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Ties that bind: mitigation meets prudential stability

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How much longer can Australia drag its feet over the need for investment in mitigation? Or to put it more bluntly, when will our myopic political leaders accept that spending more on flood levees, sea walls, stronger buildings and the like holds the key to insurance affordability?

The stopwatch may have possibly started ticking now that the Australian Prudential Regulation Authority (APRA) has waded into the matter.

Rarely does APRA touch on topics that are outside its remit, which essentially is all about maintaining the prudential stability of the financial system.

The regulator has certainly raised more than a few eyebrows with its push for a new approach by the Federal Government by doing something that the insurance industry and many federally funded studies and think-tanks have already concluded is the only way to go: heavy investment in mitigation.

In taking this stance the regulator has essentially exposed the policy direction being pursued by a fellow regulator – the Australian Competition and Consumer Commission (ACCC) – for the expensive waste of time that it is.

The way APRA sees it, there is a clear link between prudential soundness and mitigation. There is no separating the two. Mitigation is the best answer to a problem that has plagued the north and unnecessarily befuddled a stubborn Canberra, which still struggles with the need to tackle climate change head-on.

And it sees its intervention in the issue as an important part of its job. “APRA has a strategic focus on addressing and mitigating underinsurance given the likely social and economic impacts which may have broader implications on the stability of the financial system,” the regulator says in its detailed submission to a recent ACCC inquiry’s interim report on the high cost of insurance in northern Australia.

“Reflecting APRA’s prudential mandate, it is concerned that pressure for lower premiums without commensurate reductions in the risk may reduce the resilience of the insurance industry.”

APRA states it in inescapable terms: insurers price premiums according to the risks they undertake. This is a core principle that responsible insurers abide by. To deviate from this would only endanger their ability to meet their claims obligations.

“To remain prudentially sound and financially viable, insurers need to set premiums that accurately reflect the risk and recoup costs over time,” it says.

“If the private insurance market is not operating efficiently, the safety net it provides is less effective and risks are borne by the individuals affected.”

Calls for more financial resources to strengthen the country’s natural disaster resilience are not new, especially when it comes to the catastrophe-prone north.

The Insurance Council of Australia (ICA) has repeatedly advocated it. As also did the Northern Australian Insurance Premiums Taskforce in its final – and presumably pigeon-holed – report released to the public in 2016, and many other independent studies.

The magic figure is $200 million. That’s what Canberra needs to put into mitigation funding every year, according to the Government’s own Productivity Commission. In the 2019/20 budget papers, just $130.5 million was set aside – over five years – to reduce the risk and impact of disasters. That’s $26.1 million a year.

Increased mitigation spending would go a long way to alleviating the pressure on premiums. Insurance is significantly more costly in the north than the rest of the country for the obvious reason that the risk of extreme weather is so much higher.

Some of the worst cyclone and flood disasters the country has experienced have taken place in the region the ACCC inquiry is investigating.

Northern Australia’s insurance woes are “a symptom of a more fundamental underlying problem – the increasing prevalence and financial impact of natural disasters in northern Australia,” APRA says in its submission.

“APRA’s view is that meaningful change can only be brought about by focusing on the root cause – the high, rising and volatile costs of natural catastrophes.

“This can only be achieved through avoiding or mitigating the underlying natural peril risk. Focusing on premium affordability alone will not address the root cause.”

Unlike politicians, APRA is clearly taking a long-term view of a problem that could morph into a national problem if not handled properly.

There is a common thread that binds natural catastrophes, insurance affordability, mitigation and, increasingly, climate change. The orderly functioning of the financial system could be shaken by a mere whiff of prudential instability.

Just a measly 3% of disaster funding available nationally is directed at mitigation and prevention measures. The rest goes to clean-up and recovery operations.

The imbalance, APRA warns, must be corrected as man-made carbon emissions wreak havoc on weather cycles and the environment. They will eventually affect premiums.

“Climate change can be expected to amplify the underlying issues in terms of both increased uncertainty in areas which have historically experienced disaster events, and in exposing previously unaffected regions where building standards and land use planning do not adequately protect against the risks,” the regulator says.

The ACCC study, which is focusing on premium affordability, is already on the well-worn moral high road to nowhere. The causes of high premiums are already well known and the ACCC investigators’ draft “solutions” cover the same old ground with only a passing flicker of attention at the need for proper investment in mitigation.

Far too much time and money have already been spent on inquiries that have followed the same route as the ACCC inquiry. One can only hope the commission’s report-compilers have to courage to accept that the only way to lower the cost of insurance in northern Australia is to lower the cost of catastrophes through mitigation projects.

As ICA Head of Risk and Operations Karl Sullivan says, “It's time to stop talking about making Australia more disaster-resilient and get on with it”.