120 KS Klein
considered emergent. For example, on 8 February 2021, the ICA announced
that following ‘A range of inquiries and reviews over the past decade focused
on issues of insurance affordability and availability in high risk areas or
sectors and have identified potential coverage gaps for some groups of consumers and businesses,’ the ICA ‘is undertaking a review of the insurance
sector’s options for reforms to improve its contribution to national economic recovery and growth, amid concern from insurers, stakeholders and
the community’ (ICA 2021). Similarly, on 19 October 2020 the California
Insurance Commissioner convened ‘an investigatory hearing to initiate a
series of regulatory actions that will protect residents from the increasing
risk of wildfires. …to stabilize the insurance market while protecting lives
and homes, reducing catastrophic wildfire losses, and increasing transparency for consumers’ addressing ‘issues including…[i]nsurance availability
and affordability’ (CDI 2020).
The shape of the problem is not hard to understand. Insurers are profitseeking businesses. Insurers will only write on homes and in communities
that are profitably insurable. Insurability requires risks must be random,
well-enough understood to make pricing and underwriting possible, diversifiable, and exist in markets with low levels of moral hazard and adverse
selection (Kousky & Light 2019, p. 355). The market behaviour of insurers is
consistent with fire cover of dwellings increasingly not meeting this standard.
Put another way, as the frequency, intensity, and economic impacts of
fire grow, the affordability and availability of fire insurance shrinks. This is
inevitable in a market where insurance is unregulated or lightly regulated.
As described earlier, insurers have access to sophisticated data analytics
tools that allow them to know with increasing confidence both the likelihood of a wildfire or bushfire coming to an individual home address, and
the likely economic impact on that structure if it does so. An insurer will be
uncompetitive if it does not use this data to isolate high-risk addresses and
then either decline to offer cover to those addresses or separately cover those
addresses priced in high-risk pools. Because a competitor undoubtedly will,
and thereby price cut an insurer that doesn’t.
The consequence of this insurer behaviour is pressure on governments to
step in with public insurance products as insurance of last resort, or publicly
subsidise private insurance products, or step in post-disaster to recompense
the losses of the uninsured. A government that creates public insurance
products faces the challenge that it may be politically unpalatable to price
this insurance as a high-risk pool but may be fiscally reckless not to do so.
A government that subsidises private insurance is creating an externality to
market forces that both may drive up price and may be politically exposed
for the implicit social equity choices embedded in any subsidy program. A
government that repetitively steps in post-disaster may create moral hazard
behaviours amongst homeowners that reduce take-up rates of insurance –
homeowners are less likely to insure large but unlikely losses if they expect
that if the loss occurs, then the government will bail them out.
considered emergent. For example, on 8 February 2021, the ICA announced
that following ‘A range of inquiries and reviews over the past decade focused
on issues of insurance affordability and availability in high risk areas or
sectors and have identified potential coverage gaps for some groups of consumers and businesses,’ the ICA ‘is undertaking a review of the insurance
sector’s options for reforms to improve its contribution to national economic recovery and growth, amid concern from insurers, stakeholders and
the community’ (ICA 2021). Similarly, on 19 October 2020 the California
Insurance Commissioner convened ‘an investigatory hearing to initiate a
series of regulatory actions that will protect residents from the increasing
risk of wildfires. …to stabilize the insurance market while protecting lives
and homes, reducing catastrophic wildfire losses, and increasing transparency for consumers’ addressing ‘issues including…[i]nsurance availability
and affordability’ (CDI 2020).
The shape of the problem is not hard to understand. Insurers are profitseeking businesses. Insurers will only write on homes and in communities
that are profitably insurable. Insurability requires risks must be random,
well-enough understood to make pricing and underwriting possible, diversifiable, and exist in markets with low levels of moral hazard and adverse
selection (Kousky & Light 2019, p. 355). The market behaviour of insurers is
consistent with fire cover of dwellings increasingly not meeting this standard.
Put another way, as the frequency, intensity, and economic impacts of
fire grow, the affordability and availability of fire insurance shrinks. This is
inevitable in a market where insurance is unregulated or lightly regulated.
As described earlier, insurers have access to sophisticated data analytics
tools that allow them to know with increasing confidence both the likelihood of a wildfire or bushfire coming to an individual home address, and
the likely economic impact on that structure if it does so. An insurer will be
uncompetitive if it does not use this data to isolate high-risk addresses and
then either decline to offer cover to those addresses or separately cover those
addresses priced in high-risk pools. Because a competitor undoubtedly will,
and thereby price cut an insurer that doesn’t.
The consequence of this insurer behaviour is pressure on governments to
step in with public insurance products as insurance of last resort, or publicly
subsidise private insurance products, or step in post-disaster to recompense
the losses of the uninsured. A government that creates public insurance
products faces the challenge that it may be politically unpalatable to price
this insurance as a high-risk pool but may be fiscally reckless not to do so.
A government that subsidises private insurance is creating an externality to
market forces that both may drive up price and may be politically exposed
for the implicit social equity choices embedded in any subsidy program. A
government that repetitively steps in post-disaster may create moral hazard
behaviours amongst homeowners that reduce take-up rates of insurance –
homeowners are less likely to insure large but unlikely losses if they expect
that if the loss occurs, then the government will bail them out.