The Australian Prudential Regulation Authority (APRA) has released its Insurance Climate Vulnerability Assessment (Insurance CVA), a prudential stress test exploring how a changing climate could affect home insurance affordability and the insurance protection gap1 over coming decades.
Affordable and widely held home insurance supports a resilient and productive economy by protecting households against large and unexpected financial losses, enabling them to recover quickly after shocks.
The Insurance CVA is not a forecast or prediction of future outcomes. Instead, APRA examined how home insurance coverage may fall under two severe but plausible global climate-related scenarios projected out to 2050: one with higher physical risks from weather-related events and one with greater economic impacts from transitioning to a lower emissions economy.
It found that, under both scenarios, climate-driven pressures on insurance premiums could significantly widen the nation's insurance protection gap, thereby increasing financial risks to the system.
APRA estimates that around one in seven Australian houses are uninsured today. Under both stress scenarios this could rise to around one in four by 2050 - equivalent to an additional one million homes without adequate home insurance.
Further key insights include:
- Regional and rural communities would be disproportionately affected, with the protection gap widening more sharply in areas that already have lower levels of insurance coverage. It could grow to over 40 per cent in rural areas under both scenarios by 2050.
- Different climate risk-related factors drive the widening protection gap under each scenario, alongside economic and income growth factors:
- In the higher physical risk scenario, rising losses from more frequent and severe weather events push premiums higher. Overall expected annual losses from weather-related events could rise from around $7 billion today to more than $16 billion by 2050.
- In the higher transition risk scenario, losses from weather events are a contributing factor but are less severe. However, significant and ongoing increases in construction costs drive premiums higher.
A widening protection gap could increase uninsured losses for households, heighten credit risk for banks, particularly in high-risk regions, and constrain growth in the home insurance market. Over time, these pressures could erode the resilience of Australia's financial system.
APRA Member Suzanne Smith emphasised the significance of APRA's stress testing work, noting how risks in the financial system may emerge due to falling levels of insurance coverage at a time when losses from weather perils are increasing.
"Insurance plays a critical role in Australia's financial system by shifting large financial losses away from households and lenders to insurers and reinsurers that are better equipped to absorb them. When homes are uninsured or underinsured, losses are more likely to be borne directly by households, banks or by the government.
"To support insurance affordability and availability and with that strengthen the resilience of our financial system, it is essential that all stakeholders work together to reduce exposure to weather-related risks. This includes emissions mitigation and risk adaptation that strengthens the resilience of Australia's housing stock, such as building protective infrastructure, retrofitting existing homes and risk-based land-use planning. Supporting insurance affordability with innovative insurance solutions and better risk management will also help limit the flow of uninsured losses into the financial system over time.
"APRA will continue to engage with government, industry and other regulators to share insights and to support efforts to manage prudential risks associated with declining insurance coverage," Ms Smith added.
About the stress test
APRA worked with industry experts and five of Australia's largest general insurers - Allianz, Hollard, IAG, QBE and Suncorp - which together account for around 80 per cent of the home insurance market by gross written premium. The scenarios are aligned to the Network for Greening the Financial System (NGFS) scenarios and assume no additional policy or physical home adaptation measures are implemented over the period, an approach in line with standard stress-testing practice.
Read APRA's full Insurance CVA report at: Mind the Gap: An Insurance Climate Vulnerability Assessment
You may also be interested in APRA's Banking CVA report from November 2022: APRA releases results of inaugural Climate Vulnerability Assessment | APRA
Footnotes
1 The home insurance protection gap refers to the extent to which losses impacting homes are not covered by insurance.
