Australia weighs up cyclone reinsurance pool or mutual insurer

by Artemis on March 31, 2015

The Australian government has launched a consultation process to see how access to insurance in  cyclone prone regions in the north can be eased, with measures such as a government backed catastrophe reinsurance pool or mutual insurer to be assessed.

At a time when there has been a considerable push in the U.S. to shift risk away from the government and into the private insurance, reinsurance and capital markets, in order to protect taxpayers, the Abbott government in Australia looks like it is heading the other way.

Assistant treasurer Josh Frydenberg announced yesterday that the government would set up a taskforce to look at ways to address rising insurance premiums in cyclone prone regions.

“Insurance costs in north Queensland are five times higher than in Sydney and Melbourne for strata insurance (residential insurance under a management company), and two-and-a-half times higher for home insurance. The biggest driver of these higher prices is cyclone risk. Similar issues exist in other cyclone-prone regions of northern Australia,” explained Frydenberg.

The taskforce will consult with the insurance and reinsurance industry in Australia over a six month period and look at a range of options, Freydenberg said.

“The taskforce will examine whether the government could provide support to a reinsurance pool or a mutual insurer that provides cyclone-specific cover. The taskforce would also assess the merits of other policy options that currently exist or are put forward by stakeholders during consultation, Frydenberg announced.

It has been suggested that any reinsurance pool could be established to take advantage of legislation already in place for the countries terrorism insurance pool, the Australian Reinsurance Pool Corporation (ARPC).

Insurance Council of Australia CEO Rob Whelan approved of the governments consultative approach to this issue and said the general insurance sector would work closely with the taskforce, “contributing expertise and insights into shaping policies that would benefit cyclone-prone communities.”

“The ICA and its members will seek to focus on disaster mitigation and improving community resilience as the best ways to reduce premiums in cyclone-affected regions.

“Various government reports, including the independent Australian Government Actuary’s two reports into North Queensland insurance, have directly linked the region’s exposure to cyclone risk as the driver of insurance premiums,” Whelan explained

The ICA’s data shows that insurers have been paying out $1.40 for every $1 they receive in premiums in North Queensland, but an actuary report also concluded there was competition in the market and there was not market failure.

“The taskforce will enable the insurance industry to fully explore the options and implications of government decisions in a rational, fact-driven environment with other stakeholders,” Whelan said.

“Though the taskforce will examine government support for a reinsurance pool and a mutual, the Minister has also been clear that other policy options will also be considered on their merits.”

It’s a difficult issue for Australia as the exposure levels to cyclone risks in northern regions are so high that insurers find it difficult to offer affordable insurance products. If the policies are priced commensurate with the underlying risk the costs could be even higher, hence insurers operating in these regions at little to negative profits.

That suggests that a government backed solution will always be required, although it is important that the Australian government manages any solution to ensure that as many homeowners as possible are in the private insurance market with no subsidy.

Only the most exposed properties should be subsidised, as has been seen in Florida where the government assisted insurance and reinsurance programmes are now being downsized and risk transferred back to private markets.

Private reinsurance, risk transfer and insurance-linked securities (ILS) markets are able to price and assume much of the exposure and with rates in these markets at or near lows it would benefit the Australian government to fully explore these options before taking a risk into its pool or mutual.

Whelan continued; “However, the best long-term and sustainable way to reduce insurance premiums is to reduce the damage that extreme weather causes. Improving the resilience of homes and businesses in cyclone-prone regions has a direct impact on insurance.”

The adoption of resilience measures alongside any move to shift risks into the governments and taxpayers hands is key.

Also key is a full assessment of how to back a reinsurance pool. It may be possible to pool the northern Australian cyclone risk into a government facility, or through a mutual reinsurer, and then to fully retrocessionally reinsure the risk with the private market, or through instruments such as catastrophe bonds to the capital markets.

Once the risk is pooled and aggregated it may then be possible to reinsure the pool more efficiently than individual insurers can manage. That would be the ideal solution as it prevents too much risk from being retained by the government itself and allows the private market to continue to participate in this risk.

With international reinsurance markets and the insurance-linked securities (ILS) space having a strong appetite for natural perils such as Australian cyclone risks, and pricing at very low levels across reinsurance and capital markets, it would seem an opportune moment to attempt to gain more reinsurance support.

If Australia takes advantage of the appetite to assume catastrophe risks, by pooling and then transferring the cyclone risks to private reinsurance and capital markets, it might be able to effectively reduce premiums for homeowners as a result.

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