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March 30, 2022

Lessons from climate risk pooling

Countries such as Australia, the US and the UK have developed financing solutions to deal with the aftermath of severe weather events, and are now taking stock of past experience.

As a bellwether for the planet’s climate future, Australia is a standout candidate. In the past few years, the country has been battered by a series of extreme weather events, from unprecedented bush fires to record floods, which have caused billions in damage and left communities in ruin.

These disasters have been accompanied by a related and cascading set of problems: for example, climate distortions led to a near-biblical mouse plague in the east of the country in 2021, generating more than A$1bn ($750mn) in damage to farms, businesses and households. 

Research from Deloitte Access Economics indicates that over the next 40 years Australia is facing a cumulative bill of A$1.2tn (in present value terms) from natural disasters. And though it may be an extreme case, the country is not alone on the frontline of the climate emergency. From the US to Southeast Asia, climate costs are spiralling for households, communities and governments around the world.

Soaring claims

This trend is exerting huge pressure on the insurance industry, as property and casualty claims, in particular, surge. In response, premiums are rising, with the Swiss Re Institute estimating that climate risks will add up to $183bn to global property insurance costs by 2040. The result is growing levels of underinsurance and non-insurance in climate-exposed markets and sub-regions.

In Australia, the rate of non-insurance in the north, where extreme weather events are more frequent, is almost double the national average, according to data from the Australian Competition and Consumer Commission. This situation is exacerbating social and economic inequalities in all markets where it exists, particularly in the wake of a catastrophe.

“Some of those people don’t have a choice [of where to live], they are living in legacy assets,” says Paula Jarzabkowski, professor of strategic management at the University of Queensland. 

Insurance rethink

These pressures are forcing a rethink of how insurance is offered, as well as the role of public-private cooperation in encouraging the provision of affordable insurance. According to Jarzabkowski, one solution is the development of protection gap entities (PGE) that blend market offerings and social objectives together. These can range from multi-country sovereign risk pools, found in the Caribbean, Africa and elsewhere, that involve national governments cooperating with development finance institutions and insurers to share risks, to domestic-level PGEs designed to address earthquakes or floods.

“If they’re well designed, they can provide a transition period for communities [to adapt and build resilience]. Ultimately, they’ll be changing the fundamental, underlying structures of a particular problem that is pushing insurance costs higher,” says Jarzabkowski. 

In the UK, the launch of Flood Re in 2016, a flood reinsurance scheme devised by industry and government, is starting to bear fruit. Designed as a transition scheme with a 2039 end point, Flood Re secures most of its funding through a levy on the UK home insurance industry. From April 2022, as it disburses support to flood affected households, the programme will provide additional funds to allow these households to ‘build back better’, as the slogan has it, and develop resiliency against flood damage. 

The programme has won praise internationally. “The Flood Re approach in the UK [is a brilliant solution],” says John Englander, a Florida-based oceanographer and climate change author. 

Build resilience

Yet not all risk-pooling mechanisms are suitable for delivering long-term change, particularly if poorly designed or based on financial support. In the US, the decades-old National Flood Insurance Program (NFIP), which covers the majority of home flood insurance plans by enabling low-cost premiums, has attracted criticism for its frequent taxpayer-funded bailouts and poor record of addressing underlying flood risk.

By the end of 2021, the NFIP was in about $20bn of debt, though efforts are currently under way to achieve much-needed reforms, including the introduction of new insurance rates. 

In Australia, meanwhile, the federal government will launch a new A$10bn public reinsurance pool for the north east region in July 2022, covering cyclone and flood-related damage. The new scheme is designed to ensure premiums remain affordable for residents in affected areas, but might not deliver any meaningful, long-term change.

By simply underwriting the risk without an end point, critics point out that taxpayer money is being used to support the status quo, rather than to build resilience and adapt to meet a new climate future. “Insurance can be a partner for climate adaptation but not in the way that it is currently being proposed in Australia,” says Jarzabkowski. 


A service from the Financial Times