Pooling risk to insure against natural disaster

Paula Jarzabkowski can remember watching her mother scoop mud from the second storey of people’s homes after the devastating 1974 Brisbane floods. “For me, insurance isn’t just some product that people buy, it’s fundamental to people’s livelihoods,” says the researcher, who warns that globally the function of insurance is being severely undermined by the effects of climate change.

As natural disasters increase in frequency and severity, the University of Queensland professor is urging the Australian government to take the lead with a more sustainable natural disaster insurance model for the international community.

“Australia has the highest level of secondary perils in the world due to climate effects,” explains Jarzabkowski, who is also a board member of the OECD High Level Advisory Board for the Financial Management of Catastrophic Risk. Australia is also one of the least insured advanced economies.

Secondary perils are natural events – hailstorms, floods, landslides, droughts and bushfires – that have typically caused lower magnitude losses compared to large earthquakes or hurricanes. But as climate change increases the impact of secondary perils, there are growing personal and financial consequences. Floods in Australia in March 2021, for example, resulted in a damage bill of AUD$2.9 billion (US$2.1 billion).

The impact on premiums is significant for households; Australian homeowner insurance for flood has increased three-fold in 15 years. “The knock-on effect is that it’s unaffordable, so large portions of the population choose to be uninsured or underinsured,” explains Jarzabkowski. “That’s going to affect people in two ways; their ability to get a home loan, because you need insurance to get a mortgage, and their ability to repair their homes after a disaster. Eventually, the social costs of the uninsured often come to rest on government services.

Jarzabkowski thinks risk pools, public-private partnerships where risk is shared by many relevant stakeholders, is a path forward. Risk pools involve parties, such as financial bodies, government bodies, commercial bodies, NGOs etc., pooling their resources to provide lower-premium insurance in recognition of the systemic knock-on effects if one part goes uninsured. This also incentivizes a more joined up approach to risk, says Jarzabkowski.

“The response to climate change risk is too fragmented – different people are responsible for different parts of the problem,” says Jarzabkowski. “Insurance companies are pricing the risk higher or withdrawing the policy product, which are really important signals. But who’s picking up on them?” This leads to the questions – who’s responsible for local authority planning, and where properties are allowed to be built, how does this link into long-term insurability, are banks involved? she says. “All these decisions appear to be made in isolation.”

Jarzabkowski has been working on sovereign catastrophe risk pools for small island countries. More than a decade ago, several Caribbean countries joined up in a risk pool, which was able to provide fast liquidity after cyclones or hurricanes. This success in the Caribbean led to new multi-country pools being established in Africa, the Pacific, and, most recently, South East Asia. Since it is unlikely that several countries will be hit by a major disaster within the same year, countries retain some of the risk through joint reserves and capital, explains Jarzabkowski. The diversification of a region wide risk pool creates a more stable and less capital-intensive portfolio, which is cheaper to reinsure. These risk pools have had a significant impact on lives and livelihoods. For example, rapid insurance payments provide food to prevent starvation during drought.

In a proactive move, a cyclone and flood damage reinsurance pool is already under consideration by the Australian government. But Jarzabkowski says an integrated approach is needed for these disasters. “People are dealing with things like floods, cyclones, bushfires, and earthquakes, as discrete events, but climate change is systemic – and that’s how we need to address these issues.”

Jarzabkowski returned home from the UK in 2021 to take up a position as a professor of strategic management at the University of Queensland, specifically to help Australians build new insurance models against climate change-related disasters. It will require a broad spectrum of input, she says, ranging from climate modellers and urban planners, to public policy experts, economists, and community groups. “It’s in everyone’s interest that these risk pools work. We know that they can work, but we’re not having enough of those kinds of conversations yet.”