Introduction Insurance Australia Group

Transcription

1 20 February 2008 Garnaut Review Secretariat Garnaut Climate Change Review Level 2, 1 Treasury Place East Melbourne Victoria contactus@garnautreview.org.au Introduction Insurance Australia Group (IAG) welcomes the opportunity to make a submission in relation to the Garnaut Climate Change Review Issues Paper 2, Financial Services for Managing Risk: Climate Change and Carbon Trading. IAG supports a consultative approach that engages with industry at all stages of the review process. IAG commends the Review for its consultative approach to date. This response is set out in three parts. Part One addresses the questions for consideration raised in the Insurance Issues section of Issues Paper 2. Part Two address Building Effective Carbon Trading Markets. Part Three focuses on Coastal Vulnerability, further exploring a potential insurance solution for coastal landowners facing the likelihood of inundation of their properties as sea levels rise. Insurance Australia Group IAG is the leading general insurance group in Australia and New Zealand, and has a growing presence in Asia and the UK. The Group generates annual gross written premium of more than $7.5 billion. The Group insures more than $1,000 billion worth of property. In Australia, it insures more than five million cars, two million homes, 250,000 businesses and 75,000 farms, and provides workers compensation services to more than 200,000 employers. In New Zealand, it insures around 950,000 cars, 575,000 homes, 185,000 businesses and 235,000 rural risks. IAG distributes its products through some of the leading brands in Australia and New Zealand: CGU nationally; NRMA Insurance in New South Wales, Queensland, ACT and Tasmania; SGIC in South Australia; SGIO in Western Australia; RACV in Victoria; and State and NZI in New Zealand. We also have interests in China, Malaysia, Singapore, Thailand and UK represented by China Automobile Association Insurance Australia Group Limited ABN George Street Sydney NSW 2000 Australia T +61 (0)

2 -2- (CAA), AmAssurance, Alba, NZI Thailand, Safety Insurance, Equity Insurance Group and Hastings Group. IAG has a crucial interest in the long-term viability of insurance as a product valued by the Australian community. IAG believes that there are four principal ways in which the insurance industry can best meet these objectives. These are: Providing affordable products that price the risks underwritten realistically. Promoting risk awareness and risk reduction both for policyholders and in the community generally. Investing in robust risk control frameworks and management mechanisms that reduce operating expenses, make claims costs more predicable claims costs and facilitate sustainable profitability for shareholders. Committing to, and supporting, on a continuing basis, a comprehensive and clearly defined regulatory framework that ensures that customers understand what they are buying when they purchase a policy and protects policyholders against financial failure of an insurer. Summary of Submission Climate change and its attendant uncertainties present significant challenges to the insurance industry. Provided the extent of climate change remains limited, with global average temperatures increasing by less than 2 degrees Celsius above pre-industrial levels, using current modelling and assumptions, we believe the Australian insurance industry is generally well positioned to deal with these challenges. Private insurance serves a crucial role in underpinning the community s economic resilience to severe weather risks and climate change. However, market distortions caused by the current inefficient systems of taxes and charges on private insurance are inhibiting the uptake of private insurance. The arguments for swift reform are compelling. Key insurance gaps facing the community within the context of climate change are flood and storm surge risk. The industry is working with government to address the challenges of flood risk that impacts building and contents insurance, but significant solutions are yet to be implemented. In pointing out that the value of coastal land vulnerable is not insured, IAG notes that coastal landowners and lenders in the banking and finance sector may face significant loss as rising sea levels threaten permanent erosion and/or inundation of land. IAG proposes for further discussion a coastal land value insurance

3 -3- concept as one of the range of strategies available to assist coastal communities to manage this risk. Insurers both overseas and in Australia continue to introduce numerous innovative products to help the community respond to climate change and changing weather risk. GPS-enabled Pay As You Drive (PAYD) vehicle insurance is an innovative insurance product with potential for significant social, economic and environmental benefits. Overseas experience to date suggests that, outside of successful niche markets, a high level of take-up has not yet been demonstrated. The business case for insurers to introduce PAYD to the Australian market would be enhanced if governments also extended the PAYD user pays concept to charges including vehicle registrations, compulsory third party insurance and road tolls. In contrast to PAYD, the Fringe Benefits Tax regime, as it currently applies to vehicles, provides a financial incentive for cars to be driven further than is necessary, with consequent elevation of greenhouse gas (GHG) emissions as well as other social and environmental costs. IAG recommends that this situation be addressed. Government has a crucial role in encouraging and regulating risk-appropriate development of the built environment through review of building standards, sound land use planning codes, and providing an appropriate emergency services and natural hazards mitigation framework and funding. Until now, building code standards have focussed in principle on protecting life and safety. It is desirable to enhance building standards so that they also cost effectively protect the property itself, and its owner s financial interest, without sacrificing safety performance. Land that is (or becomes) at unacceptable risk from hazards such as flood or coastal inundation including storm surge should not be zoned for residential or commercial use. Without sound and consistent government land use controls, there is little to prevent ongoing building in flood plains or in coastal locations of extreme vulnerability. Provided the extent of climate change remains limited, the insurance industry is generally well positioned to continue to provide an adequate range of insurance products in the absence of government intervention. Long-term forestry-based carbon sequestration projects present both opportunities and challenges for insurers. If, in the future, nuclear energy and/or geo-sequestration of carbon dioxide were to be taken up in Australia, insurers would be unlikely to cover a significant portion of the risk associated with these technologies. Government has an important role in supporting the insurance of risks that the private sector is not capable of underwriting alone. IAG does not otherwise consider that government has an appropriate role in providing insurance against weather risks already covered by the industry. The government insurance

4 -4- arrangements in the State of Florida provide a useful case study demonstrating the problems that can arise. Through its support for initiatives such as the Australian Climate Group and the Australian Business Roundtable on Climate Change, and through its submissions to Australian and international government reviews, IAG has for several years been a leader in the business community in calling for early introduction of an emissions trading scheme (ETS) and a target to reduce Australia s GHG emissions by 60% by IAG supports a binding 2020 target for Australia s emission reductions similar to the commitment of the European Union to reduce emissions by 20% of the 1990 levels by 2020, and potentially by 30% as part of a global agreement if other developed counties also commit to similar reductions by McKinsey & Company s report An Australian Cost Curve for Greenhouse Gas Reduction issued in February 2008 indicates that it is very feasible and affordable for Australia to adopt a target for emissions in 2020 similar to the European Union position. McKinsey s modelling indicates Australia has sufficient negative-cost abatement opportunities available to reduce carbon dioxide emissions to 20% below 1990 levels by 2020 at no net cost to the economy. McKinsey also estimate that emissions could be reduced to 30% below 1990 levels by 2020 if all abatement opportunities costing A$65 or less per tonne of carbon dioxide equivalent were to be utilised, equivalent to an average annual cost of only $290 per household. A forthcoming report from the Australian Climate Group, convened by WWF Australia and IAG recognises that early, substantial global reductions in emissions will avoid larger long-term economic costs and reduce the risk of triggering significant impacts from climate change. The report calls for Australia to o o o Stabilise national emissions by 2010 through both domestic measures and the purchase of international emissions reduction permits; Establish an emissions target for 2020 consistent with that of other developed countries such as the European Union; Ensure that the emission trading scheme is designed such that the Australian Government is not burdened by failure of participants to comply with it; and o Ensure that the national emission trading scheme is flexible enough to respond to new information quickly. IAG considers that the proposed ETS will operate most effectively when there are a greater percentage of permits being auctioned. Accordingly the scheme should move to this state as quickly as possible. IAG strongly recommends that a policy be agreed by all governments involved regarding the application of funds raised through the sale of permits. Priority should be given to developing community resilience to adapt to climate change,

