Tower Insurance will soon start pricing premiums based on how at-risk residential properties are to all ''natural perils'' in a move experts predict will shake up the local insurance industry and encourage other companies to follow suit.
Tower has already begun pricing premiums according to how at-risk each property is to earthquakes. That new pricing scheme came into effect on April 1. Many commercial policies already operate with granular pricing but this is the first move towards it for residential cover.
And now the company, the country's third-largest insurer, has signalled that earthquake-risk is just the beginning of a broader shift.
Tower chief executive Richard Harding said the recent change to granular-pricing for properties at risk from earthquakes was about challenging the ''traditional'' approach
to insurance and the new pricing model
would be a fairer and more equitable way of pricing risk.
''Previously, while regions at risk did pay for more house insurance, insurance premiums still did not reflect the full cost of providing cover for these properties and this meant other customers were paying too much,'' Harding said.
''Our new approach to pricing will see locations facing higher risk from natural disasters meeting the actual cost and paying more than locations where the risk is lower.''
The vast majority of Tower customers will not see any significant change to their insurance premiums from the April 1 change. Less than 2.5% of customers will receive an increase of more than $250 and 1% of customers face an increase of more than $2000.
Customers facing premium hikes will typically have high-spec homes in high-risk locations such as Wellington, Napier and Gisborne.
The change to risk-based pricing was ''the right thing to do'' for the long-term benefit of New Zealand and ''fronting up publicly was the right thing to do for customers,” Harding said.
''This is because the New Zealand economy faces a range of climatic and geological risks, which in the long-term could see
insurers charging more, or restricting cover in certain areas.
''One of our roles as an insurer is to put risk signals in the market to help change and influence community and government behaviour. The pricing of insurance for risk is one of these signals.
''We believe risk-based pricing is the fairest way to distribute the costs we face as an insurer and is an important step in better educating the community about the risks facing
New Zealand.''
Granular pricing is not unusual in high-risk locations around the world, including Australia and North America, but Tower says their new pricing approach was not about ''playing catch-up'', but rather anticipating where demand would be in the years to come.
''The change we have made is about preparing for any future potential events and ensuring New Zealand can continue having a high-quality insurance product well into the future,'' Harding said.
Tower uses various sources of data to assess the level of risk each address faces, looking at factors such as soil type and how close it is to an earthquake fault. It combines this data with information about the building itself - such as its age, number of storeys and its construction material. Those data sets allow it to build a comprehensive profile of every individual property.
Tower also uses RMS, a California-based global catastrophe modelling firm, to further understand earthquake risk in New Zealand. RMS earthquake models are built using technologies, science and data that includes looking at historical events, geological data, ongoing global research and damage statistics.
Will other insurers now follow Tower's lead and start implementing risk-based pricing? Insurance Council CEO Tim Grafton says it is too early to say.
''Insurance is a competitive market,'' he said. ''Some insurers may see this as an opportunity and others may see it as an indication of the right direction to head in. It's too soon yet to say how each insurer might respond.''
There were benefits to risk-based pricing, he said. ''Consumers with low-risk properties may benefit by paying less to subsidise those with high-risk properties, while those with higher-risk properties will pay more for their insurance. For businesses implementing this type of pricing model, it allows them to price risk more accurately.''
Risk-based pricing would have an effect on where future residential developments would be built, and that would be a good thing, Grafton said.
''Ideally, it would encourage people away from building in high-risk locations – such as those prone to storm damage, flood and liquefaction,'' he said. ''It’s too early to say, however, what impact this will have on the building and property markets in New Zealand.''
Grafton said there was also a bigger picture to consider, with climate change looming as a potential threat to New Zealand communities. This was an issue for the country as a whole, and not just the insurance industry, he said.
''Climate change is a certainly a pernicious issue in New Zealand and the risks it poses to communities, particularly from flooding, need to be looked at more closely and better addressed,'' Harding said.
''We strongly advocate that action is taken to reduce the risk of flooding in areas that will be vulnerable to frequent flood events in the years to come. This is a responsibility for all communities in order to avoid social, economic and environmental disruption and not simply something that should be thought of as a response to how insurers might price risks in future.''
Jeremy Holmes, a principal of actuarial firm Melville Jessup Weaver, said most insurers at this stage were already considering their strategy in regard to risk-based pricing for natural disasters.
''I would expect that in a few years we will be looking at a market which is more risk-based than it is today,'' he said.
''All insurance companies use risk-based pricing to some extent. Tower has simply signalled a move towards stronger risk-based pricing in regard to natural disaster.”
Holmes indicated that the market would be keeping a close eye on Tower's move, particularly if there was pushback from consumers.
“Other insurers may well follow suit with stronger risk-based pricing than they already do, to reduce the risk of adverse selection. But that will depend on how Tower's customer base responds to the changes and whether Tower continue with their proposed pricing changes should there be pressure from policyholders,''
he said.
Tower's approach also raises another issue. If customers are being asked to pay extra to insure their property, can they be confident of the accuracy of the models companies use to assess risk?
''The data available varies but some of it is very granular, for example right down to the individual property level,'' Holmes said. ''There are numerous sources of available data so I can’t comment on the accuracy of all sources.
''However, I would expect that any insurer intending to use natural disaster data for pricing will undertake their own assessment as to the accuracy of the data before using it.''
