loss to the insurer if an event happens, and the likelihood of that event happening. Higher risk equals a higher premium. For example, Townsville, in Queensland’s north, is one of the most flood-exposed cities in Australia, and is also vulnerable to cyclones. ICA data shows that the average premium for a building that is compliant with cyclone building codes and has no significant flood exposure is $1933. For buildings that are cyclone non-compliant with high flood exposure, average premiums rise to $2710. In Cairns, the average premium for a building that is compliant with cyclone building codes and has no significant flood exposure is $1801. For buildings that are cyclone non-compliant with high flood exposure, average premiums are more than one thousand dollars higher ($2841).11
APRA’s view, which we outlined in our submission to the ACCC’s Northern Australia Insurance Inquiry last September, is that declining insurance affordability and accessibility in Australia’s north can best be meaningfully and sustainably addressed by tackling the root cause: the high, rising and volatile cost of natural disasters. The most effective way to do this is through greater investment in mitigation to protect homes, businesses and infrastructure from damage. There may be other approaches that serve, for example, to subsidise the cost of insurance, but on their own they will ultimately be less effective because don’t lower the risk and may reduce the incentive to mitigate it.
Taking the aforementioned examples, the ICA estimates that removing high flood risk in Townsville and Cairns through effective mitigation would see premiums for protected properties fall by around 20 per cent a year. In the northern New South Wales city of Lismore, where flooding in 2017 caused around $315 million in insured losses, it forecasts average premium reductions of about 40 per cent if flood mitigation works removed the flood risk.
Of course, fixing these things is neither cheap nor easy. Even conducting a scoping study can cost a local council hundreds of thousands of dollars in fees to engineers, hydrologists and other consultants. The cost of completing the work can run into the tens of millions of dollars. Lismore City Council recently received a Floodplain Risk Management Study for consideration. The cost of the most beneficial option was estimated at more than $14 million. Further south in New South Wales, Stages 1 and 2 of the Wagga Wagga flood levee upgrade cost $23 million.12 The total cost for major flood mitigation works in the northern Tasmanian city of Launceston was $58 million.13 Regional and rural councils with small tax bases simply can’t afford that kind of outlay without state or federal assistance. Indeed, both the Launceston and Wagga Wagga projects were only possible thanks to extensive financial support from the Federal Government and their respective state governments.
There is no doubt that some physical mitigation measures, such as flood levees or sea walls, can be expensive, however the billions spent each year cleaning up from disasters suggests the money is there – it’s just being spent after the damage is done. There is a lot of merit in the Productivity Commission’s assessment that paying for mitigation is far cheaper than paying for post-event remediation, and enduring the subsequent economic repercussions.
From the ashes
The responsibility of creating safer communities cannot simply be a task for governments. Households and businesses can also take greater responsibility for protecting their own properties, particularly from threats such as storms and cyclones that can only be mitigated at the individual address level. Insurers can do more to incentivise mitigation, whether at the community or individual address level, by ensuring it translates into appropriate premium reductions for their policyholders. Although there is evidence in places such as Roma in Queensland that flood levies have put downward pressure on premiums, the ACCC says it’s unconvinced that households are getting adequately rewarded for taking steps to increase the resilience of their homes, especially to cyclones.14 It’s not realistic to expect a homeowner to spend tens of thousands of dollars installing reinforced doors and roof battens, shatterproof windows and waterproof seals if the consequent premium relief is negligible. If insurers want their argument that lowering the risk lowers the premium to be taken seriously, they must do more to recognise mitigation by home and business owners, and reward it accordingly.
Ultimately, creating more resilient communities that are better able to withstand the physical and financial impacts of natural disasters and a changing climate requires a whole-of-society response. There are some problems that are simply too big, too complex or too expensive for any individual household, business or organisation to fix on their own. On this front, I am pleased to say there is a growing number of outstanding examples of community groups, businesses and other organisations combining their resources and expertise to seek to protect – not only their own interests – but the interests of the societies they live and work in. This very forum is one such example. Having businesses of the size and profile of IAG, Westpac, Optus, Munich Re and Australian Red Cross funding research and speaking up about disaster resilience and mitigation sends a powerful message that it’s an issue of real significance to Australian society.
