Breaking the banks
Why the insurance affordability crisis could spell bad news for borrowers and lenders alike
By Claire Heaney
Soaring insurance premiums have left about 5% of Australia’s mortgaged households facing insurance stress and risking a breach of their home loan agreements, according to S&P Global Ratings.
Home and contents premiums have increased by 65% over five years, data published by the Australian Prudential Regulation Authority shows.
The rises are blamed on high numbers of claims, the cost of building materials, rising rental prices for emergency accommodation, reinsurance and operating costs.
But while premiums have increased, wage growth has stalled.
And there is little relief for policyholders, with an S&P report – Australia’s Home Underinsurance Could Spread Risks – predicting insurers will keep lifting home and contents premiums to improve margins and cover weather-related claims.
Insureds may also be affected by the recent California wildfires, which could drive up global reinsurance costs.
S&P analyst Angela Zhou says people facing cost-of-living pressures may reduce or stop their insurance coverage. “Underinsurance is especially likely in higher-risk locales, where insurance costs are multiple times higher.”
And S&P financial institutions ratings director Lisa Barrett told a seminar in February that underinsurance could become a blind spot for Australian banks.
She says a “back of the envelope” estimate of credit losses caused by underinsurance would be about $200 million.
The ratings agency says that while this amount represents a small risk to big banks, it could be disastrous for regional lenders if a weather event damaged a whole city, town or suburb that was under or uninsured.
When banks issue home loans, they require owners to verify that the property is insured. A bank can reduce or cancel the loan if adequate cover is not maintained.
But after initial checks, banks often do not follow up. Previously, mortgage-holders being under or uninsured was not considered a problem, because owners were wary of the ramifications if their house was damaged or destroyed. But cost-of-living pressures are changing priorities.
Banks following up on coverage could be seen as a breach of privacy and result in negative customer experiences. Ms Barrett told the seminar she understands that in New Zealand there have been talks between banks and insurers about cross-referencing to ensure compliance with loan agreements.
Given the crossover in ownership between Australian and New Zealand bank and insurance groups, any solution may be considered across the Tasman.
Banks have some insurance protection should a mortgage-holder not be covered.
An Actuaries Institute paper – Home Insurance Affordability and Home Loans at Risk – found the proportion of households facing premiums equivalent to more than four weeks’ gross income rose to 15%, or 1.61 million households, in the year to March 2024 – up from 12% in 2023 and 10% in 2022.
Such “affordability stressed” households spend an average of 9.6 weeks’ gross income on home insurance, seven times more than non-stressed households, the August 2024 report found.
The 5% of mortgaged households experiencing insurance affordability stress represent $57 billion of loan balances and 3% of all home loan assets.
Report lead author Sharanjit Paddam says while insurance is “generally affordable” for 85% of households, others are struggling.
“Unfortunately, we expect this will continue because of the overall increasing risk of natural disasters associated with climate change, which will continue to put upward pressure on premiums,” he writes.
The institute says it has historically been too expensive for lenders to check if insurance is in place after the originating documentation is verified. Many people will refinance or sell, so checks are made then. Even if people are insured, lenders do not check the level of coverage.
S&P’s Ms Zhou says soaring insurance costs could lead to wider gaps in coverage, exposing more homeowners and their lenders to risk.
“Higher premium rates accurately reflect risks for insurers but may stifle new policy growth and lead to underinsurance,” she says.
She predicts government involvement may be needed in high-risk locations as insurers exit or limit coverage.
“Housing trends point to further upward pressure on home insurance costs,” says the S&P report, on which Ms Zhou was lead author.
“For example, growth in housing stock on the east coast of Australia will contribute to more weather-related claims. We expect insurers will prudently price for underlying risks of properties.
“Premiums are already very costly in high-risk areas such as floodplains or bushfire zones and are unlikely to fall any time soon. Building new housing stock in these types of high-risk areas will ultimately burden household budgets with high insurance premiums.”
In 2022, the federal government established the cyclone reinsurance pool, allowing insurance companies to transfer risk for cyclones and related flood damage.
The arrangement between the Australian Reinsurance Pool Corporation and insurers is backed by a $10 billion government guarantee, reinstated each year. ARPC analysis published in May last year pointed to an improvement in insurance affordability in cyclone-prone regions since the pool was introduced.
S&P notes that if insurers withdraw from high-risk regions, homeowners will struggle to sell and buyers will not secure mortgages without cover.
“The value of properties in high-risk areas would significantly decline if they are uninsurable. This is where government-backed schemes could play an important role.”
However, the ratings agency warns such schemes can create “moral hazard risk and a false sense of protection”.
“Deviating from risk-based pricing masks the underlying risks of living in a high-risk location,” Ms Zhou says.
She says state and federal governments continue to invest in resilience and mitigation, including improved building standards and levees, but it is not viewed as enough to negate the underlying threat.
The federal government has committed up to $1 billion over five years to the Disaster Ready Fund, aimed at reducing risks and building resilience to catastrophes caused by climate change.
Ms Zhou says removing GST and other duties, which vary between states, could reduce insurance premiums by as much as 20%.
