The outlook for house insurance is much worse than we're being told

The big news on house insurance this week was the response of the insurance industry’s peak body to a parliamentary committee’s extensive criticisms of its treatment of people claiming on their policies after the massive floods of 2022.

The Insurance Council of Australia accepted some of the committee’s recommendations, announced an “industry action plan” and generally promised to be good boys in future. But the consumer groups were unimpressed.

Drew MacRae, of the Financial Rights Legal Centre, said the insurers “have a long way to go to restore trust and confidence in a sector that systematically failed customers during the 2022 floods. Today’s announced plan to get there is welcomed, but ‘trust us’ just won’t cut it.”

Meanwhile, in their pre-election campaigning, Anthony Albanese and Peter Dutton are as one in portraying our insurance problem as a matter of misbehaving insurance companies.

Asked if he accepted a journalist’s claim that the companies had doubled premiums in recent years, “had plenty of money” and “are ripping us off”, Albanese flatly agreed. “We will certainly hold the insurance companies to account,” he added.

Dutton’s response was to threaten to split up the big insurance companies – until wiser heads in his team calmed him down.

Sorry, all this is delusional for some and, for others, a knowing attempt to mislead us on the seriousness of the problem. Have the insurance companies been behaving badly? Yes. Should they be forced to treat their customers fairly? Of course.

But will that fix the problem? No. Have the companies been ripping us off, putting up premiums just to increase their profits? No. They’ve been grappling with a problem they know they can’t solve: you can’t insure against climate change.

The cost of house insurance has been rising rapidly for several years because more bushfires, cyclones, storms and floods have led to more claims. We know that continuing climate change will cause extreme weather events to become more frequent and intense.

So the great likelihood is that house insurance premiums will just keep rising rapidly. The outfit that’s doing most to alert us to the deep trouble we have with insurance is the climate campaigning Australia Institute. Its recent national poll of 2000 people found that while 78 per cent of home owners said their home was fully insured, 15 per cent said they were underinsured and 4 per cent said they were uninsured.

As house insurance premiums rise, more people will become underinsured – many with no insurance against flood damage, for instance – and more will be uninsured. Many of the latter will be people whose homes the companies have refused to insure.

The insurance companies know what’s coming, as do the banks and the government. They know what’s coming, but they don’t want to talk about it before it happens, mainly because they don’t know what to do about it.

Remember, insurance is an annual contract. So if I’m confident there’s little chance of your house being destroyed in the next 12 months, I’m happy to give you the assurance of insurance. But when, sometime in the future, I decide you’re a bigger risk, it will be a different story.

The point is, there’s no magic in insurance. It can do the possible, but not the impossible. The way insurance works is that, if I can gather a “pool” of many thousands of home owners, each with only the tiniest risk of having their house burn down, I can promise all of them that, in return for a modest premium, they’re all fully covered in the event of a major mishap.

A few of them will have such a mishap, but I can pay them out from the pool of premiums and still have enough left to make it worth my while being in the insurance business.

Once the risk of your home coming to grief becomes less than tiny, however, the game changes. When more than a few people in the pool make claims, I make no profit, or maybe a loss. So I can start by making owners with bigger risks pay more than those with low risks, but once your risk is too high, I can either charge you a premium that’s impossibly high, or just refuse you insurance.

Because of their ever-growing record of claims, the insurance companies are well-placed to make a reasonably accurate assessment of how risky it is to cover your house – even to the point of charging more in some parts of a suburb than others.

This means, of course, that home owners in some parts of the country will be charged far more than others. Premiums will be highest in northern Australia, where cyclone risk is higher, but also in areas where flooding or bushfires are likely. And even people living well away from harm in the inner city will be paying more to help out.

All this is why we should be doing more – and have been doing more this long time – as our part in the global effort to limit climate change. But what should we do to reduce the damage that’s arrived or is on its way?

Well, certainly not having the government subsidise insurance. That would just encourage people to keep doing what they should stop doing. Taxpayers’ money should be used only to help people get away from the risk of fires and floods.

Just as fighting a fire is easier than fighting a flood, bushfires are less difficult to get away from than floods. We must start by preventing anyone else building in risky areas.

Then we need to move people off the flood plain. As for Lismore, the whole town needs to be moved to higher ground.

But here’s a tip. Don’t hold your breath waiting for Albanese or Dutton to raise these issues in the election campaign. That’s not the way losers behave. Much easier to shift the blame to the greedy insurance companies.

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Never mind carbon, let’s put a price on bad driving

What would an economist know about road safety? More than you’d think. Certainly, more than the road safety establishment thinks.

