2 CPD Points
Summit 2025: Modelling Solutions for the Home Insurance Availability and Affordability Crisis in Flood-Prone Areas of Australia: An Analysis Using CGE Technique
The impact of extreme weather events on home insurance pricing in Australia has escalated significantly over recent decades, driven by increased frequency and severity of climate-related disasters. Despite the vital role of insurance in mitigating financial risk, there remains a gap in the macroeconomic assessment of insurance programs, particularly in relation to their long-term economic effects. To address this, we employ the TERM (The Enormous Regional Model), a sophisticated multiregional computable general equilibrium (CGE) model of Australia, where each region functions as an independent economy. Our framework builds upon TERM by distinguishing 216 sectors and 334 regions, which are aggregated into sectors of interest, notably insurance-related activities. The model also focuses on regions particularly vulnerable to flood-induced damage, where localized premium increases typically follow catastrophic events. The core contribution of this research is to integrate climate change considerations into flood insurance pricing models. We apply actuarial theory to simulate post-disaster premium hikes for insurance agents in affected areas, capturing both short-term pricing responses and long-term shifts in insurance market dynamics. The overarching objective is to evaluate how climate change exacerbates risks and affects insurance availability, affordability, and insurability, with homeowners increasingly facing higher premiums due to elevated risks. Insurers play a pivotal role in the economy by providing financial protection against extreme weather events, contributing to the recovery and rebuilding of homes, businesses, and communities. However, in the face of rising climate risks, insurers must also balance risk management with affordability and access to insurance products. The study highlights how market inefficiencies, especially under conditions of small group monopolistic competition (i.e. few large firms operate in the market), may lead to a disconnect between efficiency gains and consumer benefits, as these gains are often distributed to shareholders rather than lowering premiums for policyholders. To realistically capture the insurance market and welfare impacts on homeowners, we develop a three-stage simulation. First, we model the uncertainty of the home insurance market by examining two periods—before and after a climate shock. Second, we introduce households located in high-risk areas, enabling us to account for differing risk aversion and decision-making processes under uncertainty. Third, we model the market for home insurance products, explicitly distinguishing between ex ante premiums paid by households and ex post payouts in the event of catastrophic losses. By incorporating catastrophe modelling and actuarial principles into this framework, we analyse how risk-sharing mechanisms in insurance programs can be optimized. The model provides insights into ratemaking approaches that balance premium affordability with sustainability for insurers. Additionally, it offers policy implications for improving the availability of insurance coverage in high-risk regions, potentially reducing the protection gap for vulnerable homeowners facing increasingly unaffordable premiums.
