Govt will have to act to stop house insurance being ‘luxury good’ only for rich

Sunday, 11 August 2024

As the climate changes, so human activity must adapt, and one of the big questions that is yet to be answered is; What will house insurance look like as extreme weather and flooding become more common.

“For Aotearoa New Zealand, which faces so many natural hazards, such insurance must not become a luxury good which only the rich can afford,” says academic Jonathan Boston in his new book A Radically Different World.

But for that not to happen, future governments will have to step in to alter the way insurance is done in New Zealand, he says.

Boston is a leading expert on climate adaptation, a term used for how human activity will have to change in a world of escalating climatic hazards, like sea level rise and extreme weather events.

He says it will be a painful adjustment, which will eventually involve the “managed retreat” of some homes and communities and, in order for it to happen in a fair and orderly way, the insurance industry has got to remain profitable and insurance has to remain widely available.

Already, extreme weather events like the Auckland Anniversary floods and Cyclone Gabrielle, which generated more than 117,000 insurance claims, had combined with earthquake risk to push up house insurance premiums dramatically, and prompt the realisation that “insurance retreat” is a growing threat to some homeowners.

Earlier this week, the country’s largest insurer IAG, which owns the State, AMI and NZI brands, released data from a survey in which it asked people whether it was acceptable for insurers to pull out of high-risk areas, and 31% of respondents agreed it was.

Jonathan Boston wrote A Radically Different World out of frustration following what he says was the failure of the last government to even publicise the expert working group’s 2023 report on managed retreat.

But Boston, who served on last year’s expert working group on managed retreat, said maintaining widespread property insurance was key to the country’s ability to recover from natural disasters, and government would have to consider how to achieve it.

In A Radically Different World, published by BWB, Boston sets out some of its options for the future of house insurance in an increasingly risky world, though he says none are without significant downsides.

Let the market sort it all out

After the Auckland Anniversary weekend flooding last year, Auckland Council and the government bought out owners of homes which were no longer considered safe to live in. It was costly, and Auckland Council said it could not afford to do it again.

Policymakers could do nothing and simply let insurance retreat escalate and unaffordability increase, Boston says.

This would send signals as to where it was acceptable to live, shift property prices as mortgages would be unavailable to buy uninsurable properties, and leave losses with property owners.

“But this would contribute to growing social inequities and greatly hamper prudent adaptation measures, most notably planned relocation,” Boston says.

It’s also something that governments have baulked at doing after large natural disasters, which has seen forms of managed retreat in Auckland, Hawkes Bay, and Christchurch, paid for by rates and taxpayer funds.

Have the Government insure all homes

The Government could decide to set up a national scheme like the Natural Hazards Commission Toka Tū Ake (the entity that used to be named EQC) and use it to become the sole provider of all forms of residential property insurance.

But this would have massive drawbacks, Boston says, including almost certainly reducing the incentives for innovation and efficiency in the provision of insurance.

The scheme would also increase fiscal risks to the Crown, as the taxpayer would ultimately guarantee the scheme could pay claims.

When California’s state government ordered insurers to provide earthquake cover for homes, many insurers stopped doing business in the state.

Force insurers to insure everyone

The Government could decide to regulate the behaviour of insurers, but Boston sees big risks here.

He says forcing insurers to regulate every home would likely require extremely detailed regulation of the insurance market, including on pricing policies of insurance providers to prevent excessively high premiums.

But the biggest threat would be insurers, and reinsurers simply closing up shop for certain kinds of policies.

“Insurers might refuse to provide residential insurance cover, leaving the local market altogether, or demanding government guarantees of financial assistance in the event of significant insurance losses. If so, the Government might be left with little choice but to provide residential property insurance itself, perhaps through Toka Tū Ake.”

Iceland is volcanically active. It shares a high risk of natural disaster with New Zealand.

Boston notes that when California’s state government required companies providing home insurance to offer earthquake cover, many withdrew from the market, prompting the creation of the California Earthquake Authority in 1996.

Force all property owners to buy insurance

In Iceland, homeowners are legally required to have fire insurance and must also pay a so-called catastrophic insurance fee.

That fee is similar to the levy that is used to fund Toka Tū Ake. In New Zealand, people without insurance cover do not get Toka Tū Ake cover, and are uninsured in the event of a natural disaster that it does cover, like an earthquake.

However, compulsion would be likely linked to requiring insurers to provide cover, and so could result in a California-style exit by insurers.

“Such an option should not be pursued lightly,” Boston says.

Govt covers ‘selective risks’, where insurers do not want them

If insurers are happy to continue providing earthquake and fire cover for some homes, but not flood and coastal inundation cover, perhaps the Government could become the insurer of risks insurers don’t want to cover.

In the UK, following disastrous flooding, the Government there set up the Flood Re scheme, Boston says.

It provided subsidised insurance to residential properties of various kinds facing significant flood risk, and it now covers 2% of British homes, though the cover is available only to homes built before 2009.

The scheme is paid for by a levy on all insurers, meaning owners of homes not at risk of flooding are subsidising owners of flood-threatened homes.

It’s a temporary scheme, supposed to be phased out in 2039, after which the free market will prevail.

Boston doubts this will happen: “Strong political pressures to retain existing arrangements are likely.”

“In principle, a scheme like Flood Re could be introduced locally,” he says, and it could be used to keep communities earmarked for managed retreat insured, until they are abandoned.

The Government helps some people heat their homes in winter. Should it consider helping some people to insure their homes?

“It might be more cost effective to extend Toka Tū Ake’s role, rather than create yet another funding pool with its own levy, reinsurance arrangements, transaction costs, administrative arrangements and possible means testing. Under such an approach, the commission would insure all residential properties for all natural hazards,” Boston says.

Govt subsidies to poor households

The Government could subsidise some people’s house insurance premiums, Boston says.

As with accommodation supplement, eligibility could be based on criteria like homeowner income, number of dependants and the size of the insurance premium.

Alternatively, as with winter energy payments, there could be a fixed amount annually, with subsidies limited to specified groups like beneficiaries and those receiving New Zealand Superannuation.

“Either way, the subsidy level could be indexed annually to changes in average insurance premiums.”

While that sounds simple, it would cost a lot. A subsidy averaging $1000 over 200,000 households would cost $200 million annually.

And, unless insurance premiums were capped in some way, a subsidy of $1000 would be insufficient for low-income households, especially those in higher-risk locations.

Subsidising insurance on homes in risky areas would also “blunt” the messages that some places are just too risky to build in, and for people to live in.

Compulsory natural disaster cover

If people can’t afford all-perils house insurance, perhaps they could be required to buy a minimum of natural disaster cover from Toka Tū Ake, Boston says.

This would require Toka Tū Ake to be reworked to cover all natural hazards, including flooding, and/or non-residential properties.