Many of you will have read the recent headlines "Homes to start losing insurance within 15-years", following the release of an insightful new report from Belinda Storey for the Deep South Challenge. The report did an excellent job of getting this important issue back into the public spotlight; however on reading it alongside other recent articles, I wonder if the media may have understated the issue and created a false sense of security.
Why? Well firstly, the author says as much - noting that the 10,000 houses stated as at risk of insurance withdrawal is a very conservative estimate (considering only coastal flooding, properties in 4 cities and within 1km of the coast, etc), therefore "we expect the true number of homes facing coastal insurance retreat to be higher, and the number on our inland floodplains to be far higher. Our results should be taken as a lower bound.”
Secondly, the timing and extent to which insurers act will be largely driven by their risk tolerance, reflected in the Annual Exceedance Probability threshold (AEP - the probability of a flood event occurring in any given year) at which they withdraw cover from a property. The report assumes an AEP threshold of 2% for partial insurance withdrawal, through to 5% for full withdrawal - presumably based on insurer input early in the research project. However things changed in 2020 - commentary this month from the insurance sector suggests climate change and Covid-driven pressures on global reinsurers have had "a much more significant impact on our highest-risk areas than most realise....They’re really looking at what they need to do to maintain their credit ratings....The instant reaction is reduction in capacity to high-risk areas, and that area in New Zealand is the cost of catastrophe cover.”
If that's not enough, NZ banks and insurers are about to be required to report on their climate-related risks, which in itself will drive companies to take timely action where their risk is high. On that basis Westpac's first Climate Risk Report released last month makes for grim reading, stating that 2.3% of its residential mortgage portfolio is potentially subject to ‘heightened risk’ from coastal hazards (which Westpac defines as an AEP of 10% or more) with 2/3 or 1.5% of properties in their portfolio at this heightened risk already. It's unclear why this is so different to the Deep South findings, however IF Westpac's mortgage portfolio is fairly representative of NZ housing stock, this suggests ~30,000 NZ homes are already exposed to an AEP of 10% or more. Which begs the question, just how many households are already exposed to the 2% AEP threshold for partial insurance withdrawal? And how many more will meet the threshold once modelling includes the more extensive fluvial and pluvial flood risks?
Westpac concludes that "In the next five years, property owners may face insurance premium increases, higher excesses, or exclusions of some hazards. In some cases, property owners may be unable to renew insurance." This is consistent with a pre-Covid prediction by the Principles for Responsible Investment (PRI) global network of a market 'response by 2025 that will be forceful, abrupt and disorderly'; however given that Covid has since exacerbated reinsurer challenges, we might expect the response well before 2025.
So it's no surprise that in late September global reinsurer MunichRe announced a new partnership which "combines MunichRe's climate hazard modelling capability with CoreLogic's AoNZ property data and connection to banking, valuation, insurance and real-estate systems", with the aim of providing NZ insurers and banks with property level information on climate risk. That's huge! In the near future I would expect your bank and insurer to have data on your home's increasing exposure to flooding over the coming years and associated ‘encounter probability’ (that a flood occurs during the remaining life of your mortgage); together with your vulnerability to such flooding (taking into account current property value, the floor height and construction of your house, and the associated likely cost of a flood event). While there's no mention of when the results will be available, one might expect initial results (possibly limited to coastal hazards) within a year or so. From that point on we can expect insurers to use the results to inform their annual renewal decisions, while banks use it to create a revised view of loan to value ratio in their mortgage decisions (ie. reducing the value to reflect the encounter probability and estimated damage).
In summary - it seems plausible that within a couple of years we could see thousands of households facing insurance premium hikes, higher excesses, policy exclusions or withdrawals. Meanwhile prospective house buyers can expect to be declined mortgages for properties, effectively creating stranded assets...and with it stranded households. So the Govt's declaration of a climate emergency last week was not before time, and while the focus of the announcement was on emissions reduction, it's clear that equally urgent action is needed on adaptation. Without this we risk a repeat of the situation unfolding in California, where insurers have responded firmly to the climate change-driven increase in wildfire risk, leaving households exposed and the state trying to limit the fallout.
Perhaps the best hope is that reinsurers and banks see the value in using AoNZ as a tiny test bed to find solutions to this huge global adaptation challenge - solutions which manage finance sector risks, protect AoNZ households from the devastating impacts of insurance withdrawal and mortgage default, and in doing so avoid insurers and banks becoming as stigmatised as fossil fuel companies.
The development of our first National Climate Adaptation Plan provides an ideal and timely mechanism for the Govt and finance sector to collaborate on this, with the findings then implemented through RMA reform - including the proposed Managed Retreat and Climate Change Adaptation Act. Whether this constructive collaboration happens or not may well come down to financial institutions' legal ability and willingness to consider social responsibility in conjunction with financial performance in their decision making. To walk the ESG talk.
(Photo credit: Ministry for the Environment)
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