The Australian Prudential Regulation Authority (APRA) has released its Insurance Climate Vulnerability Assessment (Insurance CVA), a stress test that explores how a changing climate could affect home insurance affordability and the insurance protection gap over coming decades.
The Authority says the Insurance CVA is not a forecast or prediction of future outcomes, instead it examines how home insurance coverage may fall under two severe but plausible global climate-related scenarios projected out to 2050: one with higher physical risks from weather-related events and one with greater economic impacts from transitioning to a lower emissions economy.
It found that, under both scenarios, climate-driven pressures on insurance premiums could significantly widen the nation’s insurance protection gap, thereby increasing financial risks to the system.
APRA estimates that around one in seven Australian houses are currently uninsured. Under both stress scenarios, this could rise to around one in four by 2050 – equivalent to an additional one million homes without adequate home insurance, the Authority said in a statement.
Further key insights include:
- Regional and rural communities would be disproportionately affected, with the protection gap widening more sharply in areas that already have lower levels of insurance coverage. It could grow to over 40 per cent in rural areas under both scenarios by 2050.
- Different climate risk-related factors drive the widening protection gap under each scenario, alongside economic and income growth factors:
- In the higher physical risk scenario, rising losses from more frequent and severe weather events push premiums higher. Overall expected annual losses from weather-related events could rise from around $7 billion today to more than $16 billion by 2050.
- In the higher transition risk scenario, losses from weather events are a contributing factor but are less severe. However, significant and ongoing increases in construction costs drive premiums higher.
APRA says a widening protection gap could increase uninsured losses for households, heighten credit risk for banks, particularly in high-risk regions, and constrain growth in the home insurance market. Over time, these pressures could erode the resilience of Australia’s financial system, it stated.
APRA Member, Suzanne Smith emphasised the significance of APRA’s stress testing work, noting how risks in the financial system may emerge due to falling levels of insurance coverage at a time when losses from weather perils are increasing.
“Insurance plays a critical role in Australia’s financial system by shifting large financial losses away from households and lenders to insurers and reinsurers that are better equipped to absorb them. When homes are uninsured or underinsured, losses are more likely to be borne directly by households, banks or by the government,” she said.
“To support insurance affordability and availability and with that strengthen the resilience of our financial system, it is essential that all stakeholders work together to reduce exposure to weather-related risks. This includes emissions mitigation and risk adaptation that strengthens the resilience of Australia’s housing stock, such as building protective infrastructure, retrofitting existing homes and risk-based land-use planning. Supporting insurance affordability with innovative insurance solutions and better risk management will also help limit the flow of uninsured losses into the financial system over time.
“APRA will continue to engage with government, industry and other regulators to share insights and to support efforts to manage prudential risks associated with declining insurance coverage.”
Insurance Council of Australia CEO, Andrew Hall says the findings of the ICVA underscore the need to scale resilience investment in our highest-risk locations, reform unfair taxes on insurance premiums, reform land use planning, and strengthen insurer-government partnerships.
“APRA’s analysis is not a forecast, it’s a worst-case scenario if extreme weather continues to worsen and further risk is baked into our system,” said Mr Hall.
“The policy choices around investment in mitigation for homes which governments make now can help to prevent rising risk.
“This is not a challenge unique to Australia – governments and markets around the world are grappling with the same pressures.
“But if we act now we can lead the world in resilience, protecting our communities and making insurance more available and affordable around the country.”
APRA worked with industry experts and five of Australia’s largest general insurers – Allianz, Hollard, IAG, QBE and Suncorp – which together account for around 80 per cent of the home insurance market by gross written premium. The scenarios are aligned to the Network for Greening the Financial System (NGFS) scenarios and assume no additional policy or physical home adaptation measures are implemented over the period, an approach in line with standard stress-testing practice.
Read APRA’s full Insurance CVA report at: Mind the Gap: An Insurance Climate Vulnerability Assessment.