Holmes also said flood risk would be next on the list of things insurers would start looking at more closely.
''Earthquake risk is generally the largest factor in estimating an insurer’s Probable Maximum Loss (PML) and is usually the largest component of an insurer’s reinsurance costs,'' he said.
''But I would expect that flood and other
natural disaster risks will be treated in a
similar manner.''
Holmes said some Tower policyholders would feel the benefits of the granular approach.
''Insurance companies have always taken risk into account when calculating pricing. The difference in this instance is that Tower has taken it to a granular level and decided not to cross-subsidise earthquake risks,'' he said. “They have said this will increase costs for some of their customers, but may decrease costs for others.
''Were other insurers to implement a similar pricing model, it is likely similar changes would be seen: increases for some consumers in high risk areas and decreases for some of the consumers who’ve been cross-subsidising those riskier policies.''
However, some insurers are sticking with their existing model, at least for now.
AA Insurance does not plan to change its approach on the way it prices home insurance premiums, which means it will not price based on how at-risk an individual property is to natural hazards.
''Our premiums are based on the claims data we collect over a period of time, rather than the probability of events occuring,'' AA Insurance customer relations manager Amelia Macandrew said.
''All regions of New Zealand are prone to the effects of a range of natural hazards at one time or another, and are often unpredictable.
''We are confident that the way we calculate premiums offers a balanced way of assessing actual risk and not just potential or future risk. We have no intention of making a homeowner wear the full cost of a likelihood of a natural hazard.''
FMG Insurance has no plans to change its approach to pricing or underwriting.
''FMG currently prices for natural disaster risk at a regional level and underwrites for specific natural disaster (and other) hazards at a granular level,'' the company said in a statement to Covernote.
''As a mutual we are always seeking to balance clients paying appropriate premium for risk, while continuing to support all of rural
New Zealand.''
For other insurers, the effects of climate change were already being felt and the industry was changing to reflect this new normal.
Garry Taylor, IAG executive general
manager-business (NZI), says insurers have faced ''unprecedented challenges'' in recent years with an increase in seismic activity and climate change-related events.
''Severe weather events are becoming more normal, and this year has already been the most expensive year on record for insurance claims related to storms that have caused devastation and floods,'' Taylor said. ''Some locations are more prone to these increased risks than others.''
Granular pricing is not new to NZ or NZI but as parts of the country become more prone to different types of risks, the price for insurance in those areas will reflect those risks.
''At NZI we have been doing this gradually, and will be increasingly putting in place pricing that aligns with risk, with a focus on educating brokers and their clients so they can be prepared for increases to their premiums.
''We encourage brokers to consider the future insurability of the communities where they operate – for example areas that are flood-prone, coastal and at risk of rising sea levels, or on a fault line – and talk to their clients about how they can prepare for the future and ensure they have adequate cover.''
NZI, as part of IAG, has the experience, expertise in risk and access to data to allow the company to price ''more accurately for risk into the future'', he said.
''We have developed sophisticated pricing technology to respond to changing risks, as we focus on ensuring we remain sustainable and here for our customers for the long-term. ''
Massey University's Dr Michael Naylor says granular insurance is here to stay.
He believes Tower's rivals will ultimately have ''no choice'' but to follow its lead and start pricing premiums on how at-risk a property is from earthquake and other natural disasters such as floods.
''Insurance companies have been fairly cautious,” Naylor said.
''What will happen is Tower will be getting all the lower-risk clients and the rest (of the insurance companies) will have to react to that.''
''They are going to have to chase the lower-risk customers too.
''But I don't think it will happen immediately. I think other insurers will sit back and see how it all plays out with Tower and watch what the reaction from Tower's customers will be and let the public react and then go from there.
''I think any change will be more gradual but it will definitely happen.''
Dr Naylor says this change will be so profound it may lead to future housing developments moving away from earthquake-prone areas. ''That's one of the hopeful developments,'' he said.
''For too long there's been houses built on poor land, for example in parts of Christchurch, places and areas that are not suitable for housing.''
Naylor said these changes were being driven by technology, and specifically by how data was collected and used.
Advances in technology for insurance models were growing at a rapid pace, Naylor said, and would have far-reaching implications for both the building and insurance industries in
New Zealand.
“There is a company in the United Kingdom that looks at the underground soil of every single house on every single street as part of its modelling.
''I just can't see how insurers here won't eventually be doing premiums on a house-by-house basis.''
The change to granular-pricing for premiums was ''absolutely'' about playing catch-up to the rest of the world.
''Countries like Australia have been doing it for years, especially with floods and bushfires,'' he said.
''How soon it starts to really happen in New Zealand, that is how much it begins to mirror how it's done in places like the UK, depends a lot on how easy and quickly the technology advances.
''The knowledge to, for instance, to look at the soil under each house in a street, is only just becoming available. It is such a new field but absolutely what will happen is Tower will get all the low-risk customers and the other companies will have to react to that.''
Up until now most actuaries who worked with local insurance companies has been based in Australia and had ''no idea'' about earthquakes, Naylor said.
''New Zealand has some of the most advanced knowledge of earthquakes and earthquake-risk in the world and now insurance companies here are having a massive catch-up to what they know about quakes. A lot of this (granual pricing) is being pushed by reinsurers here. No one wants to be caught out again.'
