Home insurance is on the rise. Is there an affordable solution?
The effects of climate change put affordable insurance, people, their homes and businesses at risk. Solving this problem requires a multi-disciplinary approach
The escalating frequency and intensity of climate-related natural disasters are significantly transforming home insurance affordability. Over the past year, Australian home insurance premiums have experienced the most substantial surge in two decades, attributed to severe weather events and heightened building costs. According to a report from the Actuaries Institute, median home insurance premiums skyrocketed by 28 per cent. Meanwhile, properties in the highest-risk zones, such as flood-prone or bushfire-prone areas, saw a staggering 50 per cent surge in premiums.
This has led to growing concerns about surging home insurance premiums and their impact on socioeconomic equity. During a recent UNSW Workshop on Climate Risk and Insurance, hosted by UNSW's School of Risk and Actuarial Studies in partnership with UNSW's Innovations in Risk, Insurance, and Superannuation (IRIS) Knowledge Hub and Institute for Climate Risk & Response, experts discussed the factors shaping home insurance affordability and their broader implications for the insurance industry, banks, and homeowners.
Is the rising cost of home insurance unfair?
Insurance premium price hikes have affected all homeowners, with those in higher-risk areas experiencing more substantial increases. The data shows the cost of building homes in Australia has surged by almost 50 per cent due to inflationary shocks, resulting in higher expenses for insurance claims to rebuild homes after disasters. This cost increase is partly due to Australia's significant insurance losses in 2022, resulting in higher reinsurance costs for insurance companies, which are then also passed on to consumers.
While the rise has been attributed to multiple factors, such as higher building costs, increased demand for buildings, supply chain issues, and a surge in catastrophic events, consumers are being asked to pay the price. But is this fair?
“The climate risks people face with their property now, in many instances, simply aren't their fault,” explained UNSW Sydney Professor Jeremy Moss, Director of the Practical Justice Initiative, who leads the Climate Justice Research program at UNSW. Professor Moss, who presented at the workshop, explained how insurance costs are unfairly passed down to consumers, preventing people from adequately insuring their homes against disasters.
“So why do we face the problem of climate change? Partly, it's because of inaction by various agencies like governments for many decades. And that's part of what's placing people at risk, and it seems unfair for them to bear the costs of that kind of risk,” he said.
So what happens when insurance costs become unaffordable? Will the majority of homes in Australia be left uninsured? Professor Moss discussed the impact of fairness in insurance pricing and different ways of approaching a working model that protects homes from climate-related risks.
“Fundamentally, we have to think harder about what we're prepared to accept as a fair outcome for people trying to insure their homes, which are essential to their well-being. We ought to do this as a society and not just as a particular industry. We have to come to a collective decision about what scenario we allow to play out. Are we prepared to have the kind of insurance based on actuarial fairness that will allow people to face the loss, or partial loss, of their property, or not being able to afford to have their property insured?” he said.
What's behind the rise in home insurance costs?
During the workshop, Sharanjit Paddam, Principal in Climate Analytics at Finity, introduced the Australian Actuaries Home Insurance Affordability Index, a tool he helped create to help address the issue of affordability. Mr Paddam is an experienced Actuary recognised for his insurance costs and climate change expertise. The index can calculate insurance premiums' cost by factoring in household income, determining affordability and highlighting the impact on different individuals.
In the past, the index has shown that the median household faces an insurance premium equal to about 1.1 weeks of gross income – an average premium of $1534, which seems likely to be affordable. However, 1 million (10 per cent) of Australian households today face home insurance premiums of over four weeks of gross household income.
“So last year, we said that approximately one in ten households, or 10 per cent of households in Australia, had unaffordable insurance – that is insurance that costs more than one month of household income. This year, this has gone up from 1 million to 1.24 million households. Approximately one in eight households in Australia now face insurance that is unaffordable by this definition. That’s a big jump,” he said.
But these price hikes have broader effects than most people realise.
How does insurance affordability impact business?