Or maybe they just don’t want to disturb the insurance companies’ nice little earner from compulsory third-party car insurance.

The economist in question is Dr Richard Tooth, a consultant with Sapere Research Group, who’s been working for some years on his pet project of using economics to reduce the road toll (with, at one point, some funding from Austroads, the peak body representing road transport agencies).

Over the decades we’ve had much success in using seat belts, random breath testing and safer cars to bring down the road toll.

But we seem to have run out of ideas. The national death toll has started going back up. Last year 1226 people lost their lives on Australia’s roads.

The newly released report of the inquiry into national road safety for the coming decade (which says little about insurance) reminds us that at least another 36,000 people are admitted to hospital each year.

“Often these are life-changing injuries, such as paralysis, brain injuries, amputations or loss of sight,” it says.

Tooth thinks there’s an obvious improvement we could make that wouldn’t cost much more initially, and would actually save money once it started affecting people’s driving habits. It’s to base a driver’s annual motor vehicle insurance premium on how risky their driving is.

Viewed the way economists see things, there are two key problems. As behavioural economists (and social psychologists) have long known, humans tend to be overconfident.

Almost all of us think we’re good drivers, it’s just those other drivers that are causing the problem.

The second problem is that, when we drive badly and cause accidents, we don’t bear the full cost of the damage we do. Economists call the part we don’t pay for ourselves a “negative externality”.

And if someone else is paying, why should we worry? Economists call this “moral hazard”.

Insurance is obviously a good idea, a way of sharing risk. Those people whose house didn’t burn down make a small contribution to the cost of building a new house for the person whose did.

The downside of all insurance, however, is moral hazard. Why should I worry much about ensuring my house doesn’t burn down, it’s insured?

Insurers have ways – usually fairly primitive – of trying to reduce moral hazard. Say, you get a discount on your premium if you have smoke alarms fitted. And on other insurance policies there’s a “deductable”, where you bear the first part of the claim yourself. And, of course, the no-claim bonus.

With car insurance, however, a lot of the cost of accidents is borne by neither the insurance company nor the policy holder. A fair bit is borne by the general taxpayer – the need to maintain many traffic police, ambulances and hospital emergency departments.

But the biggest “cost” is one that’s hard to measure in dollars but is very real: the grief, pain and suffering caused by avoidable deaths and disablement.

Whatever price we put on a human life, it’s safe to assume it would be a whole lot higher than $200,000 – which is what Tooth says is the average cost paid via insurance.

He’s concerned that our system of dividing highly regulated compulsory third-party insurance (which covers injury to people) off from general vehicle insurance (which covers damage to property, plus other things such as theft) makes it hard to give drivers a greater monetary incentive to avoid driving riskily.

With a few exceptions, the state-government run CTP schemes charge people a flat premium that bears no relationship to how carefully they drive. Which, when you think about it (as an economist would), means the schemes effectively tax the low-risk drivers so as to subsidise the high-risk drivers.

That, of course, is the wrong way round if we’re trying to discourage rather than encourage risky driving. And that’s Tooth’s point.

He says we should do what most other advanced countries do and allow insurance companies to offer policies that cover third-party bodily injury in a package with property damage and other risks. The CTP component could remain compulsory and the other components remain voluntary.

This would allow the companies to charge premiums based on the individual’s assessed risk of having an accident, as is happening increasingly in Britain. It would better align insurance companies’ motivation to reduce claims with the community’s desire to reduce road death and injury.

It would mean higher premiums for drivers who were young - or very old. But technological advances have made it possible to assess risk more accurately than just via the driver’s age.

People using “advanced driver assistance systems”, such as autonomous emergency braking, would pay less. Young people driving cars with such assistance systems would get bigger discounts than older drivers.

And then there’s “telematics”, such as onboard devices that record the way a car has been driven – hard braking, swerving and so forth. Such UBI – usage-based insurance – is very big in Britain.

According to Tooth, research shows this can reduce crash risk by at least 20 per cent overall, and by up to 40 per cent among young drivers.

He believes risk-based insurance premiums can influence whether people drive (young people may delay becoming drivers, with ride-sharing apps helping this choice), what they drive (safer cars or cars with added assistance systems) and how and when they drive.

But Tooth would like us to go one better than the Brits (and anyone else). The government could “internalise the externality” of the intangible costs of death and disablement on society by imposing a commensurate charge on insurance companies, which they would pass on to customers having accidents in which they’re at fault.

The government could use the proceeds to build safer roads or for some other worthy cause. The real purpose of such a tax would be to encourage people to avoid it by driving more carefully.

Is this ringing any bells? Putting a price on bad driving follows the same logic as putting a price on carbon.

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