5 -5- funding low income households to offset the expected higher electricity costs, regional development for projects which are expected to reduce GHG emissions, and the promotion of new technologies geared towards the reduction of GHG emissions. IAG considers the proposed ETS should allow banking of permits so as to establish a strong liquid forward market and encourage early GHG emission abatement. If borrowing were to be allowed there should be a requirement for margin calls backed by collateral assets so as to protect the scheme. Conclusion If you wish to discuss these matters or make further inquiries please do not hesitate to contact me on (02) or Nola Watson, Head of Government and International Relations on (02) Yours sincerely Tony Coleman Chief Risk Officer and Group Actuary Insurance Australia Group

6 Insurance Australia Group s comments in relation to Garnaut Climate Change Review Issues Paper 2, Financial Services for Managing Risk: Climate Change and Carbon Trading Part One: Implications of Climate Change for Insurance Does the Insurance Industry have the capacity to provide adequate and affordable insurance products in a future of climate change? Climate change and its attendant uncertainties present significant challenges to the insurance industry. Provided the extent of climate change remains limited, with global average temperatures increasing by less than 2 degrees Celsius above pre-industrial levels, using current modelling and assumptions we believe the Australian insurance industry is generally well positioned to deal with these challenges. Weather-related property risk Weather and climate are core business for the general insurance industry. At its most basic, insurers underwrite weather-related losses (including physical damages to insured property and interruptions to business continuity) by assessing, pricing and spreading the risk and then meeting claims when they arise. A changing, less predictable climate has the potential to reduce insurers capacity to assess, price and spread weather-related risk. It also has the potential to increase the overall cost of risks insured unless appropriate action is taken by the general community to mitigate and adapt to this risk. Insurers often classify severe weather events in terms that reflect the likely frequency of events of similar severity (eg in very simple terms, as a 1 in 100 year event ). Such classifications are based in part on the analysis of past events and long-term weather records. A changing and less predictable climate reduces the adequacy of past weather records as a basis for the models used to estimate the return period for severe weather events. In response to this challenge, IAG has for several years been sponsoring research to understand how current weather risks and claims distribution functions might be expected to change as temperatures rise. 1 1 Examples of published research sponsored by IAG are Leslie, Karoly, Leplastrier and Buckley (2007), Variability of tropical cyclones over the southwest Pacific Ocean using a high resolution climate model. Journal of Meteorology and Atmospheric Physics. Leslie, Leplastrier, and Buckley (2007), Estimating future trends in severe hail storms over the Sydney basin: A climate modelling study, Atmospheric Research 1

7 IAG anticipates a likely increase in both the cost and the variability of weather-related claims as a result of climate change. Severe weather events affecting heavily populated regions are a significant driver of property insurance costs in Australia. As referenced in the Garnaut Review s Issues Paper, IAG-sponsored research indicates that the frequency and/or severity of cyclones over south-east Queensland and hailstorms over the Sydney Basin are expected to increase as a result of climate change. As the frequency and/or severity of claims costs increase, insurers must respond by increasing premiums and/or reducing risk. Further, an increase in the variability of claims costs means insurers will require a higher level of capital and/or reinsurance to ensure they have the capacity to meet costs during unusually bad periods. Each of these factors has implications for the affordability of insurance, particularly for households or businesses for whom affordability is currently marginal. The industry in Australia is likely to be affected not only by changes in the cost of claims in our own country, but also through the impact of climate change on the global markets for reinsurance and other risk transfer mechanisms. Catastrophic losses in international regions with major concentrations of exposure (eg a sequence of major hurricanes striking Atlantic and Gulf Coast cities of the United States) could potentially have a significant short-term impact on the price of global risk transfer services available to Australia. It should be noted that over the past decade, the pool of risk capital available to insurers has been expanded significantly through the development of risk transfer tools such as catastrophe bonds. These facilitate the securitisation of risks into global capital markets, thereby accessing much larger amounts of capital than has traditionally been available to the global insurance and re-insurance industry. This, in turn, increases the industry s capacity to cope with the impact of climate change globally. Climate change also presents operational challenges to insurers and governments. Severe weather events that simultaneously damage tens of thousands (or more) properties generate a sudden surge in demand for repair services and materials. Ensuring that sufficient capacity is available to meet such dramatic spikes in demand presents challenges for insurers and the wider community, particularly when transport, power and communications infrastructure might also be compromised and the workforce disrupted by the same weather event. It is important to appreciate that insurers are not just concerned about weather mega-events such as cyclones and major hailstorms. Insurance industry experience shows that even small increases in event severity (< 10%) can cause multiple increases in damages (UNEP Finance Initiatives, Climate Change & The Financial Services Industry Module 1 Threats and Opportunities, 2002). IAG s analysis of our own experience shows that just a 25% increase in peak wind gust strength (from the knot range up to the knot range) can generate a 650% increase in building claims. This is because once wind gusts reach a critical threshold, entire roof sections are blown off or additional damage is caused by falling trees and flying debris. Yet below this threshold damage may be minimal. 2

8 Other insurances impacted by climate change The insurance sector provides numerous additional forms of insurance including Business Continuity, Professional Indemnity, Environmental Liability and Directors and Officers Liability. The pricing and conditions of some of these types of insurance have the potential to be affected by climate change. Directors and Officers Liability insurance provides cover against financial loss claims made against the directors, executives or other employees of companies. If the financial performance of a company were to be affected by emissions reduction issues or climate impacts, its directors and officers may potentially face legal action for their handling of these issues. In other words, insurers may be facing climatechange-related latent liabilities now for legal action that may emerge some years into the future, based on behaviour or decisions that have already taken place. It should also be noted that climate change also presents new business opportunities for insurers. These are discussed in more detail below in the discussion responding to the Garnaut Review Issues Paper question on innovative products. Life and health insurance This submission focuses on property and business insurance, but IAG notes that climate change presents threats to human mortality and morbidity experience that are of particular relevance to the superannuation, life and health insurance industries. Insurers as institutional investors Insurers invest the premiums they collect (and their shareholder s equity) so that, together with investment earnings and reinsurance arrangements, sufficient funds are available to pay claims as they arise. Insurers are thus major institutional investors in the Australian economy, and are exposed to climate change through its impact on the value of investments. As the world moves to a low carbon economy, insurance companies therefore need to evaluate and manage the climate change risks and carbon risks in their investment portfolios. As major institutional investors, insurers can also influence the environmental initiatives of the companies in which they invest. This action can be taken against a backdrop of increasing investor awareness of the financial impacts of climate change on shareholder value and improved corporate disclosure of the risks. One initiative supported by IAG to this end is the Carbon Disclosure Project (CDP), originally launched in December The CDP s aim is to collate quality information on the carbon impact of 3000 major corporations around the world to support a productive dialogue on responses to climate change. The CDP represents institutional investors with combined assets under management of $57 trillion (2008). 3

9 Are there any market failures associated with the provision of insurance that are specifically related to climate change risk? Market distortions encourage underinsurance Insurance Council research shows that nearly 25% of all Australian households do not have any form of home or contents insurance (The Non-Insured: Who, Why And Trends, May 2007, available at Insured-Who-Why-and-Trends/default.aspx). IAG contends that this imposes an unwelcome burden on government when catastrophes occur and that a major contributor to this situation is the current taxation arrangements which directly increase the cost of insurance. The Insurance Council argues soundly in its recent submission to the New South Wales Independent Pricing and Regulatory Tribunal Review of State Taxation that At a time of increasing concern over climate change and the accompanying need for sound public policy that encourages adaptive behaviours, reforms that support greater take up of private insurance are fundamental to individual, business and community. Similarly, with more erratic weather patterns arising from the effects of a changing climate, the public interest is well served from policy settings that adequately fund emergency services for the challenges of climate change and that simultaneously encourage private adaptation. Tax reform becomes fundamental in this regard Measures that remove distortions and in so doing, encourage general insurance uptake are fundamental. (Insurance Council submission, Page 3. This document is available at The impact of combined Federal and State government taxes and charges on insurance premiums is to increase an insurance premium in metropolitan areas by up to 77.9% for business insurance, and up to 44.0% for home insurance. In rural Victoria the impost is even higher. (IAG submission to the New South Wales Independent Pricing and Regulatory Tribunal (IPART) Review of State Taxation, 20 November This document is available at Research by Access Economics, presented in the Insurance Council s 2008 Federal Government Budget Submission, finds that stamp duties on general insurance are amongst the least economically efficient taxes in Australia. ( %20Submission.pdf.aspx) Further, in New South Wales, Victoria and Tasmania, fire services levies on insurance policies add significantly to the cost of insurance, distorting price signals and discouraging private uptake of insurance. As noted by the New South Wales Treasury, 4

