Government’s Intervention Spurs Riskier Insurance Choices: Productivity Commission

Flood water is seen flowing through the Parramatta wharf in Sydney, Australia, on April 5, 2024. Saeed Khan/AFP via Getty Images

The Productivity Commission (PC) has said that the government’s intervention in the insurance market could distort choices and encourage people to make risky decisions.

At a Senate inquiry hearing on Sept. 30, Steward Turner, a research manager at the PC, raised the issue that measures implemented by the government to reduce home insurance premiums, such as the cyclone reinsurance pool, could bring about unintended consequences.

“First, they can distort investment decisions to the detriment of productivity growth and can inadvertently encourage communities to make decisions that can increase the costs of future natural disaster risks,” he said.

Turner’s remarks were previously echoed by Actuaries Institute CEO Elayne Grace, who gave the example of the beach flood insurance policy introduced by the U.S. government, which encouraged property development in risky areas and caused significant problems.

Turner also noted that the cyclone reinsurance pool could have significant fiscal impacts.

“Arrangements like the cyclone reinsurance pool exposed the Australian government to significant contingent liabilities, which in the future, can have real and significant costs to government budgets.”

Amid the negative impacts of the cyclone reinsurance pool, Turner said it should be abolished.

“The PC recommended that over the medium term, the Australian government should set a time frame for phasing out the cyclone reinsurance,” he said.

What Is the Cyclone Reinsurance Pool?

The cyclone reinsurance pool was legislated in March 2022 and took effect in July of the same year.

It allows insurance companies to transfer their risk for cyclones and cyclone-related flood damage and is backed by a $10 billion (US$6.92 billion) government guarantee.

The government charges a reinsurance premium on insurance companies to fund the pool using a special pricing formula.

The cyclone reinsurance pool covers a wide range of insurance policies, including those for residential homes and residential strata, as well as commercial property policies with an insured value of $5 million or less.

According to government data, as of July 2023, 65 percent of all Australian home insurance policies were covered by the cyclone pool, which included three major insurers: Allianz, QBE, and Suncorp.

In a recent report, the Australian Competition and Consumer Commission pointed out that while the pool had resulted in some savings for insurance policies in higher cyclone-risk regions, the cost reduction was insignificant for consumers due to various market factors.

Remove Insurance Taxes, Levies: PC

Turner said there were several things state governments could do to reduce insurance premiums for Australian households.

The first and foremost solution is to remove stamp duties, charges, and levies on insurance premiums.

“These taxes and charges increase the price of insurance, reduce the level of insurance that people take out and are an inefficient source of revenue,” he said.

PC Commissioner Barry Sterland also stated that stamp duties distorted the decisions of Australian households, causing them to opt for poor choices.

“We’ve been talking about people underinsure, and they will move house less commonly than they should,” he said.

“People won’t make the right decisions because of the tax, and I think that’s a reasonable, layman’s way.”

As such, PC representatives said insurance taxes should be abolished and replaced with a more efficient one.

At the same time, the PC proposed that state and federal governments invest more significantly in risk mitigation.

“Increasing investment in mitigation could, over time, significantly reduce the natural disaster risks faced by households and businesses and ultimately reduce their insurance premiums,” Turner said.

“In addition, they could reduce the government’s exposure to the cost of natural disaster relief and recovery.

“Governments can also use tools such as building codes and land use planning regulations to ensure that buildings are resilient to natural disaster risks and are built in lower-risk locations.”