De-risking climate challenges

There is a role for the insurance industry to assist governments with planning for natural disasters, argues Mark Senkevics, Managing Director, Swiss Re Australia & New Zealand.

Just over a year ago, Tropical Cyclone Debbie made landfall at Airlie Beach in Queensland as a Category 4 cyclone. The damage has been devastating, with some families and businesses still recovering. According to the Insurance Council of Australia, Cyclone Debbie is the second most expensive cyclone in Australia’s history and the most expensive cyclone to ever impact Queensland. Swiss Re’s sigma research ranked Cyclone Debbie 12th globally in terms of the most costly insurance loss, equivalent to AUD 1.69 billion.

Globally, 2017 was a horror year for natural disasters. Hurricanes, floods and wildfires in the Americas, earthquakes in Mexico and the Middle East, and floods in Asia and Africa sadly demonstrated with heart-wrenching repetition the devastating economic and community impacts of these events.

In Australia, we are particularly exposed to extreme cyclones and floods. It is inevitable that we will again face a national recovery and reconstruction bill in the billions of dollars. And science is telling us that natural disasters are increasing in intensity and likely, in frequency.

In addition to the direct cost for households and businesses, we know that natural disasters can create a significant and long-term financial burden for governments. As noted in the recent report of the Australian Business Roundtable for Disaster Resilience and Safer Communities, natural disasters are a growing unfunded liability for government. Total natural disaster costs are projected to reach $39 billion per year by 2050. And, if governments are not financially prepared, taxpayers wear the unfunded cost.

The 2010-11 disasters in Queensland provide a salient lesson for policy-makers. The recovery from these events cost the federal Government $5.6 billion. Nearly a third of that – $1.8 billion – was borne directly by taxpayers via the Queensland flood levy. A further $2.8 billion came from federal Government spending cuts, and the remaining $1 billion through delaying major infrastructure projects around Australia.

Post-event funding of disasters by governments can cause further economic harm. A natural disaster tax or levy suppresses economic activity and hits consumer confidence. If a government borrows money to deal with the recovery effort, the cost of borrowing can divert funds from critical public services such as health and education.

The cost to governments of natural disasters can affect sovereign creditworthiness. The economic impacts can last for years. Indeed, rating agency Moody’s has recently indicated it will take climate change risks into account for credit ratings of cities and states – and credit downgrades could occur.

Our federal and state governments manage disaster funding with the National Disaster Relief and Recovery Arrangements (NDRRA). However, as outlined in the 2015 Productivity Commission Report on National Disaster Funding Arrangements, the NDRRA are limited in scope. They are not efficient, and they only act as a safety net to help communities recover. Assistance is usually for partial reimbursement of state expenditure for relief and recovery costs, and payments can take months to finalise. Disagreements between federal and state governments over the amount of money to be paid can play out in the public domain – as happened in the wake of Cyclone Debbie.

The Productivity Commission found that governments are overinvesting in post-disaster recovery and underinvesting in mitigation and insurance. In recognition of the need for financial preparedness, the NDRRA guidelines do require states to have adequate capital in place and to proactively explore a range of insurance options in the marketplace.

While our states have insurance arrangements in place for state-owned assets, these arrangements do not consistently cover essential public infrastructure like roads and bridges, and they do not protect against the broader economic impacts of a major disaster.

In the same way that families and businesses are encouraged to insure against a financial shock, governments can protect their financial resilience and transfer their economic risk.

Governments and public sector entities around the world are increasingly transferring catastrophe risk to the global insurance and capital markets to strengthen economic resilience to natural disasters. From the Caribbean Catastrophe Risk Insurance Facility to the recently issued Pacific Alliance catastrophe bonds, global insurers are playing an increasing role in public sector disaster risk financing.

Risk transfer and insurance solutions can assist governments in Australia with innovative arrangements that can facilitate rapid payments, with simplified administration and claims requirements after a natural disaster.

Parametric solutions can provide efficient risk transfer for governments and public sector entities. These solutions pay out pre-arranged sums when pre-defined conditions are met – for example, a specified amount of heavy rain within a 24 hour period in a certain area – and can provide rapid financing in the aftermath of a disaster. A state government or local council could utilise the payment to quickly rebuild damaged public infrastructure to a more resilient standard, and to complement emergency relief funds and community support.

The insurance sector employs sophisticated climate and geological models to determine vulnerabilities to natural disasters depending on location and underlying exposures. In this way, risk pricing carries important market signals to inform policy-makers of their overall preparedness, and supports targeted investment in climate adaptation and risk reduction measures.

The insurance industry can and does leverage its capital strength and expertise to de-risk public sector balance sheets and remove some of the financial burden of natural disasters that would ultimately rest with taxpayers. In this way, Australian governments can significantly improve financial preparedness for the inevitable next disaster.