10 The principle underpinning the Fire Services Levy is to ensure beneficiaries of the fire services contribute to funding the service. However, the presence of non-insurance and under-insurance indicates that a significant proportion of beneficiaries are either not contributing to funding the fire services or are under contributing. As a means of matching contributions to fire risk, the levy performs poorly particularly for householders. Fire risk is only one element of insurance policies, and it is evident that there is not [a] strong correlation between fire risk and fire services levy contributions. A weakness of the current arrangements is that the government is not able to ensure the extent of recovery from each type of insurance policy category is appropriate. However, even if this were addressed, the fact remains that insurance policies are much broader in scope than fire so that the premiums will substantially reflect risks other than fire risk. It is also apparent that insurance is relatively highly taxed with the fire services levy the highest impost. High tax levels are likely to discourage insurance and lead to under-insurance with adverse consequences for resource allocation and economic growth. (New South Wales Treasury submission to the New South Wales Public Accounts Committee Inquiry into Fire Services Funding, 2003, quoted in IAG s submission to IPART, Page 8. This document is available at IAG argues that there is a clear social and economic case for eliminating or at least reducing State insurance taxes and charges as a priority for any reform agenda. This case is based on recognition of the essential benefits of insurance to the economy and community generally and of the role of the tax system in encouraging insurance coverage. There is a clear economic case for reducing State Government insurance taxes and charges ahead of many other taxes in order to reduce the taxation burden on businesses and households. Governments should recognise the essential benefits of insurance to the economy and community generally and implement a taxation system which does not penalise insurance relative to other more discretionary purchases. These issues are discussed further in the submissions of IAG and the Insurance Council to the New South Wales Independent Pricing and Regulatory Tribunal (IPART) Review of State Taxation, November 2007, as well as in the Insurance Council s 2008 Federal Government Budget Submission. Community awareness of risk: publicly-available tools The Garnaut Climate Change Review Issues Paper 2 notes that property owners or prospective buyers are often not aware of the physical risks their property faces. This has implications for market effectiveness. The Issues Paper raises this matter in the 5

11 context of flood risk, and the same point could also be made regarding a number of other natural physical hazards. IAG notes that market participants have started to release simple tools to the general public to further raise public and corporate awareness of natural threats to property and life. An example is the partnership between MapData Sciences and Risk Frontiers, who have launched two new street-address based online services to the general public. The providers state that these services provide "threat by peril" risk ratings for individual Australian properties as they pertain to bushfire, earthquake, hailstorm, tropical cyclone, and, where available, riverine flood. They also provide other contextual information such as elevation above mean sea level, aspect and distance from the shoreline. Property owners and/or buyers can access this service for individual properties for a fee of $50. Further information on the MapData Sciences and Risk Frontiers products is available online at What are the key insurance gaps relating to climate change? Flood risk Flood remains a significant community issue that stands to worsen with the various inundation predictions arising from current climate change models. IAG is an active participant in the general insurance industry s considerable work towards developing greater access to residential flood products for Australian communities when the risk of flooding is reduced to an acceptable level through mitigation measures. Through the Insurance Council of Australia, the industry is developing a national flood mapping tool and a minimum standard definition for flooding, to support better understanding of the risks to the community. Cooperation and data sharing with government is essential to ensuring that the risks can be mapped and understood, and significant solutions are yet to be implemented. Coastal land value insurance A second insurance gap relating to climate change is the non-insurance of the value of coastal land at risk of permanent inundation from rising sea levels. This is discussed in Part Three of this submission. Storm surge Many insurance contracts exclude damage to property caused by sea-related events such as storm surges. Accordingly the risk of major storm surge damage is already in effect borne largely by government. 6

12 What kinds of innovative products could the insurance industry provide to deal with increased weather risk associated with climate change? General In its report From Risk to Opportunity: How Insurers Can Proactively and Profitably Manage Climate Change, Ceres documents numerous new insurance products emerging around the world to tackle climate change and rising weather losses. (Available online at Examples of new product opportunities that may well arise from climate change include insuring the value of carbon credits sequestered in forest timber against the risk of loss through fire. IAG product innovations IAG s operating brands continue to tackle climate change and rising weather losses. For example, NRMA Insurance offers a discount to drivers of fuel efficient cars and helps customers offset their car s greenhouse gas (GHG) emissions via an online tool called Climate Help. IAG believes it is important to improve community understanding of the risks caused by climate change so individuals can actively manage and reduce these risks. IAG s Greensafe car profiler website rates cars by environmental and safety performance while the Home Help website offers design and building, emergency disaster safety, and energy and water saving suggestions. IAG continues to improve existing products in response to climate change and changing weather risk. An example is IAG s ongoing research into the weatherresilience of different building materials and constructions methods. This has led to some differential premiums being charged depending upon the type of roof on an insured property for example, properties with a slate roof are more easily damaged by hail and more expensive to replace than other roofing materials so an additional premium is charged if a property has a slate roof. Coastal land value insurance IAG continues to explore the concept of coastal land value insurance, addressed in detail in Part Three of this submission. Pay As You Drive insurance The emergence of low cost Global Positioning System (GPS) receivers has spurred the development of an increasing number of satellite-based positioning applications for the motor industry. GPS technology enables motor insurers to provide an insurance product called Pay As You Drive (PAYD) whereby the insurance premiums for cars are calculated on actual usage (eg distance travelled, time of day, location, type of road) as well as the more conventional rating factors such as vehicle make and driver age. Under PAYD, customers who drive less and at safer times than the average motorist would be rewarded by a cheaper insurance premium correlating with the associated lower risk. 7

13 Government can also apply GPS-enabled Pay-As-You-Drive (PAYD) pricing to roaduse-related charges such as vehicle registration fees, compulsory third-party (CTP) insurance schemes, road tolls and, in relevant jurisdictions, congestion pricing. Potential exists for a very wide range of environmental, economic and social benefits to be achieved through the direct financial incentive that PAYD offers. Practical considerations, however, include the up front capital investment, privacy issues, and the need for a high level of take-up before many of these benefits are realised. There are a number of insurance companies worldwide who have started offering or trialling voluntary insurance products linked to the PAYD concept, including Norwich Union in the UK and Progressive and Aviva in North America. Industry experience suggests that, while the concept may have succeeded in some small niche markets, it has not yet achieved the widespread popularity and market penetration that would enable PAYD to deliver the wide range of benefits it appears to offer. The economic case for the market to offer PAYD insurance in Australia would be significantly enhanced by a comprehensive approach that also applied the PAYD concept to statutory costs such as vehicle registration and CTP insurance. This would allow GPS unit installation costs for each vehicle to be spread more economically over a wider revenue base. In contrast to PAYD s incentives to responsibly change usage of private cars, IAG notes that Australia s current Fringe Benefits Tax (FBT) regime provides a perverse incentive for individuals to drive unnecessarily. FBT arrangements encompass, among other items, the provision of fully maintained motor vehicles by employers to employees. The FBT tax rate decreases as the number of private kilometres travelled by the employee increases. As a result, employees who utilise this arrangement to access a motor vehicle for private purposes may receive a perverse incentive to drive more than they would otherwise, simply to reduce their tax burden, thereby increasing GHG emissions. Accordingly IAG advocates that enhanced debate, investigation and review take place in relation to the way this tax operates so as to remove this disincentive to reduce GHG emissions. What is the appropriate burden of risk sharing responsibilities between government, individuals and the insurance industry? Role of government IAG recognises the crucial role of government in providing a comprehensive and clearly defined regulatory framework that promotes community resilience to risk and facilitates more affordable premiums and more predictable claims costs. Government has a particular role in encouraging and regulating risk-appropriate development of the built environment and providing an appropriate emergency services framework. IAG suggests that key areas of government responsibility include: Building standards. IAG s post-event analysis of building damage after major cyclones such as Cyclone Larry suggests that the implementation of relatively low- 8

