Current approaches to measuring and

funding risk

Rob Whelan

Insurance Council of Australia

This presentation has been prepared for the Actuaries Institute 2018 Catastrophe Risk Seminar.

The Institute Council wishes it to be understood that opinions put forward herein are not necessarily those of the

Institute and the Council is not responsible for those opinions.

Risk based pricing – the new normal

• Risk based pricing is now used extensively for property risks

• This approach delivers a price signal to those who need to

mitigate risks to an acceptable level

• This can be a very uncomfortable message to deliver, yet the

industry remains free of government intervention on pricing issues.

• How are risks currently measured?

Measuring the residual risk – its complex

• Insurers price for the residual risk of damage occurring to an asset.

• Insurers must estimate that risk after taking into account all of the measures in place to reduce exposure and vulnerability.

• The role of insurers in this context, coming at the end of the risk valuation chain, is not well understood by non-industry stakeholders.

• 10 government inquiries and commissions have examined this principle since 2011 – all have agreed

RESID

UA

L R

ISK

RISK MITIGATION

EFFECTIVEMITIGATION

RISK APPROPRIATEBUILDING STANDARDS

RISK AVERSELAND-USE PLANNING

THE RESIDUAL MITIGATED RISK

Compressing the risk

RESID

UA

L R

ISK

RISK MITIGATION

EFFECTIVEMITIGATION

RISK APPROPRIATEBUILDING STANDARDS

RISK AVERSELAND-USE PLANNING

THE RESIDUAL MITIGATED RISK

Lismore, NSW - Building in non-exposed areas reduces risk

Median premium 350k SI, $3,875

Median premium 350k SI, $1,109

Compressing the risk

RESID

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RISK MITIGATION

EFFECTIVEMITIGATION

RISK APPROPRIATEBUILDING STANDARDS

RISK AVERSELAND-USE PLANNING

THE RESIDUAL MITIGATED RISK

Building standards must reflect the level of exposure to a hazard

1976 Wooden frame and clad building in Victoria in dense woodland.

Compressing the risk

RESID

UA

L R

ISK

RISK MITIGATION

EFFECTIVEMITIGATION

RISK APPROPRIATEBUILDING STANDARDS

RISK AVERSELAND-USE PLANNING

THE RESIDUAL MITIGATED RISK

$124 million in claims costs over 3years

$15 Million Construction Cost

483 homes protected from flooding

75 businesses protected from flooding

Average Premium Drop 34%

Peak Premium Drop 75%

The affordability issue

• What is driving the insurance affordability issue?

• How bad is it? What are households paying for cover?

• What are the potential solutions?

The affordability issue - Drivers

• Claims costs» Frequency of claims

• Locating buildings in highly exposed areas• 17% of addresses are flood exposed in Australia

• The return period in northern Australia for cyclones reaches 1:4 years in many locations.

• Building to inappropriate standards and older buildings• Pre-cyclone wind code constructed buildings are approx. 25% more

expensive to insure.

• Strata buildings built to modern standards still suffer significant (but non-life threatening damage during cyclones)

» Supply costs. In non-urban and remote areas the cost of

trades and supplies is significantly higher.

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Key Points

• Northern Australia is far more expensive to build/rebuild/repair property in.

• The additional costs are driven primarily by labour and supply costs, the region being

more remote.

• An insurer must naturally consider this when predicting claims costs.

• Combined with the anticipated higher frequency with which repairs and rebuilds

need to occur (higher exposure) the fundamental of why premiums in the north are

higher are not difficult to understand.

Building costs vary across Australia by region due to the

additional costs of labor, trades, supplies and more

rigorous building standards. Indexed again Melbourne,

costs across northern Australia range from 22% to 42% more

expensive.

Sources: Cordell Sum-Insured, Defence Building Costs

The affordability issue – How bad is it?

The affordability issue – The solutions

• The easy solution – Make everyone else pay– Subsidise those with high risks, by charging low risk

policyholders more

– Creates disincentive to mitigate and expands the problem over time (see international examples).

• The sustainable solution – Fix the root cause– Use price signals to focus on problem areas and further

compress the residual risk

– Continue to improve land-use planning regimes

– Improve building codes to harden buildings to future risk

– Targeted retrofitting of older properties

– Investment in mitigation infrastructure

– Targeted retrofitting of older properties

– Encouraging the industry to adapt products and prices that assist the community and are sustainable.

RESID

UA

L R

ISK

RISK MITIGATION

EFFECTIVEMITIGATION

RISK APPROPRIATEBUILDING STANDARDS

RISK AVERSELAND-USE PLANNING

THE RESIDUAL MITIGATED RISK

Two Cyclones – A Contrast in Products and ApproachCyclone Yasi, 2011

• Category 5, wind and flood damage

• 72,000 claims

• $1.2bn insured loss

• Less than 50% of policies covered riverine flood

• No standard definition of flood

• Little flood data available

• Many products cross subsidized

• 1,200 disputed claims with FOS

• Intense community backlash on claims performance

• 95% claims closed at 19 months

Cyclone Debbie, 2017

• Category 4, wind and flood damage

• 72,000 claims

• $1.7bn insured loss

• 96% of policies cover riverine flood

• Standard definition of flood

• Flood risks well understood

• Product pricing strongly risk based

• 312 disputed claims with FOS

• Strong community interest in mitigation

• 95% claims closed at 12 months

What does this show?

The industry has demonstrated an ability to improve and adapt its approach, to deploy innovative products and to respond to community needs and deliver on the promise offered by insurance. The freedom to continue improving without intervention is in the communities interest and is worth defending.

The industry can not reduce the physical risks that the community faces, this is a responsibility for government and the community to address.

However, the industry can assist government and the community to identify where risk reduction is required, can continue to offer an undiluted price signal that will warn and emphasis the need to mitigate and can recognize (through lower premiums) when those risks have been suitably addressed.