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Bushfire losses reignite debate about insurance reform

An increasing trend towards more frequent and severe bushfires has created uncertainty over insurance coverage. AAP

The Australian summer has become synonymous with bushfire risk. Tasmania, New South Wales and Victoria have witnessed devastating bushfires generating millions of dollars of damage. Many individuals have experienced the heartache of having their property destroyed and Australia has also seen thousands of hectares of land transformed into blackened savannahs.

Now, as the flames start to subside and the blackened rubble remains, the problem with property losses becomes economic. The question that arises from individuals, governments and insurers is: Who is going to pay?

There a number of different options for dealing with property losses arising from catastrophic events. These options include individual responsibility, governmental assistance, insurance, ad hoc funding arrangements, catastrophic bonds, and specific purpose taxation levies etc. In Australia, insurance is the preferred economic protection measure to protect against losses to private properties. Ironically, there are widespread levels of underinsurance. Given the difficulty of determining who is underinsured — particularly when some people do not know this themselves — figures from academic literature vary slightly. The Australian Securities and Investment Commission has suggested that the number is anywhere between 27% to 81% of consumers. The cause of this underinsurance stems from a multitude of factors particularly the cornerstone issues of access and affordability.

In relation to bushfires, the issue of access is not problematic given that losses arising from bushfires will be covered by a standard insurance policy. In contrast with flooding, this contingency is automatically included within a standard household insurance policy. Notwithstanding the existence of insurance coverage, the issue is about the level of coverage and the monetary value of protection the insurance policy represents.

The legal and regulatory frameworks, which guide the operation of the private insurance industry, ensure uniform terms and conditions of insurance contracts Australia-wide. However, insurers retain autonomy over pricing the risk. Therefore, the commercial market and competition between insurance firms has been seen as a mechanism for promoting consistent pricing.

While these institutional practices have been somewhat effective, fears of climate change and an increasing trend towards more frequent and more severe bushfires in Australia has created uncertainty.

Efficient insurance practices suggest that the premium charged for insurance cover should be based on an actuarially sound model. To date, the use of probabilistic modelling and historical events to predict a likely future trajectory of risk and damage has been satisfactory.

However, as climate variability alters the size, impact and frequency of events existing pricing structures are being questioned. Further, notwithstanding the known exposure of some areas, profitability and demand for housing means that more property is being located in vulnerable areas. The granting of planning permission to develop areas with great risk exposure uncovers the lack of transparency and accountability for such decisions.

Essentially, profitability is becoming the paramount consideration to the detriment of the safety of persons or property in some areas. From an insurer’s viewpoint, this warrants conservative increases in the cost of providing insurance.

Many individuals respond by reducing the level of insurance coverage attributing affordability as their primary motivating factor. For some individuals, the cost of obtaining insurance is proportional to the risk exposure assessed by insurance firms using actuarially sound insurance models.

Yet for others, the uncertainty and the difficulty of accurately predicting risk, means that some insurer charge high premiums and artificially inflate the cost of insurance coverage. This causes the economic burden of paying for insurance premiums to be prohibitively expensive for some people living in areas where there is uncertainty surrounding risk exposure. For individuals falling within this latter category, a number of them will knowingly underinsure to ease the economic burden of paying for insurance coverage. Some rationalise this decision with a naive belief that bushfires will never affect them and yet if a bushfire or other catastrophic event destroys their home, they may be thrust into a cycle of economic uncertainty and consequently experience poverty or heightened economic problems.

There is, however, a third category of individuals who are underinsured. These people perceive that insurance coverage is unaffordable or an unnecessary expense when it may not be, which may be due to human frailty. Although the current insurance system facilitates individual choice as to the level of insurance coverage, individual choice becomes problematic when those not covered burden the government in the aftermath of a bushfire.

The problems associated with insurance including the levels of flood coverage, the sufficiency of coverage and the cost of purchasing insurance which included cover for flooding were evident in 2011 in the aftermath of the Queensland floods. Now in 2013, two years have passed since the issues associated with insurance gained political momentum, yet there have been no major advancements to ease the problem of underinsurance and increase insurance penetration levels.

Despite the National Disaster Insurance Review and a multitude of other parliamentary inquiries, the only major achievement is a formal recognition of the problem.

Simply reiterating the problem without proposing workable solutions will not save the Australian people, property or the Australian economy from the economic implications of bushfire. The only way forward is through a cleverly crafted and economically efficient solution to ensure greater levels of adequate insurance in risk-exposed areas.

Bushfires are, and always have been, a reality of Australian life. Consequently, the economic protection against property losses should not naively be ignored, rather actioned as an item of critical national importance.

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