14 cost mandatory cyclone building standards in the past has significantly reduced the damage to properties built to comply with such standards. There is a crucial role for government to support community resilience by ensuring that new buildings in at-risk areas embody appropriate measures to withstand hazards such as cyclone, hailstorm and fire. In particular, as the regions at risk from cyclone are anticipated to spread further south, IAG recommends that the geographic extent of cyclone building standards be reviewed and extended. Further, until now, building code standards have focussed in principle on protecting life and safety. IAG suggests that it is desirable to enhance building standards so that they also cost effectively protect the property itself, and its owner s financial interest, without sacrificing safety performance. It is proposed that such an approach, in improving the resilience of the built environment to severe weather, would also enhance the community s economic and social resilience to climate change. IAG notes that severe weather events can cause significant costly physical damage to ancillary structures such as fences and sheds that are not currently covered by building standards. There is scope for further data analysis and research in this area in order to inform a review of the current situation. Planning codes. Government has a crucial role to play in risk-appropriate landuse planning and zoning. Land that is, or becomes, at unacceptable risk from hazards such as flood or coastal inundation including storm surge should not be zoned for residential or commercial use. Without sound and consistent government controls, there is little to prevent ongoing building in flood plains or in coastal locations of extreme vulnerability. Flood risk data. IAG contends that flood maps represent information that is of significant public interest and importance, and that it would be inappropriate for governments to restrict in any way public access to flood map data. For all parties with a legitimate interest in a property including potential purchasers, tenants, residents, developers and insurers flood risk mapping data should be up-to-date and transparently accessible. Natural Disaster Relief Framework. The Insurance Council s pre-budget submission to the Federal Government highlights the industry's position in relation to the natural disaster relief framework, noting: It is timely for the Federal Government to consider a review of natural disaster relief and in particular the impacts that such relief may have in supporting appropriate incentives to mitigate against risk. The Insurance Council contends that, although worthy in its intentions, the current natural disaster relief framework may be inadequate to ensure individuals and communities are well prepared for future weather events. In this regard, the 9

15 Insurance Council suggests that the natural disaster relief system may benefit from the introduction of a mutual responsibility framework for recipients. Again, the Insurance Council contends that concerns over erratic and changing climatic conditions may be sufficient to warrant an examination of natural disaster relief arrangements" The submission also noted: "Existing climate change scenarios suggest an enhanced need for greater capital funding, especially for mitigation capital works, including replacing or upgrading critical stormwater mitigation works and the maintenance and extension of levies and flood management devices. Evidence suggests that failure or inadequacy of public stormwater mitigation accounts for approximately 1/3rd of water damage experienced by private property owners during large rainfall events. "The National Disaster Mitigation Program, which supports many of mitigation initiatives, is scheduled for review. The Insurance Council welcomes such a review but also urges a wider terms of reference. In particular, the Insurance Council submits that a broader review of the adequacy of present funding levels for mitigation style works be examined by the Commonwealth under the auspices of COAG. This review would combine including examining the review of the National Disaster Mitigation Program with the results of the Productivity Commission study into Local Government Revenue Raising." Role of insurers The role of the private insurance market is to continue to deliver appropriate cover to individuals and businesses. Insurers also have a role in encouraging development of a resilient built environment through sharing research results, providing guidance on best practice, and delivering pricing structures that reward use of risk-reducing building design and materials. Is the insurance industry likely to provide an adequate range of insurance products in the absence of government intervention? Provided the extent of climate change remains limited, with global average temperatures increasing by less than 2 degrees Celsius above pre-industrial levels, the Australian insurance industry is generally well positioned to continue providing an adequate range of insurance products. However, three specific steps that Australia may take in order to mitigate or adapt to climate change could present particular insurance challenges that will require further exploration. The three matters, discussed briefly below, are carbon sequestration and offsets, geosequestration, and nuclear energy. Carbon sequestration and offsets There may be demand for insurance industry involvement in guaranteeing the delivery performance of carbon offset contracts, whether these are settled financially 10

16 or physically. Insurance involvement could potentially include protection for upfront carbon finance payments, and weather insurance products to cover operational risks. Indeed, the absence of a robust insurance solution could challenge the viability of forestry-based offset projects. In the case of forestry-based offsets, for example, there may be scope for insurers to cover the liability for delivery of the promised carbon sequestration over the entire life of a forestry project, regardless of fire or weather conditions destroying the forest or slowing its growth. This is an emerging area, however, and insurers would need to consider carefully the extent to which they would be prepared to accept the potentially long term liabilities attached to forestry carbon sequestration guarantees. This may need to be addressed by a series of annually renewable contracts. Geosequestration Carbon capture and storage is an immature technology and as such its risk profile is still unclear. However, geosequestration (storage of carbon dioxide deep underground in rock structures) has the potential to present large-scale long term liability risks. IAG suggests that, while insurers would be likely to consider insuring the operations associated with carbon capture and storage on a case by case basis, they may be cautious or unwilling to accept liability for leakage of carbon dioxide. Accordingly the liability for carbon dioxide leakage may need to remain with government given the scale and complexity of the risk involved. Nuclear energy IAG, along with the rest of the insurance industry, currently excludes nuclear risk from domestic and commercial policies. In Europe, government backed nuclear insurance pools have been created, similar to the Australian Reinsurance Pool Corporation (terrorism insurance), to ensure the community is covered. If nuclear energy were to be adopted in the future as part of Australia s energy mix, IAG suggests that the European model for insuring against the inherent risks would be worthy of consideration. More generally, is there a useful role for government in providing a mandatory, regulatory insurance against climate change risks, or is the general prudential supervisory role of government enough? IAG considers that government should continue its general prudential supervisory regulation of the operation of the private insurance market. Importantly, IAG recommends that government should enhance the resilience of the community to climate change by reforming taxes and charges that are currently impediments to the private uptake of insurance cover. 11

17 IAG considers that government has an important role in supporting the insurance of risks that the private sector is not capable of underwriting alone. Current examples include terrorism insurance in Australia, and nuclear insurance in Europe. A potential future example is coastal land value insurance, discussed in Part Three of this paper. IAG does not otherwise consider that government has an appropriate role in providing insurance against weather risks already covered by the industry. The government insurance arrangements in the State of Florida provide a useful case study demonstrating some of the problems that can arise. IAG contends that, if insurance products are priced unrealistically and fail to adequately reflect the underlying risks, a number of undesirable consequences are predictable, including: cross-subsidisation from members of the community who choose to live in lowerrisk areas to those who choose to live in higher-risk areas (eg coastal or waterfront areas), leading to attendant problems of inequity and/or underinsurance particularly if low risk groups simply decide not to insure at the high price offered; distortion of the normal incentives for responsible risk-reduction behaviour; and disincentives for private insurer participation in the insurance market, leading to increasing political and financial pressure on government in the extreme event of private insurers withdrawing from the market. Florida Citizens Property Insurance Corporation: how a government insurer of last resort became Florida s largest insurer In the United States, a number of traditional insurers of last resort are growing significantly and, in some cases, are even becoming the largest insurers in their state. This phenomenon is detailed in a research report by the New York-based Insurance Information Institute (I.I.I.), Residual Market Property Plans: From Markets of Last Resort to Markets of First Choice (June 2007). The report is available at With its state-based insurer Florida Citizens Property Insurance Corporation, Florida illustrates the challenges that can arise for the community, insurers and government when a state-based organisation provides insurance in direct competition with private insurers at the same time as worsening weather damage drives insurance price increases. Florida is a region that combines high vulnerability to hurricanes with a high value of assets exposed to damage: not only are hurricanes more likely to hit Florida than any other US state, but the value of insured coastal property in Florida also ranks first in the US and now exceeds US$2 trillion. The information presented below is based upon the following I.I.I. publications: Florida Citizens Property Insurance Corporation (CPIC): What It Is and How It Works (August 2007) available at 12

