S&P warns on impacts from escalating floods, fires

Property and casualty insurers’ ability to absorb additional natural catastrophes could be tested in the case of severe downside scenarios involving an escalation of events such as fires and floods, S&P Global Ratings says.

For the next two to three years Australia-based insurers, governments and banks should be able to absorb the equivalent of the worst blows from natural disasters in the past decades, given prudent risk management and solid balance sheets and profitability, the report says.

But sensitivity analysis suggests the creditworthiness of insurers, governments and banks would weaken if the frequency and intensity of events “materially” increase.

“Our scenario analysis suggests that our ratings on many insurers, governments, and banks would be at risk if the direct financial impact from bushfires and floods were two to three times worse than in the past two decades, or if major disaster events were to become recurrent,” S&P says.

The report notes the severity and frequency of bushfires and floods is increasing, and Insurance Council of Australia figures show the southeast Queensland and NSW catastrophe last year was the nation’s costliest. Floods and torrential rain have since continued in parts of the country.

“For insurers, governments, and banks the threat is not new, but we believe the physical risks and second-order economic knocks from weather events could damage their creditworthiness in our downside scenarios,” the report says.

Insurers’ exposures are greatest in home and contents and motor and also extend to commercial lines, collectively accounting for about 65% of gross premiums written for the year to September 30.

Higher declared catastrophes and significant events, including bushfires, floods and hailstorms have particularly affected claims since September 2019, but the blow to insurers’ earnings has been cushioned by reinsurance, which has grown to soak up 35-40% of the gross claims cost in recent years, S&P says.

The report says the cost of reinsurance has increased at record pace, rising by about 35% over the past three years alone for Australian insurers, outweighing gross written premium growth of about 30% and squeezing underwriting earnings.

Insurers, also facing stricter terms and increased retentions, are setting higher losses allowances and are adjusting their risk appetite and enhancing risk exposure assessments, such as for flood.

The report notes the Australian government has implemented a $10 billion cyclone-related reinsurance pool to support capacity and affordability.

S&P says insurers have breathing space and in a base case, on average, their underwriting profits in the next two to three years should be able to absorb additional catastrophe claims equivalent to 1.7 times the highest of the top three catastrophe claims in recent years.

“Our ratings on insurers could face downward pressure if additional claims exceed this level, or remain consistently high, surpassing the worst seen in the past,” it says.

The report also says that “all things being equal”, its sovereign credit rating on Australia could come under downward pressure if the costs of natural disasters are more than three times as damaging as those in 2021-2022 and were to recur over multiple years.

“That said, we consider that the Australian sovereign is well prepared to weather its increasing exposure from wildfires, floods, storms, and sea level rise,” the report says.

Over 2002-2014, about 96% of central government spending on disasters was allocated to post response efforts and just 4% to pre-disaster risk reduction, but S&P says the balance may be shifting, given the Disaster Ready Fund and state government programs.

But despite numerous independent tax inquiries finding that state-based insurance levies and stamp duties make cover less affordable, governments “have had little political appetite” to phase out the lucrative taxes without an obvious source of replacement revenue.

S&P sees “some risk” that political pressures will impel the expansion of the Northern Australia Cyclone Reinsurance Pool, increasing the federal government’s role as insurer of last resort.

The pool is designed to be notionally cost-neutral to the government, but “saddles it with a new contingent liability” in the form of a $10 billion guarantee, the report says.