The shifting sands of insurance risk in Australia

Adam Battista, Executive Director, CRE

In the last five years, insurers and financiers have been forced into a scenario where they are not only concerned that the risk of climate change will cost them money, but that they will also be seen as socially responsible and vicariously liable.

These pressure points see most insurers and financiers capitulate, increasing premiums and/or reducing cover.

And while transitioning to a more sustainable energy mix is clearly everyone’s goal, this pre-emptive strike on fossil fuels and commodities has been outside of the industry's ability to directly control or respond to with any degree of fairness. The coal mine that markets insured last year is the same coal mine insurers are declining or tapering off on their participation this year; not because the risk itself has changed but through governmental and societal pressures. Producers and contractors alike are uniformly faced with significantly increased premiums, their cover being eroded through abridged terms and conditions, the number of insurers available to quote competitively reducing, or simply viable cover not being available at all. This article discusses the underlying issues surrounding the perceived risks, using the wide lens of the insurance advisor.

Why have insurers' appetites for coal changed?

As insurance advisers, we invest significant time explaining to clients why their business appears to have such a demonstrably increased risk profile, from an insurance perspective. In some cases, these changes are entirely justified, such as: • large and/or frequent claims • patent increases

Photo: Geoff Hunter

The insurance and finance sectors, along with some world governments, are generally failing to reconcile that their blackand-white treatment of the coal industry’s perceived risk is causing more damage than it is preventing.

• changes in production, bringing increased risks • labour shortages resulting in quality or safety compromises But outside of these easily explainable reasons, the reality is that the tangible, year-to-year risk profile for insurers to the Australian coal industry has not markedly changed through deterioration or losses. Perceptions, hearts, and minds have been indelibly altered, but the factually quantifiable risks have not. Let’s examine what feeds into those perceptions.

The climate context

In a bizarre dichotomy, we appear to be basing our future energy investment, development, and reliability on the very thing we can’t predict – weather. In an insurance context, losses from natural catastrophes including bushfires, cyclones, earthquakes and prolonged rain depressions causing floods, have undeniably escalated over the last 50 years, rising from less than US$80 billion (rationalised to 2021 prices). Population growth is estimated to have increased 110% in 50 years from 3.5 billion to 7.8 billion, and density is estimated to have increased from 25 people per km2 to 52 over the same period. In affected regions, common sense dictates that this growth escalates the impact on insured losses and life.

In Australia, the early 2022 flood events were the costliest floods in our history at A$5.28 billion, and the second most costly disaster after the Eastern Sydney hailstorm in 1999, costing A$5.57 billion. So, while large and significant natural disasters continue to occur, pre-dating and persisting throughout the industrial revolution, the main variable for the insurance industry has not been increased weather patterns or severity. It has been our sprawling development across the globe and therefore our susceptibility to these events.

Can we categorically deduce climate-related causality?

Climate science seems to point out that the growth of our populations and the way humans inhabit our planet detrimentally affects it in some way, including its weather patterns. But it should be considered that there’s been a distinct lack of resilience-building in naturally hazardous climates, along with deficient and dangerous community planning of our communities, which has increased the impact of climate events. For additional context on this aspect alone, Australian taxpayers have paid around A$24 billion in disaster relief since 2005, while only spending A$500 million on disaster resilience.

Is insurance still viable?

Surprisingly, insurers still seem to think so, despite these disaster trends. Strikingly, the two largest markets for Australian-based risks, local carriers and the Lloyds insurance market in London, have released some compelling profitability data in the last two years despite a global pandemic and persistent natural disaster losses averaging US$80 billion payout over the same period. The Australian insurance market recorded A$6.3 billion to 30 June 2022 of underwriting results against A$60.4 billion of collected premiums. Lloyd's achieved an underwriting profit of £1.2 billion for the first half of 2022.

But is it viable for the coal sector?

Yes, but a pragmatic, long-term lens is needed. In the midst of record revenues, retained earnings to guard against the rainy (forgive the pun) days and the potential for uninsured losses are what is required in this stage of the cycle. Mine owners and operators can naturally become less reliant on their insurance regimes during this phase of the cycle, so larger deductibles, skinnier limits and coverage carve outs are generally accepted. This causes the insurance procurement function to become more benign in its effectiveness. However when prices return to more ‘normalised’ states, and costs start to squeeze margins, insurance and its value will become a huge focus again. The concessions that many have made to mitigate cost (or simply fill their limits) will be tremendously difficult to wrestle back. Concurrently, many insurers, reinsurers, and large insurance brokers have moved away from the sector because they have been ‘forced’ to assess the sector’s viability against often-illegal slanderous corporate attacks by militant environmentalists. While these factors have tightened supply, terms and conditions, there are still opportunities like captives and mutuals to effectively transfer risk if it is well measured, managed and articulated.

Alternative Risk Transfer (ART) – Captives

Alternative risk transfer (i.e., non-traditional insurance) opportunities are now gaining prevalence. A captive is a structure created by a business whereby it acts as its own insurance company and is controlled by a captive manager on behalf of the business. Instead of paying an insurer the premiums each year, these are paid to the captive who acts as the insurer for potential claims – still governed by an insurance policy, but generally with broader acceptance and potentially fewer exclusions to core risks. Critically, the captive also purchases reinsurance to protect itself from paying out on large claims on its own, which would potentially destroy or materially erode its liquidity.

Captive insurance arrangements are the logical choice to divert the immense premium spend into the company’s own vehicle, with the opportunity to tap into the reinsurance market directly. Managed correctly, these mechanisms can be highly effective risk management, tax, investment, and safety net tools once fully capitalised. As a guide, captives are generally considered a solution for well-established businesses with several years of loss/ underwriting data, spending a minimum of A$ 1million-$2 million in premiums per class of insurance.

ART – Mutuals

A mutual behaves similarly, with a few critical differences. While a mutual is owned by its policyholders (members), it is controlled by the manager of the mutual who sets the rules – and in our experience, with limited input from its members. If you don’t fit, you’re not invited. From an industry perspective, these structures have either been squarely focused on the provision of significant government assistance in bringing them to fruition, or on reaching a level of industry harmonisation and cooperation that is often extremely difficult to achieve. Mutual structures are generally a solution for client industries with a replicable and/or similar risk profile across many participant members. Therefore, the ‘input of the many to prop up the few’ mantra becomes viable.

ESG – the insurance angle

Insurers were very early adopters of ESG credential assessment. Unfortunately, while the conceptual premise was appealing, most had little idea what to ask. It was often a checkbox that simply needed to be ticked in the underwriting process. But now it’s fast becoming one of the most exhaustive and detailed parts of the underwriting process. Dusting off a document once a year is not enough to appease the imposed protocols for risk acceptance. Most companies are working hard toward some remarkable developments in mitigating and abating carbon emissions throughout the extraction and combustion cycle. If successfully implemented, they should (technically) allow the insurance market to soften its autocratic stance on insuring coal-related assets and businesses. In closing, I offer the reassurance that we do understand the predicament of the moving goalposts of ESG. But the insurance and finance sectors, along with some world governments, are generally failing to reconcile that their blackand-white treatment of the coal industry’s perceived risk is causing more damage than it is preventing. In my view, the collective challenge we face now is understanding how best to shine the torch back at insurers, financiers, and governments to rationalise how their social justifications are constructed, in the full knowledge that their virtuous decisions today on only the environmental aspect of ESG are severely affecting their obligations to help balance the quality of life around the globe. 