18 Florida Property Insurance Facts (January 2008) available at Eight of the ten most expensive hurricanes ever to make landfall in US history hit Florida (Hurricane Andrew in 1992, Hurricanes Charley, Frances, Ivan and Jeanne in 2004, and Hurricanes Katrina, Rita and Wilma in 2005). Florida homeowners insurers underwriting losses in 2004 (US$9.3 billion) and 2005 (US$3.8 billion) resulted in a four-year cumulative loss of US$6.7 billion, even after including the profitable years of 2006 and 2007 when there were no hurricanes. These figures are for private insurer losses only and exclude the results of the Florida Citizens Property Insurance Corporation (Citizens). Citizens is a state regulated association and historically has provided property insurance to policyholders unable to obtain coverage in the private insurance market. It provides multi-peril and wind-only insurance coverage to Florida homeowners, commercial residential and commercial business property owners. In 2002 Florida combined its two high risk insurance pools, the Windstorm and Joint Underwriting Association, to create Florida Citizens. Since then, Citizens has evolved from market of last resort to become the state s largest property insurer with more than 1.3 million policyholders as of July 31, A new insurance law passed in May 2007 expanded the role of Citizens and made its rates competitive with the private market. Florida homeowners can now purchase coverage from Citizens if the rates for a policy from a private insurer are more than 15 percent higher than for a similar Citizens policy. In addition, Citizens can offer homeowners insurance to its high-risk policyholders as well as wind-only coverage in other parts of the state. Citizens total exposure to loss and total policies in force are extremely high and growing. Total exposure to loss under Citizens has grown to US$434.3 billion at March 31, 2007, up from US$154.6 billion in Citizens total policy count surged from 658,085 policies in 2002 to reach 1.35 million at July 31, Under the new insurance law, Citizens will experience even further growth in exposure and total policies because of the state s significantly expanded role in insuring homes across Florida. When Citizens losses exceed its claims-paying capacity in a single year, it is required by state law to impose a statewide assessment on every line of insurance, other than medical malpractice and workers compensation. By law, insurers may recoup the amount from policyholders as part of the homeowners insurance rate-making process in the state. The surcharge is shown separately on premium notices when eligible insurance policies come up for renewal. In addition to levying assessments and buying reinsurance, Citizens has the ability to strengthen its finances by issuing bonds. For example, in early July 2007 Citizens closed a US$950 million bond deal, along with a US$1 billion bank line of credit. Plans such as Citizens can also receive bailouts from state funds. Following the record hurricane damage claims from the 2005 season, Citizens incurred a US$

19 billion deficit for that year. In an effort to offset the deficit, state legislators provided for a US$715 million appropriation of state general revenue dollars to the fund. These developments have led to many of the larger private sector insurers in the USA simply withdrawing from the Florida market. As a result, the underlying risk is becoming more and more concentrated to be borne (one way or another) by the residents and insured population of Florida. Previously this risk was much more widely dispersed and borne around the world via the operation of global reinsurance markets. 14

20 Part Two: Building Effective Carbon Markets IAG considers that an emissions trading scheme (ETS) is a crucially important step in achieving deep cuts in GHG emissions at the lowest economic cost, and in allowing producers and consumers to take into account the costs that emissions impose on other businesses - and the rest of society - through the environmental degradation caused. Are there any institutional inhibitors to the emergence of an Australian ETS? IAG does not consider that there are any institutional inhibitors to the emergence of an Australian ETS. On the contrary, IAG has consistently argued for the early introduction of an ETS as the central component in enabling Australia to achieve real short and long term emissions reductions. McKinsey & Company s report An Australian Cost Curve for Greenhouse Gas Reduction issued in February 2008 indicates that it is very feasible and affordable for Australia to adopt a target for emissions in 2020 similar to the European Union position. McKinsey s modelling indicates Australia has sufficient negative-cost abatement opportunities available to reduce carbon dioxide emissions to 20% below 1990 levels by 2020 at no net cost to the economy. McKinsey also estimate that emissions could be reduced to 30% below 1990 levels by 2020 if all abatement opportunities costing A$65 or less per tonne of carbon dioxide equivalent were to be utilised, equivalent to an average annual cost of only $290 per household. IAG supports a binding 2020 target for Australia s emission reductions similar to the commitment of the European Union to reduce emissions by 20% of the 1990 levels by 2020, and potentially by 30% as part of a global agreement if other developed counties also commit to similar reductions by Australian Climate Group The Australian Climate Group (ACG) is an alliance of leading scientists and commercial experts. It was convened in late 2003 by WWF-Australia and IAG in response to the increasing need for action on climate change in Australia. The ACG s first report Climate Change Solutions for Australia (2004) recommended six key initiatives, including: a target to reduce emissions of greenhouse gases by 60% by 2050; and establishment of market mechanisms to trade greenhouse gas emissions. Climate Change Solutions for Australia is available at In a forthcoming statement, the Australian Climate Group explains that: An overwhelming body of scientific evidence now clearly shows that the Earth is warming. This warming has already impacted on biological and physical systems around the world and here in Australia. Global warming since around 15

21 1950 has resulted largely from human-caused emissions of greenhouse gases. Ongoing growth of these emissions will deliver far greater impacts on the environment and our economy as we progress into this century. There is increasing evidence that catastrophic climate change is a possibility and, if this occurs, it is highly likely that Australia (and the Asia-Pacific region generally) will be severely affected within our lifetime. There is now compelling evidence that both the extent and the impacts of climate change are likely to be at the higher end of the range projected by the Intergovernmental Panel on Climate Change (IPCC). Australian policy needs to take account of this possibility by designing a national emission reduction scheme that is flexible enough to respond to new information quickly. The IPCC has found that global emissions of greenhouse gases would have to peak by 2015 and fall by 50% to 85% by 2050 to limit global temperature rise to 2.0 to 2.4 Celsius over pre-industrial times. This rise is likely to avoid many of the worst impacts of climate change but will not be without very significant consequences. Accordingly, we need to take account of this by stabilizing emissions in the near term and establishing a clear emissions reduction target for 2020 so that short-and medium-term reductions will be achieved. This will also avoid the risk that emitters will game the system (by failing to make reductions and then defaulting or seeking government assistance when unable to do so). Australia must seek a global agreement to reduce greenhouse gas emissions. This will only happen if Australia and other developed countries commit to significantly reducing their own national emissions. Early, substantial global reductions will avoid larger long-term economic costs and reduce the risk of triggering significant impacts from climate change. The Rudd Government s climate policy has been very progressive: ratification of the Kyoto Protocol; a 20% renewable energy target by 2020; a renewable energy fund; a low emission coal fund; an emission trading scheme by 2010; a long-term national emission reduction target; a commitment to develop a clear 2020 emission reduction target; measures to improve energy efficiency, and the progressive stance adopted by the Government at the UNFCCC Conference/Meeting of the Parties at Bali and particularly its strong support for a collective emissions reduction target for developed countries of 25%- 40% below 1990 levels. The only major outstanding commitments for the Government are to stabilise and reduce emissions in the short-term; actions that will signal to the Australian community and the rest of the world that Australia is committed to tackling dangerous climate change. 16

