Disaster resilience and northern Australia
8 May 2015|

Post cyclone Australia

The Abbott government wants to accelerate the development of northern Australia. To advance that goal, Assistant Treasurer Josh Frydenberg recently announced a taskforce to explore options for reducing insurance premiums in northern Australia.

The taskforce will examine whether to set up a government-run reinsurance cyclone pool, or a community-owned northern Australia mutual insurer, to provide cyclone-specific cover.

Presumably the taskforce will look at the Australian Reinsurance Pool Corporation that provides government-backed reinsurance coverage for terrorism incidents. The cases of terrorism and natural disaster are actuarially different, although it’s possible the ARPC could administer a separate pool for natural disasters.

People, buildings and communities must recover fast and with minimal disruption after major disasters.

The concept of resiliency—the ability to withstand a severe disruption, blunt the impact, recover quickly, and adapt to emerge stronger than before—is a key focus of both federal and state governments’ natural disaster management strategies.

Leveraging insurance is a key part of disaster resilience. But as I’ve noted in an earlier ASPI report on this subject, after each disaster many people express concern about underinsurance and high premiums in disaster-prone areas.

Since insurance companies use risk-based modelling to determine insurance premiums, if natural disasters increase then homeowners and business will see price hikes. The Australian Government Actuary, for example, recently found that the estimated cost of cyclone risk is likely to be the main reason why north Queensland premium rates are, on average, significantly higher than premium rates in most other parts of Australia.

But the Abbott government has already received clear advice on this problem. That guidance isn’t consistent with setting up expensive reinsurance pool for cyclones, which would risk government budgets and blunt price signals by trying to provide low premiums to high-risk homes.

We should be promoting cost savings through mitigation. Last Friday, the Productivity Commission released its final report on natural disaster funding. It concluded that:

‘Current government natural disaster funding arrangements are not efficient, equitable or sustainable. They are prone to cost shifting, ad hoc responses and short-term political opportunism. Groundhog Day anecdotes abound’ (p. 2)

It suggested that the states and Commonwealth needed to split the costs of reconstruction 50:50, and the money kick in only once a higher threshold had been reached.

The Commission identified natural hazard risk as the key driver of insurance premiums and recommended a five-fold increase in annual mitigation funding, phasing out of stamp duty on insurance and improved land use planning laws.

It looked at insurance pools that have been introduced internationally to transfer natural disaster risks to the taxpayer and subsidise the cost of insurance. The Commission found that private risks just grow without robust price signals, with real dangers of government bailouts for reinsurance pools.

It concluded that:

‘International experience has shown that government intervention in property insurance markets through subsidies is overwhelmingly ineffective. It creates moral hazard as well as fiscal risks. Some foreign governments have had to bear significant costs following large natural disasters because their insurance schemes failed to accumulate adequate reserves’

David Murray’s financial system inquiry released in December, noted that the cost of insurance can be high, especially for coverage in higher-risk areas, such as flood plains and cyclone-prone areas. But it concluded that this issue should be primarily handled by ‘risk mitigation efforts rather than direct government intervention, which risks distorting price signals’ (p. 227).

The clear message is that the best way to lower premiums and reduce the risks of natural disasters is through public investment in mitigation to protect infrastructure.