Australian home and contents insurance costs are soaring. S&P Global Ratings believes this trend could lead to wider gaps in coverage, exposing more homeowners and their bank lenders to risks. Government involvement in the sector could rise, particularly in high-risk locations where insurers may exit or limit coverage.

For insurers, the trend may drag on volume growth for policies but could improve margins and firm up capital positions. We believe insurers will continue to sharpen their underwriting tools to better price for risk and improve sustainability of premiums and products.

Banks, in our view, have limited systems in place to ensure that mortgage borrowers are staying insured as required by the terms of their loans. Coverage gaps have not in the past been a source of credit losses for banks. However, given these gaps may widen, we think the risks are worth highlighting.

Our stress scenario indicates that if a major natural disaster occurs at a time of acute household financial stress, underinsurance could expose the banking sector to about A$200 million of credit losses. This is a minor risk to the major banks, but could be more material to a geographically concentrated regional lender.

Insurers Are Passing On Cost Strains Through Higher Premiums

Australian insurers will continue to raise premiums to cover higher costs and expenses. This includes higher claims, with the home and contents insurance segment reporting underwriting losses annually since 2020, until a turnaround in the second-half of calendar year 2024.

The rising value of homes and housing construction is another driver of costlier home-related coverage. Over the past five years, the average cost of completing a new residential dwelling has risen by 28%, amid labor and material shortages. As a result, insurers incurred higher claims to remediate damages.

Housing trends point to further upward pressure on home insurance costs. For example, growth in housing stock on the east coast of Australia will contribute to more weather-related claims. We expect insurers will prudently price for the underlying risks of properties.

Premiums are already very costly in high-risk areas such as floodplains or bushfire zones, and are unlikely to fall anytime soon. Building new housing stock in these types of high-risk areas will ultimately burden household budgets with high insurance premiums.

All these factors leave us with premium rates that accurately reflect risks for insurers but stifle new policy growth and may increasingly lead to underinsurance. Total premiums for home and contents insurance have risen about 65% over the past five years, according to data published by the Australian Prudential Regulation Authority (APRA). This is largely rate growth rather than policy count or sum insured, and far higher than general consumer inflation and wages growth.

Coverage Gaps Could Widen As Insurance Becomes More Expensive

In our view, it's possible, homeowners will reduce or discontinue their insurance coverage to meet other necessary spending obligations. Underinsurance is especially likely in higher-risk locales, where insurance costs are multiple times higher.

Elevated insurance premiums are hitting at a time when consumers are battling higher cost of living expenses, elevated interest rates, and mixed wages growth.

Chart 1

The Actuaries Institute estimates that 15% or 1.61 million Australian households experienced affordability stress for home and contents insurance as of March 2024. About a third (5%) of these households have a mortgage.

We expect a good proportion of these households to lower or drop insurance cover. For example, flood cover can be a separately priced option for home and contents insurance, so some households may opt to drop this to lower their insurance bills.

Some Properties In High-Risk Locations May Be Uninsurable

Low-lying properties in flood-prone regions and properties exposed to natural weather events, such as cyclones, bushfires, coastal erosion, and land-slips, have seen larger premium rate increases to reflect the higher risk than other suburban properties.

According to fresh data (December 2024) published by the Insurance Council of Australia (ICA):

• The insurance industry has incurred about A$35 billion of normalized catastrophe claims over the past 10 years;
• This is about a third of the gross written premiums for home and contents earned over the same period; and
• About A$27.7 billion was related to flooding, storms and hailstorms, and A$7.4 billion was due to bushfires, cyclones and tornados.

Chart 2

Banks Don't Have Systems In Place To Ensure Their Borrowers Are Insured …

Australian banks don't closely monitor whether their customers have the right levels of property insurance. This could become a blind spot, in our view. Maintaining adequate insurance remains the borrower's responsibility and this has not been an issue in the past, given most homeowners have a huge incentive to avoid the catastrophic financial ramifications of not insuring their property.

Banks require proof of adequate property insurance only at the time a loan is provided. Under the terms of a mortgage contract, a homeowner is required to maintain adequate property insurance during the term of the loan for the full amount of the replacement value. The insurance policy should cover fire, storms, flood and hail. Moreover, the bank can reduce or cancel the loan if adequate insurance is not maintained.