22 Accordingly, the ACG s key recommendations are: Stabilise national emissions by 2010 through both domestic measures and the purchase of international emissions reduction permits; Establish an emissions target for 2020 consistent with that of other developed countries such as the European Union; Ensure that the emission trading scheme is designed such that the Australian Government is not burdened by failure of participants to comply with it; and Ensure that the national emission trading scheme is flexible enough to respond to new information quickly. In advocating this stance, the ACG draws attention to the risks of catastrophic climate change: If global emissions continue to rise at the current rate, we dramatically increase the risk of triggering exponential and irreversible large-scale events ( tipping points ) such as: Turning oceans from sinks that absorb around half the carbon dioxide entering the atmosphere into carbon dioxide sources that release the stored carbon dioxide and exacerbate the rate of global warming; Releasing large quantities of stored greenhouse gases from thawing permafrost which will lead to further increases in temperature; and Disintegration of the Greenland and West Antarctica ice sheets raising sea levels and decreasing the amount of solar energy being reflected back into the atmosphere (which would further accelerate global warming). While these are unknown probability or low-probability events, prudent policy needs to be precautionary given the uncertainty of the exact temperature trigger and the scale and long-lasting nature of these impacts. The ACG notes that some temperature increase is already a certainty and recognises that Australia must implement adaptive management strategies and capacity building to increase the resilience of both human and natural systems to changes in climate conditions. The members of the Australian Climate Group are Professor Ove Hoegh-Guldberg, University of Queensland; Professor David Karoly, University of Melbourne; Professor Ian Lowe, Griffith University; Professor Tony McMichael, Australian National University; Dr Graeme Pearman, Monash University; Tony Coleman, Chief Risk Officer & Group Actuary Insurance Australia Group; and Greg Bourne, CEO WWF- Australia. 17

23 Stern Review IAG s 2006 submission to the Stern Review on the Economics of Climate Change argued that a carbon emissions trading scheme must be the central component in achieving emission cuts at the lowest economic cost. Greatest impact and emission reductions could be achieved through a global mechanism and the EU Trading scheme presents an ideal starting point as the basis for a global scheme. IAG also argued for a multi-faceted approach and supporting policy framework whereby all levels of government and industry need to aggressively pursue fuel switching, aggressively pursue energy conservation, and encourage innovation in technology and business practices. IAG s submission is available at Australian Business Roundtable on Climate Change As a member of the Australian Business Roundtable on Climate Change, IAG was a signatory to the 2006 report, The Business Case for Early Action. The Roundtable commissioned CSIRO to determine climate impacts on Australia, and the Allen Consulting Group to model the economic effects of producing a 60% reduction on year 2000 emissions by The report examined the economic impact of two alternative scenarios that resulted in the same level of total emissions over the whole period up to In the early action scenario, emission reductions were assumed to be made rapidly in early years. In the delayed action scenario, emission reductions were delayed at first until after 2020 but then became more severe in later years than the early emission scenario so as to eventually equalise the total amount of emissions over the period up to 2050 in the two scenarios. The results showed that : In comparison to early action, delaying action to 2022 would result in lower real GDP growth by an average of 0.2% p.a. through to 2050, and concentrate any disruptive shocks over a shorter period. A 60% reduction in GHG emissions is possible while maintaining strong economic growth, with real GDP averaging 2.1% p.a. through to 2050 if early action is taken. An additional 3.5 million jobs will still be created in the economy under the early action scenario over the period ; equating to 250,000 more jobs than under the delayed action scenario. Noting that climate change is a critical business issue that warrants precautionary, prudent and early action, the report concluded that If we act early, Australia can afford the policies needed to achieve deep cuts in its emissions. Early action will also keep our policy options open. By contrast, delayed action will increase the cost of action, the risks to climate, and the likelihood of a disruptive shock to our economy. 18

24 The Roundtable s members were BP Australasia, IAG, Origin Energy, Swiss Re, Visy Industries, Westpac and the Australian Conservation Foundation. The Business Case for Early Action is available at Is permit price realisation and discovery best facilitated through the use of auctioning under an ETS? To what extent, and on what basis, might it be desirable that permits are not allocated via an auction system? Clearly there are currently winners and losers as a result of the market failure that allows externalisation of the environmental and social costs of GHG emissions. Similarly, as this situation is redressed there will also be winners and losers as the transition to a carbon-constrained economy entails the distributional impacts of auctioning and/or allocation of permits. IAG strongly recommends that a policy be agreed by all governments involved regarding the application of funds raised through the sale of permits. Priority should be given to developing community resilience to adapt to climate change, funding low income households to offset the expected higher electricity costs, regional development for projects which are expected to reduce GHG emissions, and the promotion of new technologies geared towards the reduction of GHG emissions. In its previous submissions IAG has supported a mixture of allocation and auction in the distribution of permits, noting that some long term permits would assist in reducing investor uncertainty. Any process for permit allocation, however, needs to eliminate the possibility of perverse incentives for companies to continue to emit. IAG considers that the ETS will operate most effectively when there are a greater percentage of permits being auctioned. Accordingly the scheme should move to this state as quickly as possible. IAG s submission to the Prime Minister's Task Group on Emissions Trading (2007) is available at IAG s submission to the National Emissions Trading Taskforce Secretariat (2006) is available at data/assets/pdf_file/0017/5138/insurance_aust ralia_group.pdf Is it possible to have strong and efficient forward markets with restrictions on the use of permits, such as limited banking and borrowing? IAG considers the proposed ETS should allow banking of permits so as to establish a strong liquid forward market and encourage early GHG emission abatement. If borrowing were to be allowed so as to allow the potential for lowest cost abatement over time this should only be done with very stringent financial conditions attached. The conditions would include a requirement for fully collateralised margin calls payable immediately to the scheme administrator against borrowed positions if/when prices move. This would protect the scheme against possible future insolvency of 19

25 participants who borrow and later find themselves unable to meet their financial and environmental commitments. 20

26 Part Three: Coastal land value insurance IAG proposes for further public consideration the concept of a potential new measure to help Australian communities adapt to climate change: an insurance fund into which owners of low-lying coastal land would pay a regular levy so as to provide compensation when rising sea levels cause their land to become permanently unusable. Such a scheme could be operated by government alone, or in conjunction with the private sector. IAG considers that, for several reasons, it is unlikely to be feasible for the private insurance sector alone to operate such a scheme. Most importantly, the globally synchronized nature of the risk of rising sea levels eliminates the scope for geographic diversification of risk on which insurers and global reinsurers normally rely. An appropriately designed scheme of this nature would introduce a user pays price signal to owners of vulnerable waterfront land that they should be responsible for funding the cost of potential compensation payable to them should that land become unusable rather than expecting future compensation to come from some other source. Coastal vulnerability overview The concentration of Australia s population and assets along the coast makes our nation particularly vulnerable to the coastal erosion and inundation that will accompany increases in sea level. Added to this, waterfront landowners and lenders who finance such properties face an insurance gap because coastal land is an asset of significant value which landowners do not currently insure. Coastal erosion and inundation are expected to worsen as sea levels rise. A predicted impact of climate change is the inundation and/or erosion of valuable coastal land as sea levels rise. The IPCC Fourth Assessment Report (2007) anticipates a global sea level rise averaging at least cm by The IPCC figures exclude the additional risk, currently of unknown probability, that increases in polar temperatures could cause large land-based ice sheets (eg Greenland, West Antarctica) to either disintegrate or melt. Should this occur, it would result in sea level rises of up to several meters, possibly over a short time scale if large blocks of land-based ice become sea-borne or if ice dam walls break. Even small rises in sea levels will exacerbate the existing problems of erosion or inundation of coastal land caused by high and king tides, storm surges, cyclones and tsunamis, and may compromise coastal storm water drainage systems. An example is a study by NATCLIM that models the extent of potential storm surge inundation in Melbourne s St Kilda area under different rising sea level scenarios. An illustrative overview of the modelled results is included at the end of this submission, and is available at 21

