The high cost of Insurance in North Queensland Discussion  Paper

Whilst the points raised below focus on North Queensland several are equally applicable to other areas of the country that may have a higher then average exposure to natural perils such as flood, hail, bushfires etc.

1. Short term planning versus long term planning
2. Spread of Risk
3. Lack of Competition
4.NDIR Recommendations
5. Government Taxes

Short Term Planning versus Long Term Planning

The major reason for the high premiums is the lack of long term planning or the setting of long term business goals. In a non event year,  insurance in North Queensland is highly profitable whilst in an event year it can be highly  unprofitable. A successful insurance market should  be able to smooth out these peaks and troughs.

To illustrate this we will use a companies Statutory Operating Ratio (SOR)
SOR is essentially claims + expenses  as a percentage of premiums collected.

A Company may  set a long term target SOR, say for example 95% and price their insurance accordingly. During a non event year, without adjusting the pricing,  a company achieves a lower SOR of say 80%. It is essential that the 15% below the target SOR  be put away for when an event year occurs. If  this strategy is adhered to on a ongoing basis year after year, when an event does occur,  it will be unlikely to result in unsustainable premium increases.

Due to the pressure on company executives by way of shareholder and board expectations, individual bonuses, remuneration structures and regular staff turnovers at executive levels, the temptation is great to ensure  the highest possible short term results instead of longer term consistency.  

By way of a simple example: 

A customer could, over a five year period with a event occurring in the middle of this time,  pay annual insurance premiums as follows. 

Industry with  a short term focus - $500, $750, $2000, $ 1500, $750 = $5,500
Industry with a long term focus - $1100, $1100, $1100, $1100, $1100 = $5,500

An insurance company over a five year period, with an event occurring in the middle of this time, could achieve the following SOR

Short Term focus - 70% - 80% - 175% - 80% - 70% = average 95%
Long Term focus - 95% - 95% - 95% - 95% - 95% = average 95% 

Question - What is better focus for the customer ?

Spread of Risk

The basic principal of insurance is to spread the risk throughout the community. The premiums of the many pay the claims of the few. With the introduction of new technologies and the copious amounts of information available to enable the insurance industry to assess potential risks, this basis of insurance is slowly being eroded.  

Insurance Companies once calculated premiums by state, then incorporated sections of the state, then cities within the state, followed by postcodes within the cites, then suburbs within  these postcodes, then streets within the suburbs and finally to individual risks within these streets.

The impact of this data filtration by Insurance Companies,  is that instead of spreading the risk they are aiming to make each individual risk stand on its own merits. The end result is unsustainable premiums for many customers. 
The more particular the rating criteria the bigger the gap in premiums between what is deemed to be a good risk and a what is a classed as a sub-standard  risk.  As a result,  the outcome is what is now a common situation in North Queensland , is that a large proportion of consumers simply can not afford to take out insurance.

By way of a simple example:

100 customers in Nth Qld pay $3000 each for home and contents = $300,000
100 customers in Sydney pay $1000 each  for home and contents = $100,000
or
200 customers in Australia pay $2000 each for home and contents = $400,000

Which option is the better distribution of the premium pool?

Lack of Competition

There is an incorrect assumption that lack of competition is contributing to higher prices. The real issue is the number of  participants in the market. 

Even though there is a limited number of Insurers there is still healthy competition between these Companies.  The premiums are high because the total exposure is spread between so few Insurers.

By way of a simple example:

Assume there is $100 million of potential claims.
2 insurers would have to pay $50m each
10 insurers would have to pay $10m each.

Which is the more viable option  ?

The Solution

The suggestions put forward in the discussion paper are only going to exasperate the above issues. There is really only one solution and that is the main reason why insurance was invented in the first place. 

"spread the risk as far and wide and through as many insurers and policy holders  as possible"

It is unlikely, in the foreseeable future that the insurance market is going to be able to achieve this spread of risk without some form of government intervention.

Whether or not that intervention is by legislation or the creation of a type of catastrophe pool will depend upon the governments political resolve as there will no doubt be public objections.

