Our homes have become sanctuaries — places of refuge in the time of coronavirus. But they can’t protect us from all threats.
Analysts say the houses we’ve built, and where we’ve built them, could increase our future vulnerability as we face the ongoing effects of climate change.
With increased damage to houses through catastrophic fires, floods and other disasters, the global insurance market is under increasing stress, and there are fears whole communities could become impoverished or homeless.
Experts doubt industry players and governments have fully come to terms with the issue — and they worry about some of the financial mechanisms insurance companies have put in place to share the risk.
Too focused on past catastrophes
Insurers have a short-term focus and often fail to be proactive in assessing future problems, according to Jason Thistlethwaite, a Canada-based academic and expert on insurance practice.
He says while global climate models are forward looking, the actuarial practices used for risk modelling in the insurance industry are not.
Put bluntly, insurers still spend most of their time looking in the rear-view mirror.
Where there has been a shift in attitude, though, is among “reinsurers” — essentially, the insurance companies for insurance companies.
“Reinsurers are starting to grasp that these extreme events are something known as correlated risk, meaning that there is a common cause underlying them,” Professor Thistlethwaite says.
“So, Australia may have a good year with very few claims in the primary insurance market, but reinsurance rates may still go up because there is bad flooding in the Philippines or the United Kingdom, for instance.
“They are operating at a global scale that allows them to pick up on data points that provide a much more coherent pattern that shows extreme weather events are getting worse and contributing to higher losses.”
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He says that broader, interconnected understanding of risk is starting to filter down to primary insurers, as they themselves experience increasing reinsurance costs.
Nevertheless, he’s predicting a rationalisation of the primary insurance market, with some companies going bust and others simply withdrawing from areas they don’t believe profitable.
Rise of the ‘red zones of risk’
Professor Thistlethwaite says it’s already happening in the United States in regions regularly affected by major climate-related events, such as hurricanes and tornados.
And it’s also beginning to occur in Australia, according to Karl Mallon, director of science at the organisation Climate Risk.
“If we see emissions continuing in the current direction, the level of warming continuing in the same direction, and if we continue to see a sort of blind attitude to what’s happening, then our risk will rise to about one in 10 properties,” he says.
“Ninety per cent of properties may be OK, as in they are still insurable, even though the costs might be elevated. [But] one in 10 may really cross into the red zone territory.”
That assessment is now backed by the Insurance Council of Australia, which changed its mind over the rise of so called “red zones of risk” during 2019’s severe bushfire emergency.
Dr Mallon cites parts of the Gold Coast in Queensland, the Central Coast in New South Wales, and West Lakes in South Australia as regions facing an impending crisis.
Legal expert Justine Bell-James warns that coastal communities could face a double hit: not only could their houses become uninsurable, but some homeowners could lose their entire asset due to erosion.
Under Australian law any area of private land reclaimed by the sea automatically reverts to the Crown, she says.
“In those circumstances, unless there is some sort of strategic intervention, landholders will look to government to compensate them,” she says.
“That might be through informal ad hoc disaster relief — the requests that always come after some sort of large-scale natural disaster.
“Or it might be by going to the court and bringing an action against a government in negligence.”
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Negligence because councils have approved development in known hazard zones.
According to a 2019 study conducted by the Grantham Research Institute in London, a rise in climate change litigation is already occurring in countries across the globe, from Indonesia to Norway.
How and when should the state intervene?
Dr Mallon cautions against an assumption that governments should simply pick up the role of providing insurance in disaster-prone areas.
Poorly designed interventions, he warns, can lead to perverse outcomes.
“It actually makes things worse,” he says.
“What we’ve seen in the UK, where there is a flood pool program, is that it’s had the desired effect of protecting the property values of people in those flood zones, but then you’ve seen a rash of development where people have said, ‘well, that’s OK then, I can just keep building whatever in these zones’.”
He also points to a recent experience in California, where a moratorium preventing insurers from pulling out of policies in high-fire regions ultimately backfired, because those companies became “gun-shy” about offering future cover.
Instead, says Dr Mallon, there needs to be an acknowledgement that what we’re facing is a planning and building problem, not just an insurance one; that too many houses continue to be built in areas that are known to be unsafe, or will be in the future.