27 As illustrated in the figure below, the sea level at the coast is a variable that fluctuates significantly from time to time, reflecting: the underlying cyclical tidal level, plus storm surge caused by low air pressure during severe weather conditions, plus wind-driven waves; plus wave runup. These four components of sea level are not experienced uniformly along the coast, but instead reflect the shape of the seafloor and surrounding bays, headlands and islands, as well as the nature of the onshore terrain. This coastal geomorphology in turn also changes over time, as a result of complex natural coastal processes as well as direct human intervention. (Source: K. L. McInnes, K. J. E. Walsh, G. D. Hubbert and T. Beer, Impact of Sealevel Rise and Storm Surges on a Coastal Community, Natural Hazards 30: , 2003 viewed at Examples of locations that have experienced significant coastal erosion events in the past include: Location Year Broadbeach, QLD 1967 Narrabeen, NSW 1974 Collaroy, NSW 1945 Forresters, NSW 1986 Byron Bay, NSW 1989 Pearl Beach, Broken Bay, NSW 1986 Callala, Jervis Bay, NSW 1974 Wamberal Beach NSW 1974,

28 Australia s population is vulnerable due to its coastal concentration Chen & McAneney (2006) estimate that approximately 6% of Australian addresses and population are within 3 km of the shore in areas less than 5 m above mean sea level. Within this overarching figure, the number, value and use of properties facing inundation from rising sea levels over the next several decades has not yet been estimated by IAG. Australian governments are conducting several projects to better assess (among other aspects of climate change) the extent of coastal asset vulnerability to rising sea levels. An early example is the NATCLIM report Planning For Climate Change: A Case Study - City Of Port Phillip which is available at An illustrative overview of this report s storm surge inundation modelling under a range of sea level rise scenarios is included at the end of this submission. Unfortunately, vulnerability mapping is not a simple matter of identifying the contour on a present-day elevation map corresponding to expected sea level rise. This is because the coast is likely to erode much further inland, depending on the geology of different locations. One longstanding rule of thumb, the Bruun Rule which must be applied with caution proposes an approximately linear relationship whereby coastal retreat is equivalent to a factor of 50 to100 times the vertical rise in sea level. Existing estimates of coastal exposure, such as the Chen & McAneney figure above, appear to overstate the likely extent of exposure, as they may include many addresses that are unlikely to be threatened this century by sea levels of the size anticipated by the IPCC, in the absence of major contributions from land-based ice. An unpublished report to the Insurance Council, A national coastal vulnerability study prepared by Risk Frontiers (2006), estimates the number of Australian addresses within 3km of the coast and with baseline elevations below 4, 5 and 6 meters. It estimates that more than 425,000 Australian addresses are below 4 meters above mean sea level and within 3km of the shore. Within the Greater Sydney region (Newcastle to Wollongong), 46,000 addresses are identified as being within 1km of the shoreline and with elevations less than 3m. The majority of these vulnerable addresses are located near sea-connected coastal waters i.e. alongside lakes or lagoons, river banks and estuaries, rather than directly facing the open ocean. The report also notes that properties in coastal settlements that are also on riverine floodplains (i.e. generally near the mouths of rivers) can be liable to both river and ocean inundation, often concurrently. The report particularly highlights the heavily populated Nerang River region on the Gold Coast, estimating it has around 15,000 properties vulnerable to both coastal and riverine flooding. Australia faces an insurance gap because land values are not currently insured Land value can represent the major component of a coastal property s overall value, especially for highly vulnerable expensive waterfront properties, yet land is not currently insured under home or building insurance policies. A crucial question that arises is who, if anyone, should compensate waterfront property owners if a government authority deems that the property is no longer safe for use, or that intervention to protect the property against rising sea levels is not to 23

29 be undertaken. Prof Jan McDonald of Griffith University canvasses a number of the legal considerations in her article A risky climate for decision-making: The liability of development authorities for climate change impacts (Environmental Planning and Law Journal, 2007). Land value represents a substantial component of the assets securing mortgages on coastal properties. Accordingly it appears likely that the banking and finance sector faces considerable exposure to permanent inundation of coastal land. To the extent that this exposure may be protected by Lender s Mortgage Insurance, the relevant underwriters may also face significant exposure. It should be noted that Lender s Mortgage Insurance partially protects the lender in the event that a mortgage cannot be repaid, but does not offer any protection to the borrower. International situation Vulnerability of coastal assets to rising sea levels is a global problem. The OECD study Ranking Of The World's Cities Most Exposed To Coastal Flooding Today and in the Future identifies total assets and populations of large coastal port cities around the world currently exposed to flood, and those that will be at risk in 2070 as a result of further development coupled with rising sea levels. Nations whose cities will face major risk include China and the USA. A copy of this paper is available at A range of mitigation and adaptation measures A coastal land value insurance scheme would involve establishing a fund into which owners of low-lying coastal land would pay a regular levy so as to provide compensation when (or if) sea hazards cause their property to become unusable. Such a scheme would fit within the context of a range of other strategies and approaches available to government and coastal managers to reduce or adapt to the hazards threatening coastal land. Examples of such measures available include: investment in permanent engineering structures such as sea walls, groynes (structures which run perpendicular to the shoreline to interrupt tidal flows and/or prevent sediment transportation along the shore), artificial reefs, flood barriers etc (note these are capital intensive, and run the risk of exacerbating the problem or creating unintended damaging consequences in other locations) active beach sand replenishment programs canals, dykes, pumps, levees, and importation of fill plantings (eg dune grasses, mangroves) to absorb the ocean s energy and/or stabilise erosion-prone surfaces sacrifice of land land buyback schemes 24

30 Some of the additional strategies focusing on protection of life and built property are effected through land use planning and zoning instruments. Strategies include: minimum floor heights and structural requirements for foundations deep setback of buildings from shoreline relocation of buildings or infrastructure (including capacity for emergency relocation of demountable buildings, such as is mandated in parts of Byron Shire, NSW) monitoring, emergency warning and evacuation procedures. Scheme design: parallels with familiar concepts In simple terms, all landowners covered under a coastal land insurance scheme could be required to pay an annual levy based on a percentage (say 2%) of land value into a fund for a fixed term of no more than (say) 50 years. Should the land become unusable, the landowner would receive the entire land value in compensation, and title to the land would revert to government. Under one possible public-private partnership model, this insurance could be sold via private insurers provided that the government gave an undertaking to pay the annual premiums into the scheme for the remainder of the original 50-year term for any land that was deemed unusable from the date that the land was deemed unusable (thereby providing a form of reinsurance to the scheme). Alternatively the scheme could be wholly operated by government but this would expose the government to potentially very large peak compensation outlays at relatively short notice in future years which would coincide with more general demands on government for general community reconstruction and funding that would obviously arise in such circumstances. Hence, the public-private partnership model would provide a cost effective pre-arranged financing option that would cushion the impact of such a catastrophe on government finances. The design of such a scheme could draw together elements of three diverse but familiar concepts: the traditional whole of life insurance policy is a long-term savings and insurance product which involves an individual paying a small regular premium, guaranteed to stay level for life, in return for a large sum insured payable on death. An insurance payment under the policy is inevitable, with the main uncertainty being the timing of death. land taxes and mandated insurance schemes such as national flood insurance schemes in other countries; and Australian Reinsurance Pool Corporation for terrorism insurance which blends private and public reinsurance for different layers of exposure. 25