Currently, Australia has no avenues or agreements in place for information to be shared between banks and insurers. That means banks are unable to verify if a homeowner holds adequate insurance for their property without a direct request to the homeowner. In New Zealand, we understand that insurers and banks are in discussions to share information. Given the largely shared ownership of banks and insurers across the Tasman, Australia could adopt a similar practice should it eventuate in New Zealand.

The U.S. has some insurance options to protect banks if their collateralized property is not insured by the homeowner. This Force-Placed insurance is imposed on the borrower should their policy lapse or be cancelled. Such a specialized product, which requires capabilities to interrogate mortgage and insurance databases, is not practically available in Australia.

However, many banks have some level of insurance coverage for aggregate losses due to underinsurance in their mortgage book. These limits are generally modest and a cost to the bank. We understand the number and value of claims has to date been minimal across the industry.

…Though The Threat To Asset Quality Is Not Significant At This Time

The loss of isolated properties that are underinsured is not likely to lead to a material increase in credit losses. Localized damage from weather events over the past 10 years have not had a noticeable impact on banks' credit losses.

That said, if a catastrophe event caused property damage to a whole town, suburb or city that was underinsured, credit losses could be sizable. And in general, widening insurance gaps will exacerbate these types of fat-tail risks.

Our sensitivity analysis

In our view, the risk of underinsurance is partially mitigated by the banking industry's size and geographic diversity across the country. Pooling of uncorrelated properties naturally offsets the idiosyncratic risks including underinsurance. The same diversity applies to residential mortgage-backed securities pools.

Our back-of-the envelope scenario analysis indicates that potential credit losses from uninsured homes is a tiny amount:

• The industry has over A$2.3 trillion of property loans outstanding as of December 2024.
• The Actuaries Institute estimates that 5% of households with a mortgage are experiencing "extreme home insurance affordability pressures" as of March 2024. This is about A$57 billion or 3% of outstanding home loans.

• We estimate that if one-third of the under-pressure households lapsed insurance coverage, and 1% were hit by a major catastrophe, then credit losses could be about A$200 million. This assumes a catastrophe event like the 2022 Southeast Queensland and New South Wales floods, where about 35,000 property were significantly damaged or uninhabitable. This is about 1% of the 3.8 million Australian properties that have a mortgage.

Relative to the total value of outstanding Australian mortgages, A$200 million is less than 1 basis point of the industry's outstanding loans. However, for a mutual bank that is geographically concentrated, the vulnerabilities could be much higher.

Mortgage insurance can provide some protection to banks assuming its terms and conditions are met. However, mortgage insurance would not cover the replacement cost of property damage if the property wasn't insured, or was underinsured. In this event, the bank would need to make good the property before making any claim on mortgage insurance for losses from unpaid interest and any property value decline on sale.

In our rated portfolio, about 90% of the Australian banks are on stable outlook. We expect that systemwide credit losses will remain low over the next two years, at about 15 basis points.

Uninsurable Homes Would Face Price Hits

If a homeowner is unable to secure insurance, they will not meet the bank's requirements for a mortgage. If insurers pull out of high-risk regions, homeowners may not be able to sell their properties as buyers are unable to get approval for a mortgage without insurance. Essentially, the value of properties in high-risk areas would significantly decline if they are uninsurable. This is where government-backed schemes could play an important role.

Government Intervention Could Support Access To Insurance Cover

We believe the Australian federal government is likely to step in with initiatives and schemes to support insurance availability and affordability. Rising insurance premiums are an unpopular political issue, especially during a cost of living crisis and with forthcoming elections. As domestic insurers continue to lift premium rates and limit their exposure to high-risk locations, the government may face pressure to aid in underwriting or guaranteeing insurance coverage.

In 2022, the Australian government implemented the Cyclone Reinsurance Pool (CRP); an arrangement between insurers and the Australian Reinsurance Pool Corp. (ARPC) to cover properties for cyclone and cyclone-related flood damages. Insurers pay a reinsurance premium to fund the pool for expected claims and operating expenses.