For example, why should a house owner outside a cyclone area or with a better constructed  building subsidise the people in a cyclone area or those with an inferior  building construction. Alternatively,  why should a person in a non hail area 
(which Nth Qld is) subsidise those in a area that hail is a common occurrence. 
The same abjections would apply to flood & non flood areas, bushfire and non 
bushfire areas.

The most logical solution that would tick all the boxes including spreading the risk, encouraging market participation and create more level pricing,  would be to take away the insurance markets current ability to pick and choose where they write business and how they price risks based on catastrophe perils such as flood, cyclone, storm, hail, and bushfires. 

By way of a simple example.

Actuarial studies determine that Australia,  as a country is  potentially going to incur $100,000 in claims for Flood, Cyclone, storm, hail and bushfires . There are 1,000,000 policy holders in Australia, therefore we need to collect $100 from every policy holder to cover this cost. It doesn't matter where the policy holder is located or whether or not the insurance company writes business in the area, every policy is charged this amount and the proceeds are put into a claims pool.

Any surplus money or dividends after claims have been paid out can then be
re-distributed back to the insurance industry. This fund could be government controlled, insurance industry controlled or operate similar to a reinsurance company owned by a combination of government and insurance industry. The important thing is that the risk is spread evenly through out the country.

If something like this is adopted there is no reason for  an Insurance Company to choose not to participate in certain areas or be concerned about their exposure in relation to catastrophe losses.

Insurance policy pricing is made up of many components other that Catastrophe losses such as fire, impact, malicious damage, burglary, glass, money, liability etc.
There would still be healthy competition in these areas,  particularly  with increased market participation. Also there would be increased enthusiasm in areas such as customer service, claims service, policy holder education and product innovation as companies compete for market share.

                                    Recommendations of  the NDIR

The recommendations of the Natural Disaster Review into the affordability of 
Strata Insurance published in Volume 2 of "In the Wake of Disasters have been largely disregarded by successive governments. 

We wish to focus particularly on Recommendations 4 and 5,  which called for direct action on the part of the Government. Although these recommendations applied to Residential Strata Insurance,  we believe the same principles should be applied to all Residential Property Insurance classes. At the time of the recommendations the main problem area was Strata Insurance but the crisis has since spread to all Residential Property Insurances transacted for North Australian locations. 

Recommendation 4 

The committee recommends that the Australian Government investigate the feasibility of requiring  insurance companies which provide types of mandated insurance  (such as residential strata title) to offer this type of cover to all regions of Australia as part of their licence to operate in Australia.

The committee further recommends that this investigation take into account the methodology for risk assessment and pricing for mandatory Strata Title Insurance and how this pricing is applied equitably throughout regions of Australia.

Recommendation 5 

The Committee recommends that the Australian Government investigate and report on the expansion of the Australian Reinsurance Pool Corporation created to provide terrorist risk Reinsurance for application to residential strata title schemes.

We realise that a conservative government is unlikely to regulate although the most significant piece of regulation affecting the industry  in recent times The Financial Services Reform Act was introduced by the Howard Government. Certainly expanding The Terrorism Reinsurance Pool to include Catastrophe events should at least be considered.

Government Taxes

Stamp Duty and GST is levied on the premium. Consequently North Queenslanders pay higher taxes for the privilege of paying higher insurance premiums. Often the people in the lowest socio-economic group are the ones that own the old fibro or wooden houses. So a wealthier couple in Brisbane who own a new block home may be paying a third of the taxes (GST and Stamp Duty) than a  pensioner who owns an older fibro house in North Queensland.  How can this be fair? The levying of taxes on already inflated premiums must be reviewed as a matter of urgency.

Other ideas which could be implemented include:
•	Insurers to publish results of the performance of their North Queensland portfolio against their overall portfolio.
•	More generous tax  concession  for Residential Investment property owners for North Queensland situations.

                                                  Cormann Release

Of the suggestions put forward in the Cormann release,  by far the most objectionable is the suggestion that lessening restrictions on foreign insurers transacting business in North Queensland is a solution. There is a reason why these restrictions were implemented and are policed so strenuously. Clearly the government  has learnt little from the HIH  collapse and ensuing chaos.