The RBNZ says dwelling insurance ‘is becoming more risk-based’ and owners of higher-risk properties may find insurance increasingly unaffordable

The Reserve Bank (RBNZ) says premiums for residential dwelling insurance have “significantly outstripped” the general rate of inflation over the last decade.

In the central bank’s view, this may lead to people being unable to afford home insurance in the future.

The RBNZ released an excerpt on insurance availability and risk-based pricing on Monday from its much-anticipated Financial Stability Report (FSR) which is being fully released later this week.

The FSR is published twice a year and provides the central bank’s analysis of the strength and effectiveness of New Zealand’s financial system.

The RBNZ’s release of its insurance excerpt from the FSR pointed to factors like rising construction cost inflation and higher reinsurance costs as reinsurers adjust their views of NZ risks being behind the sprint in premiums.

The central bank expects insurance for high-risk properties to gradually become less available and says some owners may find insurance “increasingly unaffordable”.

“Insurers may begin to make coverage of some risks optional as risk-based pricing becomes more commonplace. Rising premiums may also lead to customers choosing to underinsure (with higher excesses and/or lower sums insured), leaving owners of high-risk properties vulnerable in a total loss event,” the bank said.

'Owners of higher-risk properties may find insurance increasingly unaffordable'

Reserve Bank Director of Financial Stability Assessment and Strategy Kerry Watt said most of the net worth of New Zealand households comes from their homes and land. Nearly 96% of residential land and dwellings have insurance which Watt said was “high” by international standards.

He said the central bank had seen the insurance industry move towards “greater use” of risk-based pricing for residential dwelling insurance. 

This means that the value of insurance premiums is more tailored to the specific risks a property is facing, ranging from an earthquake or a flood.

“The use of risk-based pricing has become evident in certain areas, and for specific risks, such as for seismic risk in Wellington,” Watt said.

He said the RBNZ expects owners of higher-risk properties may find insurance increasingly unaffordable and for some properties may see a withdrawal of insurance availability

In the report excerpt, the central bank said NZ’s residential insurance market was currently characterised by the widespread offering of comprehensive “all perils” policies by insurers. 

In New Zealand, house insurance typically covers major risks like fires, storms, floods, earthquakes, and volcanic activity. This coverage offered by NZ insurers differs from insurance policies in other countries, the RBNZ said.

For example In Australia, flood coverage in residential policies increased significantly from around 3% of policies in 2006 to around 93% by 2020 following government and industry efforts post the 2010-2011 Queensland floods.

Similarly, in California, only about 13% of households choose earthquake cover after insurers withdrew it in the 1990s, which the RBNZ says was likely driven by concerns about potential large-scale claims after the Northridge earthquake in Los Angeles in 1994.

The FSR report excerpt described insurers adoption of greater risk-based pricing as a “rational response” to a changing operating environment both in terms of seismic and flood risks.

In the last 10 years, advancements in data, modeling, and systems have sped up the adoption of pricing based on seismic risk, the RBNZ said.

When it comes to flood risk, the RBNZ found NZ insurers had adopted a partly community-focused strategy for handling flood risks in residential areas in the past.

Now, the central bank said insurers are using “varied approaches” to set prices based on flood risks and are using a larger combination of data sources to gain better understanding around it.

As insurance pricing becomes more risk-based, the RBNZ noted that while it's harder for high-risk properties to afford insurance coverage, “the evidence to date suggests that insurance continues to be generally available”. 

“Over time, risk-based pricing can provide a strong signal to encourage the proactive mitigation and lowering of exposure to risks, which can be beneficial for society’s overall risk management.”

Banks need to pay attention

The FSR excerpt concludes insurance retreat presents a long-term challenge for the financial system. 

It said affected shareholders  – insurance companies, governments, home buyers, and lenders – needed to take action to understand natural hazards better in order to address future affordability which included risks to policyholders.

Banks needed to be conscious about the “ongoing insurability” of the properties they lend against, the report added.

“Banks also need to pay closer attention to insurance coverage, as there is a risk that owners underinsure high-risk properties over time in the face of rising premiums.”