Insurer climate risk responses 'significant for society'

Insurer decisions to reduce coverage due to climate change risks could have “significant implications for society, the economy and the financial system”, Reserve Bank of Australia (RBA) Head of Domestic Markets Jonathan Kearns says.

Dr Kearns says insurers, which must plan for larger potential losses as the frequency and severity of extreme weather events increases, have “a bit of a head start” in managing the risks as they already have systems for assessing the likelihood and cost of events and premiums are repriced annually.

Insurers can also decide not to write policies in some locations, as climate change alters the payouts they may have to make.

“Such a reduction in insurance coverage could have significant implications for society, the economy and the financial system,” Dr Kearns told a Credit Law Conference in Sydney yesterday.

“Also, the fact that insurers can later decide not to provide cover means asset owners should not take comfort from being able to insure climate risks at this moment in time.”

Dr Kearns says changes in insurance and increased costs could present challenges for banks requiring borrowers to have cover for their property.

“If climate change means a home isn’t insured, then lenders could find that damage from flood, storm or fire results in the collateral value being significantly lower, and so their expected loss-given-default on climate-impacted properties is much larger,” he said.

The RBA, the Australian Prudential Regulation Authority and the Australian Securities and Investments Commission are part of the Council of Financial Regulators, which in 2017 created a Climate Working Group.

Dr Kearns says climate change has implications for the efficiency and stability of the financial system and understanding of how best to respond to the complex issues will evolve over time.

“But it is critical that financial market participants and regulators act now to best manage the financial risks and facilitate the associated opportunities,” he said.