Is insurance the next big challenge for home owners?

It has already claimed the lives of 24 people, razed more than 12,300 homes and businesses (according to Cal Fire), and resulted in looting – all this, with three fires still burning.

While the true cost of the fires won’t be known until the fires are extinguished and the clean-up concludes (with more international fire crews arriving to help extinguish the multiple fires), weather forecaster Accuweather has put out preliminary estimates of the damage and economic loss to be between US$135 billion and US$150 billion ($219–$243 billion).

But it’s the insurance industry that is really reeling; with investment bank JP Morgan estimating the insured losses could be more than $20 billion (or more, depending on how long the fires uncontained) – more than double its original estimates.

Indeed, in an update on Friday (10 January), the company said the losses would be mostly confined to home owner coverage, as well as commercial property.

A building insurance crisis?

The crisis highlights a chilling reality: natural disasters are growing more frequent, intense, and expensive to recover from. And securing insurance to cover property in disaster-prone areas may become impossible.

For Australia, which faces its own mounting climate risks, the Los Angeles wildfires offer a glimpse into a troubling future. As rising insurance premiums and a growing number of uninsurable properties converge, home insurance could become the next major challenge for home buyers and the financial system alike.

If borrowers aren’t able to afford – or even qualify for – building insurance due to climate risks (whether it be fire or flood), it could fundamentally change the property market.

The insurance issue in Australia

The property insurance issue has been of growing concern for bankers, borrowers, and politicians alike and could impact broker clients (given borrowers are required to take out building insurance when they settle their mortgage).

In October last year, the House standing committee on economics released its damning report on the inquiry into insurers’ responses to 2022 major floods claims.

The report, titled Flood failure to future fairness, put forward 86 recommendations to create “a fairer system” after noting “the collective failure by insurers to meet their obligations to policyholders after the 2022 floods”.

It said that “too many cases were badly mishandled”, according to committee chair Daniel Mulino MP, while “inconsistent decision-making” meant neighbours received different outcomes after the same event.

“Long delays caused emotional, mental health and financial strain. More than two years on, many people still can’t go home. Initial offers were often too low, which was especially problematic for cash settlements,” he said.

Further, the report also flagged the growing number of uninsurable properties at very high risk.

Mulino said “some form of government intervention” would be needed for such properties and that guiding principles for such intervention include the need for ongoing community and household level mitigation investment and that no further development should occur in high-risk areas.

Recommendations included:

• Disclosure of flood risk levels through property conveyancing and rental agreements.

• Exploring regulatory mechanisms to discourage banks from financing new housing developments at a 1-in-100 flood risk or higher.

• Changes to building codes to boost flood resilience.

• Extending the Bushfire Resilience Rating app to flood risk.

• Requiring insurers to reduce premiums after household-level mitigation works.

• Further development of buyback and resilience programs for the highest-risk properties.

Bank CEOs on the insurance issue

Banking leaders have also been acknowledging the growing underinsurance problem in Australia for property; whether due to cost-of-living pressures resulting in home owners not taking out policies at all or being unable to do so due to limited coverage.

In 2023, for example, the CEOs of Australia’s major banks sounded the alarm on the growing issue of maintaining adequate home insurance in the face of rising premiums and increasing natural disasters.

Speaking to the House of Representatives standing committee on economics for its review of Australia’s four major banks in July 2023, Commonwealth Bank of Australia (CBA) CEO Matt Comyn highlighted the dramatic rise in premiums, with some properties becoming virtually uninsurable.

“There will presumably continue to be areas which will be very difficult to insure,” Comyn said. “We’ve still got housing supply where people are resident in areas that are a high-fire risk.”

Similarly, Rachel Slade, NAB’s group executive for personal banking, described the situation as an “emerging challenge”. She said that some borrowers in high-risk areas are underinsured or unaware of their obligation to maintain adequate coverage.

“We really feel like – whether it’s climate change, cost of living, or cost of insurance – that this is a potential emerging issue for our customers and for our bank,” Slade said.

NAB group chief risk officer, Shaun Dooley, agreed that this was “an emerging challenge” as the cost of insurance increasing will have implications for affordability.

“And so we need to continue to work with customers and insurance partners on how we’re going to deal with this issue both in the short term but also from a strategic perspective,” he said, flagging that NAB has some plans in development at the moment.

Former NAB CEO Ross McEwan concluded by saying: “We need to consider what fraction do we put into the system? And then, what do you do after that, as well? Do you take the mortgage away from people?

“All those sorts of issues I think we have to really work our way through.

“I think it is a good topic for the industry to work its way through as well because – you’re quite right – when things get tight: what gives?”

As Australians watch the devastation in Los Angeles, the parallels are hard to ignore. With climate change exacerbating the impacts of flood and fire damage and more frequent and severe natural disasters taking place, the pressure on home owners, insurers, and banks is only set to grow.

The question remains: can Australia find a way to protect its housing market from the twin threats of underinsurance and climate risk? If not, the wildfires in Los Angeles may be just a glimpse of the challenges ahead.

Do you think insuring properties will be the next big challenge for mortgagors? Let us know in the comments below.