Mr Paddam discussed the correlation between socioeconomic status and natural disaster risk. Lower-income households, he said, tend to afford cheaper housing, often located in high-risk areas like flood-prone regions. This results in vulnerable individuals residing in vulnerable homes.
“There is a systemic impact between social status and risk status and natural disaster exposure. Climate change will have an impact over time… one in ten homes with unaffordable insurance is going to one in eight, and that will grow until more and more of our houses face unaffordable home insurance,” he explained.
Climate change has a broad impact on the economy and businesses, including banks relying on homes as collateral. This makes insurance affordability a crucial issue with far-reaching consequences, highlighting the need to understand how seemingly small effects can lead to systemic economic problems.
“The affordability challenge also has consequences for insurers and banks, as many people cannot afford insurance, making it harder for them to secure home loans,” explained Mr Paddam. “That's an issue for insurance. Insurers will have less people to sell policies to this is a top-line strategic problem for them. It's not necessarily a claims problem, because they can increase premiums. But there are limits to that. And its affordability that drives those limits.
“But it's an even bigger problem for banks. Our banking system in Australia is secured by residential property. If you can't get insurance, you can't get a home loan; your small and medium enterprises are all secured against residential properties. You have to look at how it changes the environment, the economic environment, the business environment in which we operate. You have to look at how small effects like only 5 per cent of people affected by flood risk in Australia, but how that is causing a systemic problem across the whole system, because it's interacting with the other systems that drive business.”
Collaboration is essential for evidence-based solutions
Also presenting at the workshop, Dr Fei Huang, a Senior Lecturer in Risk and Actuarial Studies, Lead – Data and AI Tech of UNSW Business AI Lab, and an investigator of the IRIS Knowledge Hub, stressed the need for a comprehensive framework to make optimal decisions about insurance affordability. This framework should draw from various disciplines, including actuarial science, climate science, philosophy, social science, economics, and psychology.
“The question is, what is the cause of the problem (insurance affordability)? How do we address this problem? Who bears the costs? Drawing from the existing literature on ethical insurance, I propose a multidisciplinary framework to answer these questions effectively,” she said.
“Understanding the causes of insurance affordability is an important first step. Things like where people build their homes, risk reduction methods, rising prices and personalised pricing are crucial right now. People have different opinions, so it's a bit tricky. That's why I'm asking for solutions based on evidence, to understand the reasons and come up with good solutions."
What would such a framework include? Dr Huang highlighted the importance of choice-sensitive fairness in addressing insurance affordability, which can balance social equity and economic efficiency. She suggested identifying and categorising uncontrollable (sensitive) factors contributing to insurance affordability into 'system-manufactured' and 'personal attributes,' leading to different types of solidarity in insurance markets, such as subsidising solidarity, chance solidarity, and preference solidarity.
To ensure people have access to affordable insurance, Dr Huang said it is essential first to understand which factors drive insurance affordability, in what way, and to what extent. Potential factors include house planning (for example, building on floodplains), climate risk, claims cost inflation, and the trend towards individualised insurance pricing. These factors can be uncontrollable by customers and can also have a disproportional impact on customers with specific protected attributes (such as race and ethnicity).
Transparent and effective customer communication is also essential to address the affordability issue. She said: “We need to convey the message clearly to customers on the factors contributing to their insurance premiums, potential insurance costs (especially for those who plan to live in high-risk areas), and measures to reduce their premiums to help them make better and informed decisions.”
Finally, Dr Huang emphasised the necessity of quantitative analysis for optimal policy decision-making, referred to as 'counterfactual policy analysis'. This method combines actuarial and economic expertise to evaluate policy options and their impact on various stakeholders and consumer groups in the insurance market for optimal decision-making. Achieving this requires government, industry, and academic collaboration to develop and implement a comprehensive decision-making framework.
For more information, or to speak with Dr Fei Huang and other experts from the IRIS Knowledge Hub directly, please contact with Dr Huang or Professor Bernard Wong, Head of the School of Risk and Actuarial Studies at UNSW Business School.