The insurance gap is not only a Pacific Island problem. Australia faces a massive insurance gap that leaves home and business owners increasingly vulnerable to either dealing with disasters without being fully insured or paying more for premiums, even if they live thousands of kilometres from a disaster zone.
That potential lack of insurance cover also has sobering ramifications for those seeking a mortgage and home ownership, especially in a world where climate-linked disasters are increasing.
The potential solutions are complex and will require government action. In 2022, when disastrous floods hit Queensland and NSW, the insured losses alone were more than AU$6 billion, and about 48% of Australian losses were not covered by insurance.
Everyday Australians are facing steep insurance premium rises, and the number now seen as being under insurance stress has increased from 10% in 2022 to 15% last year. That leaves many people in vulnerable areas underinsured or uninsured, and even those who can get insurance are
paying much more.
In advanced economies, there is an assumption that insurance will pay for rebuilding, but a disaster insurance protection gap means many people affected by disasters are uninsured, with no identified source of funds for recovery.
The recent Los Angeles fires have been estimated to have cost up to US$250 billion in economic losses, but only $40 billion was covered by insurance.
Why there is a gap
There are three key reasons for this insurance gap:
• In risk-reflective pricing, insurers charge higher premiums to those properties that are likely to incur more losses. This pricing is based on a combination of previous losses and proximity to, or location in, high-risk zones, and means the higher premium reflects the potential for higher loss.
• Insurance is a pooling mechanism, in which the premiums of the many pays for the losses of the few. As increasingly severe and frequent disasters cause multiple losses, more premium capital is needed to cover the ‘losses of the many’. Insurance companies buy a reinsurance policy on the global market, so as losses increase globally, the cost of reinsurance capital goes up around the world, creating a ripple effect.
• Climate uncertainty increases insurance market volatility from unexpected losses. Uncertainty is associated with higher capital reserving by insurers and reinsurers to cover unexpected losses and is reflected in increased premiums.
Why does it matter?
The insurance protection gap means that global capital does not flow to rebuild homes in local economies after disasters. Without sufficient insurance, the burden for recovery falls disproportionately on those who lack sufficient insurance and are already financially and socially vulnerable. And being unable to get insurance means people probably won’t be able to get mortgages. The broader cost to society is also high, as government disaster funds cover costs like temporary housing and rebuilding.
The way forward
Any approach to the insurance gap needs to bridge both the financial gap and reduce the physical gap.
Government-legislated insurance mechanisms, known as protection gap entities, are needed to subsidise those at high risk to keep them in the insurance pool.
Protection gap entities need to be compulsory to ensure the entire population can be covered and offer multi-peril protection that covers all key hazards. The frequent criticism of protection gap entities is that they are unfair to those at lower risk, or that by suppressing price signals about high-risk areas they allow people to rebuild in floodplains or cyclone or bushfire-prone regions.
Overseas experience shows that any solution will be complex, requiring collaboration across all layers of
government, targeted risk interventions, and public-private collaboration to support the integration of insurance into the resilience ecosystem.