His solution involves a rigorous tightening of building codes and convincing insurance companies that they need to begin calculating their policies on more than just the traditional criteria of “exposure to risk”.
“Exposure is only half the story. The question is how resilient is the house?” he says.
“If I had a house and I put a burglar alarm in, I get a lower insurance premium. So, if I build a house, it might be in a high-hazard zone, but if I make it more resilient, I should be rewarded for making my assets safer.
“There are lots of engineering solutions, but we need insurance to reflect that.”
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But Dr Bell-James believes the scale and magnitude of the problem will eventually see governments forced to progressively relocate whole communities.
This occurred with the town of Grantham in Queensland, she points out, after it was inundated by floodwaters in 2011.
Their own worst enemy
Dr Bell-James believes the growing frequency and predictability of natural disasters will eventually reshape the nature of insurance available to desperate homeowners.
“The whole basis of insurance is that it is underpinned by that element of uncertainty. It’s a little bit like gambling, you might win, and you might lose and that’s how insurers make their money and remain solvent companies,” she says.
“But if you’re looking at properties that are definitely going to be inundated by sea level rise, that’s at odds with the entire concept of property insurance.
“It’s more akin to something like life insurance — you know that you’re going to die, you just don’t know when it’s going to happen.”
And that kind of change, she says, will likely result in a steep rise in premiums.
Korey Pasch from Queens University, Ontario, believes many insurance companies need to be more discerning about the industries they choose to deal with.
“The industry is still heavily connected to the underlying causes exacerbating climate change and global warming,” he says.
“Insurers are actually quite heavily invested in the fossil fuel industry.
“They also support the sector by providing insurance to fossil fuel projects. If those projects, like new coal power plants or fossil fuel intensive infrastructure, if they don’t have insurance then those projects can’t be built.”
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It’s a point not lost on the head of Australia’s largest general insurer IGA.
CEO Peter Harmer says his company has ceased insuring coal mines and is progressively phasing out insurance for other fossil-fuel related businesses.
“Over the last number of years we have significantly shifted our investment portfolio,” he told ABC RN’s Breakfast program earlier this year, “and we have shifted towards companies that are on a pathway towards a lower emissions environment and have a strategy, a demonstrable strategy to do that”.
Cat bonds and the risk of creating risk in order to counter risk
Mr Pasch worries that some of the mechanisms insurance companies are now employing to mitigate risk could be building greater long-term instability into the industry and the financial sector more broadly.
He’s warned about the rise of what are called insurance-linked securities, catastrophe securities or cat bonds, which first started appearing in the US in the mid-1990s as a way of keeping insurers afloat following a series of major natural disasters.
Catastrophe bonds work by transferring risks from an insurance provider to investors. If the pre-determined disaster doesn’t eventuate over a set period of time, investors gets get their money back, with a handsome bonus.
If the disaster does occur, the insurance company can use the money to offset its losses.
“The types of investors that typically buy cat bonds are not your everyday kind of individual but institutional investors, so things like hedge funds, other reinsurance companies, pension funds, foundations, sovereign wealth funds, et cetera,” he says.
“And a lot of these instruments are domiciled in tax havens and tax shelters where oversight is minimal.”
He worries that while such bonds are designed to decrease the costs of reinsurance for primary insurers, they also have the potential to distort the market.
“If you lower the price of reinsurance to a degree where it becomes cheaper for insurers to buy, it can change the underwriting habits of those insurance companies,” he says.
“They can underwrite properties that they may not have underwritten previously. It can lead to them taking on risks that they may not have taken otherwise.”
The end result, says Mr Pasch, could prove as damaging as the 2008 sub-prime mortgage crisis in the US, which sent the world spinning into a global financial crisis.
“It’s one of the issues that has led the European Insurance and Occupational Pensions Authority to flag these instruments as a potential source of systemic financial risk,” he says.
But more than that, he worries that all such financial mechanisms ultimately achieve is a deferral of the inevitable.
“All of this is predicated upon business-as-usual continuing indefinitely, and the climate crisis, in my opinion, is nature essentially saying business-as-usual can no longer continue.”
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