Insurers in New Zealand are under increasing pressure to avoid over-exposure to natural catastrophes in high risk regions and coast lines up and down the country. As a result, risk-based pricing has come to the fore as underwriters look to place greater emphasis on individual exposures.

Once just a trend in the sector, taking a more granular and individualised approach to pricing is fast becoming the new normal for an industry that, like the rest of the world, is grappling with the ongoing and increasing effects of climate change.

Risk-based pricing means customers are offered different prices based on the level of risk they present. It allows insurers to set prices based on the assumed risk and to tailor policies accordingly.

Insurers use risk-based pricing to be competitive. The more accurate underwriters are, the lower the premiums they can offer to low-risk customers. Insurers don’t want to overcharge or undercharge; they want the premium to reflect the actual level of risk.

Risk-based pricing is significant in New Zealand as the local economy faces a range of climatic and geological risks such as earthquakes and floods, which could see insurers charge more or restrict cover over the long term.

Insurers can price individual properties using sources of data that assess the level of risk each address faces. They look at factors such as soil type, how close a home is to an earthquake fault, or how exposed it may become to coastal erosion. They then combine the data with information on the building itself, such as its age, number of storeys, or construction materials.

Those data sets allow underwriters to build a comprehensive profile of every property. Global catastrophe modelling firms like RMS, used by Tower Insurance, can drill down even further, using RMS earthquake models using data based on historical events, geologic information, ongoing global research, and damage statistics.

It isn’t a new idea. New Zealand has been relatively slow on the uptake of risk-based pricing when compared with other nations. Following an increase in wildfires in the United States and Australia over the past decade, underwriters have moved towards risk-based pricing structures, superseding the traditional pooling structures used by insurers.

A host of insurers have made the move towards risk-based pricing in recent years. Tower introduced it for domestic property in mid-2018. AA Insurance announced it would use granular pricing, citing climate change as the catalyst. The country’s largest home insurer, IAG, also changed its home and contents insurance, raising premiums for those in disaster-prone areas. AAMI also made the switch.

The changes were expected. Data show that New Zealand has been hammered by more than 150 natural disasters and extreme weather events in recent years. Aotearoa is rated as the second riskiest country in the world for natural disasters.

Crombie Lockwood’s Brett Down cites climate change as the main driver behind risk-based pricing. He says it represents the biggest shift in the insurance industry the country has ever seen.

“For generations, Kiwis have valued the ownership of coastal property,” he says. “But with current scientific modelling predicting a rise in sea levels of between 50cm and 100cm this century, the ability for many properties to get adequate insurance cover could become much more complex.”

Massey University's Dr Michael Naylor says granular pricing is here to stay. He says insurers that don’t make the switch will end up with higher risk clients, to their financial detriment.

“If you accept global warming, then you accept sea levels will rise, and you accept there will be more severe storms, all of that affects coastal properties,” he says.

What does the shift mean for brokers?

Dr Naylor says insurance brokers need to play catch-up on the vast body of research and knowledge available regarding climate change, flood and earthquake risks in New Zealand.

“Brokers are going to need to be able to know their catchment areas and their flood lines and land heights and factor all that in when talking to customers,” he says.

Jeremy Holmes, a principal of actuarial firm Melville Jessup Weaver, says the concept of risk-based pricing isn’t new; it is simply about charging a premium that reflects the inherent risk.

‘“Insurers have been doing that for a long time,” he says. “However, insurers’ understanding of risk can change over time, and that is what we’ve seen with some of the localised premium increases in recent years.”

The PML will still be driven by earthquake risk rather than flood for most insurers, says Weaver.

“The Reserve Bank requires insurers to hold capital or reinsurance to cover a 1 in 1000-year earthquake. For flood, insurers are only required to cover a 1 in 250-year event. For all the insurers that I work with, the top layers of the reinsurance programme are dominated very much by earthquake rather than flood.”

Weaver expects to see a more collaborative approach to risk between local government, insurers, and banks.

“You can’t build a house without permission from the council, and you can’t get a mortgage without insurance. Just because the council deems a piece of land as suitable for development, it doesn’t mean that the insurance market will deem it insurable. But with flood risk modelling improving over time, this should be less of an issue.

“What is more of an issue is developed land that is later found to be a significant flood risk. If a property subsequently becomes uninsurable, this will seriously affect its market value.”

Properties that sit in high-flood risk areas could remain insurable but “at a price”. Others could be ‘red-zoned’, says Dr Naylor.

“We can ignore this, and we'll get more and more frequent floods, and the houses will rot. And we can rebuild them, then there are more floods, and there's more rot as we rebuild. The insurers won't stand for that.”

Naylor says the increasing understanding of flood risks could prompt government intervention in some regions.

“The government could come in and say, well, we're going to move the houses,” he adds. “But if the government comes in, people will demand that compensation. My prediction is the government will be very reluctant to do that. So, I suspect they'll stand back and leave it to the insurer.”

The most significant changes to the insurance market are set to unfold over the next decades as insurers develop a greater understanding of climate risks. With premiums set to increase for many, multinational insurers will be watching New Zealand consumer reactions as their costs rise.

Naylor adds: “Risk-based pricing is going to become the new normal worldwide, and New Zealand is a very good country for multinationals to experiment in. All of the big overseas companies want to find out how customers are going to react.”

September 2021

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