Reserve Bank warns of uncertain insurance future for flood-threatened homes

Wednesday, 1 May 2024

Most owners of flood-threatened homes are still able to get quotes online from insurers, and are not being asked to pay more for their house insurance, research from the Reserve Bank Te Pūtea Matua shows.

However, it does not expect that to continue as insurers get better data on which homes are threatened by flooding.

“There is a clear trend of insurers moving towards greater use of risk-based pricing for residential dwelling insurance, meaning that the value of insurance premiums is becoming more tailored to the specific risks a property faces (for example, seismic or flood) as opposed to reflecting broad averages of the risks facing properties over wide areas,” the central bank said in a policy paper with its Financial Stability Report.

And when insurers move to greater risk-based pricing, it could happen fast, the Reserve Bank said.

That’s because house insurance policies renew each year allowing insurers to offer new quotes and even decide to withdraw cover for certain risks.

One of the threats that is faced by owners of homes considered to be at high risk of disaster damage, such as an earthquake or flood, is that insurers could “unbundle” the cover they offer, and essentially, tell the homeowner they can have cover only or some perils like fire, while not covering others, like flood.

This unbundling could help maintain insurance cover for things like fire and earthquake, while leaving homes uninsured for other risks like flood, the Reserve Bank said in the paper.

About 120,000 homes are assessed as being at high risk of flooding, defined as properties where flooding can be expected more frequently than once in every 100 years.

Just a fifth of quotes on these high-risk homes included additional flood-related premiums, the research conducted for the Reserve Bank found.

There were about 12,000 homes assessed as being at high risk of both flood and earthquake.

“A withdrawal of insurance availability for high-risk properties is likely to occur only gradually. However, some owners may find insurance increasingly unaffordable,” paper author Charles Lilly said. “Insurers may begin to make coverage of some risks optional as risk-based pricing becomes more commonplace.”

Homeowners could also start to under-insure their homes as a result of rising premiums, he said.

“Rising premiums may also lead to customers choosing to underinsure (with higher excesses and/or lower sums insured), leaving owners of high-risk properties vulnerable in a total loss event,” he said.

This posed a threat to banks, Lilly concluded. Banks require borrowers with mortgages to keep their homes fully-insured. Not to do so is a technical default on their home loans.

“Banks need to be conscious of the ongoing insurability of the properties against which they lend. This will require more scrutiny in their lending decisions than currently,” Lilly said. “Banks also need to pay closer attention to insurance coverage given the risks of underinsurance for high-risk properties over time.”

To date, risk-based pricing has been most prominent for seismic risk, Lilly said, affecting regions such as Wellington. But, he said: “Granular pricing for flood risk is at varying stages of being rolled out by insurers.”

Market forces were driving the change, and so were the demands of global reinsurers, who insure New Zealand insurers so they can pay claims after massive natural disasters.

Lilly said insurance retreat posed a long-term challenge to the financial system, and banks, insurers and home owners all needed to take action to improve their understanding of natural hazards.

House insurance premiums have been rising for a decade at a rate far in excess of inflation, The Reserve Bank said.

Adjusting for inflation, the average amount spent on home insurance in Wellington grew from $1539 to $2452 between 2017 and 2023, the Reserve Bank said.

This compared to the average for all of New Zealand of $1397 to $1867, over the same time period.

Former Labour cabinet minister Kris Faafoi, now chief executive of the Insurance Council of New Zealand Te Kahua Inihua o Aotearoa, said: “Some of the factors driving premium levels are out of our control such as higher construction costs as well as the impact of climate changes on global reinsurance costs, which is insurance for insurers and spreads the financial risk of major local events across the global market.”