31 Parallels between whole of life insurance and coastal land value insurance Whole of Life Insurance The risk of payment (death) increases with time as the person ages. The insurer accepts a regular annual premium that stays level for as long as a person stays alive, ceasing at age 95. In return, the insurer guarantees to pay out a fixed sum insured whenever the person dies. The insurer charges enough in the early years to build up and invest a fund so that it can pay everyone, regardless of whether they die early or late. The insurer uses projections of population mortality, together with individual mortality risk factors (age, health, lifestyle) to calculate each person s premium. The insurer buys reinsurance in case mortality experience turns out much worse than expected. Annual review process distributes emerging surplus via bonuses added to the sum insured. Coastal Land Value Insurance Fund The risk of payment increases with time as the underlying sea level rises. Annual levy is payable over a finite long-term period, such as 50 years, stays level (maybe relative to some index), and ceases if the property becomes unusable. The fund guarantees a defined compensation payment once the property becomes unusable Payment is guaranteed regardless of how soon or late the property becomes unusable. The insurer uses rating factors such as regional sea level rise projections, storm / cyclone risk factors and individual properties Digital Elevation Model data to rate risks. Reinsurance (ultimately with government) is in place in case destruction by high sea levels occurs much faster than expected. Scope for a regular review process to promote equity as experience emerges. Parallels with existing mandated insurance schemes There are a variety of structures whereby members of the community are compelled to contribute towards the cost of compensating for contingent losses. Examples include CTP and workers compensation schemes, or national flood insurance schemes in other countries. Land taxes are of course a familiar mechanism whereby governments use the value of land as a basis for calculating and collecting payments. Parallels with Australian Reinsurance Pool Corporation Commercial insurers responded to the 9/11 terror attacks by introducing terrorism exclusions, and government believed this would hamper commercial project development. In response, the Federal government introduced a terrorism insurance scheme - a hybrid public-private model that combines layers of terrorism risk retention: 26

32 risk retained by property owners (the policy excess, plus any damage exceeding the government post-funding limit) risk retained by commercial insurers a government-backed reinsurance pool with a line of credit, and post-funding by government, up to a specified total, in the event of insured terrorism losses. Scheme funding and operation: government or publicprivate partnership? IAG considers for the following reasons that it is unlikely to be feasible for the private sector alone to be able to provide such an insurance scheme. Because rising sea levels are a significant global issue, this risk will be likely to impact globally at much the same time and is therefore likely to have a greater impact than the global private reinsurance market is equipped to manage in the absence of government financial backing. The world s private reinsurance markets rely on geographic diversification of risk, expecting that poor experience in some locations is likely to be offset by good experience in others. The global nature of climate-change-induced rising sea levels would severely limit the capacity for geographic diversification of this risk. Further, there is also expected to be some local correlation of risk, as groups of claims would be expected to emerge at the same time due to regional weather effects such as storms and storm clusters causing major erosion events. The extent to which government and the international community will restrict atmospheric concentrations of GHG and mitigate climate change remains unknown, as does the extent to which Australian governments will introduce adaptive measures to physically protect coastal land. Wildcard risks cannot be ignored, particularly the risk of rapid disintegration of major land-based ice sheets leading to rapid and significant increases in global sea level considerably in excess of current IPCC projections. Government has control over coastal hazard risk mitigation programs and the overall development, management, protection or sacrifice of coastal land. Government also has direct control over the land use planning instruments that, depending on scheme design, may trigger a claim by prohibiting future residential or commercial use of the land. Government thus has significant influence over the likelihood and timing of claims. 27

33 Accordingly, IAG envisages that a coastal land value insurance scheme could be operated and funded either by government alone, or could also draw on private sector involvement as outlined above. The table below outlines design and funding implications of these two approaches. Basis of funding and operation Responsibility for payment of regular levy into the scheme Risk capital Scheme coverage Government only, with no private insurer participation Landowners would pay a regular levy up until the date of making a claim, at which time their levy would cease and title to their land would revert to government. At the time of a claim, Government would be liable for the funding to pay any difference between the amount claimed and the balance of the fund accumulated up to the date of claim. This could have a substantial fiscal impact. Government could structure the scheme to allow either compulsory or voluntary participation. Mandating that all coastal property owners must take out such insurance could be problematic: there are still remote parts of Australia where owners might assess the value of the land as low, and there Public-private partnership Landowners would pay a regular levy up until the date of making a claim at which time their levy would cease and title to their land would revert to government. Government would then take over the responsibility for meeting the regular levy payments into the fund for the remainder of the agreed term. The private sector would provide the capital to pay any difference between the amount claimed and the balance of the fund accumulated up to the date of the claim. Private sector capital arrangements would be facilitated by the guaranteed future stream of levy payments from government. Scheme participation would need to be compulsory. The challenges for insurers under a voluntary scheme arrangement would include: Anti-selection (whereby freeloaders do not elect to join the scheme until they are confident that a claim is 28

34 may be many persons who would consider the imposition of compulsory insurance as onerous and unnecessary. imminent) If there is limited takeup under a voluntary scheme, satisfactory pooling of risk will not be achieved. Further practical design considerations Definition of the insured event The proposed insurance scheme will require a clear definition of the circumstances under which a claim is payable due to actual or imminent permanent inundation by the sea. An appropriate trigger for an insurance claim under the scheme may be, for example, the introduction or new application of a government land use zoning instrument that prohibits residential or commercial occupation of the land. As climate-change-related sea level increases emerge in future, land value might be lost as a result of: Physical erosion of the land, eg when some or all of the property (even one lying some metres above sea level) collapses into the sea due to wave action. Permanent submersion of some or all of the land due to erosion and/or increases in tidal levels. A government instrument that prohibits continued occupation of the land due to sea hazard. A government instrument prohibiting future building development on the property due to sea hazard. Identification of properties to be included under the scheme The proposed insurance scheme will require a clear definition identifying which properties are to be covered. One appealing option would be to define scheme coverage using a simple elevationbased definition such as properties lying within (say) 1 metre below the Highest Astronomical Tide mark. Unfortunately, the expected unevenness of coastal inundation, being sensitive to different local conditions, means that such an approach may not distinguish adequately between land at high risk and land that is reasonably expected to remain safe. 29

35 In defining the scheme coverage, there are a number of promising avenues for further exploration. As noted previously, Australian governments are conducting several projects to better map the extent of coastal asset vulnerability to rising sea levels. An illustration from one such study is presented on the following pages. At least some coastal regulators at local government level have introduced planning instruments that recognise the risk of sea level rise, combining it with an understanding of elevations, local geomorphology and property elevations, tidal behaviour and storm risk (eg Pittwater Council). Academic research to develop coastal risk contours (for example, Dr Peter Cowell, Insitutute of Marine Science and School of Geoscience, University of Sydney) may also provide a basis for identifying appropriate coverage of the scheme. Images City of Port Phillip / St Kilda foreshore storm surge inundation modeling with rising sea levels The aerial photograph on the following page shows Melbourne s St Kilda foreshore and surrounds, located on Port Phillip Bay. The inset box represents a digital elevation model of the same area and shows regions of low to high elevation above sea level. The different blue-shaded regions mapped onto the photograph illustrate the extent of storm surge inundation modeled under a range of potential storm surge plus sea level rise scenarios. These are presented in the NATCLIM study Planning For Climate Change: A Case Study - City Of Port Phillip. (2007) which is available at The NATCLIM report explains that past storm surge heights in the study area have been modeled at 1.25 m, and this is represented by the area shaded palest blue near the canal. Based on past events, allowances for increased wind speed and a range of possible future sea level rises, predictions of possible future storm surge levels in Port Phillip Bay include: A storm surge of 1.65 m with a 35 cm sea level rise (represented in the illustration by the next shade of blue) A storm surge of 2.06 m with an 80 cm sea level rise (represented by the second darkest shade of blue) and A storm surge of 2.31 m with an 80 cm sea level rise and a 10% wind speed increase (darkest blue region). 30

36 Source: Commentary is on the previous page. 31

37 Wamberal: property damage in 1978 due to beach erosion Source: Belongil Beach: Erosion on Belongil Beach on the NSW Far North Coast Copyright: NSW Department of Land and Water Conservation Source: Collaroy Beach: erosion at Collaroy on Sydney's northern beaches Copyright: Warringah Council; Photographer: Daylan Cameron Source: 32