Why 'insurance retreat' will drive our housing market away from flood risk

Here’s a prediction. ‘Insurance retreat’ will drive our housing market away from flood risk, more than any government led ‘managed retreat’.

In August last year the country’s biggest insurer IAG (owner of big brands State, AMI and NZI) made their views on flood risk abundantly clear. CEO Amanda Whiting said “those homes and businesses that are the most exposed to flooding will find it difficult to obtain or afford insurance”.

More recently in the wake of Cyclone Gabrielle, Jimmy Higgins, CEO of Suncorp (owner of Vero, Asteron and AA), made the ominous statement that “recent events will cause risk models to be updated, and comparisons will be made between existing flood hazard models and actual flooding observed”.

What was he saying? Insurers are commercially nimble, quick to react and will reassess risk and charge higher premiums, faster than the next lightning strike. In 2021 insurers paid out just over 70% of net premiums, on claims against domestic homes and contents. In the four years prior to that, the loss ratio varied between 48 and 59%. No doubt 2022 and 2023 will be uglier, although there’s still a healthy margin in that mix.

Letterbox pricing fear

Even if our premiums are not currently priced letterbox-by-letterbox, insurers have the ability to. Tower insurance already do this. Even worse, they have the ability to cherry-pick and refuse to quote on our address.

It’s called ‘insurance retreat’.

Whether we live on a cliff top, cliff bottom, coastally, by a river, near slope-risk or inland with high rainfall, the language from insurers is getting stronger.

If we can’t insure ourselves cost effectively, our buying, building and borrowing behaviour will change rapidly. But insurers face a moral hazard. People’s lives will fall apart if properties become unsaleable.

Large insurers will find themselves duty-bound to work more gently alongside government policy to avoid, protect, accommodate and retreat from high-risk areas. In short, that means stop building (avoid), place barriers in some areas (protect), raise floor levels (accommodate) and enter into buy-out arrangements with home owners (retreat).

NZ’s first National Adaptation Plan

Have you heard of this 196-page document? The National Adaptation Plan sets out how we will cope with climate change. It was produced in August 2022 by the Ministry for the Environment. In 2025 there’s going to be the launch of a public climate hazard education strategy. That gives you an idea of the pace of this thing.

The report explains “some assets could become uninsurable”. Followed by the blindingly obvious “There will be issues if those assets are used as collateral for lending”.

It tells us the value of buildings exposed to coastal flooding could increase from $12.4 billion now, to $44 billion if the sea level goes up 1.2 metres.

This sounds like gentle pitter patter, but to financial ears the big red alarm bell is ringing. There’s the financial stability of the whole system to manage. Sudden moves are dangerous and maybe this 196-page report is doing its job, slowing down reactions and education.

Around 200 of our largest financial institutions are being made to disclose their climate change risks and opportunities. Again, another alarm bell. It’s the ‘risk’ which is in firm focus.

Climate Change Minister James Shaw points out “Risk and cost will fall across different parts of society, including asset or property owners, their insurance companies, the banks, local government and central government. The Government can choose the role it plays and how it influences the way these costs and risks fall.”

Part of that statement doesn’t quite ring true on a commercial level. Insurers will never wear the costs of repeat flood events. They will retreat. Banks will not over-expose their lending books and will also retreat, leaving home purchases to mortgage-free buyers, who currently don’t have access to the risk-models used commercially.

Central government and local government may help with buy-backs or land swaps (managed retreat), but as experience shows, they only deal with the very worst situations like an ambulance at the bottom of a cliff. And cost-wise that’s the only real option open.

Our personal risk will increase

It’s my prediction the biggest trend in this slow-moving drama will be a shift of risk onto private individuals. Insurers and banks are not charities. They have responsibilities to their shareholders to extract themselves.

Our 196-page Adaptation Plan promises a list of options to keep home flood insurance available and affordable. It doesn’t take a genius to see the structuring options of higher excesses, capped insured values, or forced risk-spreading in the industry.

The UK government scheme “Flood Re”, is a demonstration of one bridging tactic. Unlike our own EQC, all risk is removed from the insurer. They sell the policy, collect the premium and deal with claims but get fully refunded for flood events. A levy is taken on all policies to fund affordable cover for high-risk homes placed in the scheme. Flood Re “aim” to withdraw from the market in 2039 and revert to people paying for address-based risk or not insuring.

An eagle-eyed cynic would note this is enough time for banks to wind down lending in these areas and ensure the risk transfer to private individuals is complete. Still, it’s a stalling solution many are grateful for. New properties and businesses don’t qualify, which prevents new-builds in high-risk areas.

Don’t be left holding the baby

The message for homeowners and business owners is obvious. You don’t want to be left holding the baby as climate change gets commercial.

The solution is obvious from a personal finance perspective. Cut-and-run might save your own bacon, but it doesn’t help the government deliver social justice for the new owner.

We have a responsibility to new owners

The insurance industry needs to move swiftly to share its risk models and ratings with homeowners using a common simple language across the industry.

While this is generally proprietary information, we need to balance it against a buyer’s legal right to full disclosure. Climate change significantly alters the longevity of an insurance model where one homeowner cross subsidises another. Given insurers are not locked into pricing practices for the term of our mortgage or ownership, we should have the right to know how many companies rate an address as high risk.