Mining magnate Andrew Forrest’s Minderoo Foundation (which the ABR is also involved with) is another prominent example of business partnering with environmental, scientific, welfare and other groups to accelerate change. What impresses me about Minderoo’s work in this area is its ambition, particularly the aim of ensuring that no dangerous bushfire in Australia will burn longer than an hour by 2025. The key to achieving this audacious goal – which that Foundation openly compares to the Apollo moon landings of the 1960s – is technology: using ground-based, aerial and satellite capabilities to detect and respond to fires much faster; and more effective fire suppression solutions such as enhanced water bombing, novel fire retardants and the use of drones.
What these and other businesses recognise is that funding measures to prevent or minimise the damage caused by natural disasters is about more than being a good citizen; it’s an investment that will save vastly greater sums of money over the long-term. In the case of Launceston, the Bushfire and Natural Hazards Cooperative Research Centre estimates the city’s enhanced flood mitigation measures saved the community $240 million dollars when major flooding struck the region in 2016.15 Research by the Australian Business Roundtable predicts the total economic cost of natural disasters to Australia will reach $39 billion annually by 2050. If we accept evidence from the US that every $1 spent on resilience saves up to $11 in response and recovery costs16, covering these losses would require the Australian community to invest about $3.5 billion each year on natural disaster mitigation and resilience. That’s an enormous sum, but it’s much smaller than the $39 billion cost!
If one positive has emerged from last summer’s bushfires, it’s been that they have refocused the public debate around how to ensure Australia is better prepared for future such disasters. Last week, the Senate released its interim report into the fires.17 In addition, the Bushfire Royal Commission, with its focus on practical resilience, mitigation and hazard reduction measures, is another important step towards better protecting lives, property and the Australian economy. While not a substitute for global action to reduce the emissions fuelling rising temperatures, the Royal Commission provides an important opportunity to make increasing the physical resilience of the community to natural disasters a national priority. The Treasurer Josh Frydenberg underscored this in last week’s Budget address when he foreshadowed more announcements on disaster and mitigation funding following the release of the Royal Commission’s Final Report. To repurpose a line from a speech I delivered last June on the subject of climate change adaptation, we either buy now or we pay more later.
Never waste a crisis
Perhaps the greatest challenge the world has faced in responding to COVID-19 is that none of us have experienced a pandemic situation of this scale in our lives. That’s not the case with natural disasters, especially in Australia where these tragedies are all too-well-known: Cyclone Tracy, Ash Wednesday, Cyclone Yasi, Black Saturday and most recently Black Summer. The fact that Australia has always experienced bushfires, floods and cyclones isn’t an argument for inaction or complacency; quite the opposite, because it means these types of events will happen again, and the weight of scientific opinion indicates they will occur more often and with greater intensity.
Investing in the types of resilience, mitigation and hazard reduction measures needed to better protect Australian communities, and keep insurance affordable and accessible, comes at a cost. In the same way, taking steps to prepare a business to adjust to new economic realities has a price. But as we witnessed last summer, failing to take action can be far more costly in the long-run, and the price paid is often far more valuable than can be measured in dollars.
3 The Bureau of Meteorology and CSIRO (2018), ‘State of the Climate 2018’, December.
7 Australian Competition and Consumer Commission Northern Australian Insurance Inquiry, Second Interim Report, November 2019.
10 Australian Competition and Consumer Commission Northern Australian Insurance Inquiry, Second Interim Report, November 2019.
14 Australian Competition and Consumer Commission Northern Australian Insurance Inquiry, Second Interim Report, November 2019.
16 NIBS (National Institute of Building Sciences) (2019), Natural hazard mitigation saves, NIBS