The Australian government backs the pool with an A$10 billion guarantee to meet any shortfalls in reserves.. Analysis published by the ARPC in May 2024 suggests that insurance affordability has improved in cyclone-prone regions since the CRP was implemented.

Government schemes are increasing in popularity globally, as private insurers lower their risk appetite to weather-related property risks. In the U.S., 32 states have some form of state-based property insurance schemes. These schemes can provide coverage to properties that are unable to obtain coverage from the private market. Often used as a last resort, coverage is typically basic with limits on sums insured and types of events covered by the schemes.

Such schemes can create moral hazard risk and a false sense of protection. Deviating from risk-based pricing masks the underlying risks of living in a high-risk location. This distorts signals to homeowners (for areas not to build in) and may discourage investment into mitigation and resilience. The international evidence suggests that over the long run, government insurers of last resort may add to moral hazard by subsidizing homeowners in high-risk areas and leaving taxpayers (rather than policyholders) to foot the bill after a disaster.

California's Wildfires Could Drive Up Global Reinsurance Costs

In our view, the 2025 California wildfires may drive up global reinsurance costs, which would ultimately flow to Australian policyholders. Reinsurers are likely to bear a sizable portion of the California insured losses, which S&P Global Ratings estimates at about US$40 billion (see "The Impact Of The Los Angeles Wildfires On California's Property Insurance, Housing Finance, And State Creditworthiness," published on RatingsDirect on Jan. 23, 2025).

Nonetheless, reinsurance capacity for Australian risks should stay resilient. Australia catastrophe claims remain a small contributor to global insured losses from natural catastrophes, which Swiss Re Institute estimated to be US$108 billion for 2023. Australia remains an attractive place to write insurance as the country adds additional geographic diversification to risks in the northern hemisphere.

While reinsurers have appetite for greater catastrophe exposure, they will be more selective on their exposure to high frequency and midsized events and reduce quota share and aggregate cover offerings. This will force primary insurers to absorb a higher proportion of total insured losses. Primary insurers are also increasing retention levels to reduce reinsurance costs. Like with other rising costs, we expect insurers will pass on rising reinsurance premiums to policyholders.

Insurance Margins And Capital Levels Will Remain Resilient

In our rated portfolio, 75% of the Australian property and casualty insurers are on stable outlook. The remainder are on positive outlook. This reflects our view of strong earnings and sizable capital resources and buffers to absorb losses.

The operating performance of the Australian property and casualty insurance will remain strong, with returns on equity staying in the 10%-15% range. This is underpinned by good risk selection and pricing trends that support profitability.

We expect the industry will maintain sizeable capital buffers to absorb losses from catastrophe events. Its excess regulatory capital exceeded A$12 billion as of September 2024, based on APRA statistics. It also has sufficient reinsurance.

At The End Of The Day, It's The Homeowners That Are The Most Exposed

High insurance costs can stifle industry growth and spread underinsurance risks. We see this with banks likely facing less compliance to terms of mortgage loans, and increased calls for the government to fill in gaps in risk markets.

By our assessment, banks and insurers would likely incur minimal losses relating to underinsurance. Plus both sectors in Australia have sizable capital buffers to manage the risk.

The story is different for homeowners. The risks associated with underinsuring are ultimately borne by this cohort.

While governments may intervene to support homeowners, this might not help if the support distorts market signals and tempts homeowners into locales that could, literally, be washed away.

Related Research

• The Impact Of The Los Angeles Wildfires On California's Property Insurance, Housing Finance, And State Creditworthiness, Jan. 23, 2025
• Asia-Pacific Reinsurance Sector Update: Improvements Are Underway, Oct. 30, 2024
• Insurers Focus On Underwriting To Tackle Climate Risk, Sept. 10, 2024
• Global Reinsurers Must Maintain Discipline To Cement Strong Performance Amid Casualty Risks, Sept. 3, 2024
• Insurance industry and country risk assessment: Australia Property/Casualty, Aug. 7,2024
• Banking Industry Country Risk Assessment: Australia, April 21, 2024
• Bigger Flood And Fire Tests Lie Ahead For Australia, Jan. 16, 2023

External sources

• Home Insurance Affordability and Home Loans at Risk--August 2024, Actuaries Institute