Disclaimer: This article is republished with permission from the authors, Simon Lewis and Dr Alexander Pui. The original article was published on Sparke Helmore Lawyers and can be found here. Any views expressed in this article are those of the original authors and do not necessarily reflect the views of Altiorem.

Extreme weather events are growing in frequency and severity; Tropical Cyclone Alfred and other recent cyclone and flood events in Northern Australia, along with the Palisade fires in LA out of wildfire season, are simply the latest reminders of the systemic threat to communities posed by climate change. In 2024 global temperatures exceeded the Paris target of +1.5 deg C by the end of century and continue to rise.

Insurance plays a critical role in supporting the long-term physical and financial viability of communities exposed to extreme weather. By pricing and allocating risk it creates a transmission mechanism which changes behaviour and informs policymakers on how risks can be equitably shared and mitigated. As a result, there is growing public interest in the ongoing availability and affordability of insurance.

It’s a challenging time for policymakers; they are under significant pressure to promote economic growth and ensure housing is provided to meet immediate needs, while facilitating adaptation in communities exposed to changing climate trends as well as take action to address the causes of it. Decisions are being made under high uncertainty and without the benefit of precise insights and further investment in production of data sets and modelling to guide them.

We consider some recent Australian developments in a rapidly evolving policy and scientific area.

Weather is inherently variable – but this variable?

There is a growing consensus amongst the science community that the frequency and impact of extreme weather events is accelerating, and that this is a trend attributable to elapsed climate change of about +1.5 deg C compared to the pre-industrial era, and not merely natural variability in weather patterns.

The extent to which climate change influences extreme events is routinely documented in state of the climate reports such as those released by the World Meteorological Organization (WMO), American Meteorological Society (AMS) and others. Closer to home, the recent Senate Select Committee inquiry on the Impact of Climate Risk on Insurance Premiums and Availability (Senate Inquiry) heard evidence of this connection, including from the National Emergency Management Authority[1]. This view is supported by the 2024 State of the Climate report jointly issued by the CSIRO and Bureau of Meteorology[2].

Double disadvantage – concentration of extreme weather in communities least able to respond

Extreme weather events disproportionately impact certain geographic and social communities.

There is a clear concentration of cyclone and flood risks in Queensland and Northern NSW[3]. Recent examples include Tropical Cyclone Alfred, which has caused significant flooding and storm surge around metropolitan Brisbane, along with the 2022 floods which devastated communities in South-East Queensland and northern NSW and was the costliest insured event in Australia’s history[4].

Similarly, there is a concentration of risk in lower socio-economic groups. Analysis of the 2024 National Flood Information Database by the Insurance Council of Australia (ICA) indicated that incomes of 70% of households exposed to the highest flood risk were below the national median and 35% of those households are in areas below the poverty line.[5]

The Actuaries Institute maintains a home insurance affordability index (Affordability Index) and has highlighted the overlap, with a concentration of insurance affordability issues in northern Queensland and Northern Territory local government areas which are also most impacted by cyclone risks[6] and predicts that climate change will have a disproportionate impact on insurance affordability for vulnerable householders[7]. The Senate Inquiry heard evidence of this ‘double disadvantage’ of communities vulnerable to extreme weather conditions being least able to deal with it[8].

Financial impacts of climate change on households and lenders

There are clear physical and emotional impacts of extreme weather events, in addition to direct insurance claims costs to individual properties. Less immediately obvious are the longer-term financial impacts on households, particularly those that are not insured or under-insured. Damage to public infrastructure such as arterial roads and coastal erosion are also often unaccounted for in impact assessment to households. Hence, both direct and non-direct impacts of disasters to household incomes creates a threat to the ongoing serviceability of loans. Reduction in market values in areas prone to extreme weather events is possible, such as significant reductions in Lismore, NSW following the 2022 floods[9]. Some households, particularly those early in their loan term, may experience negative equity.

These impacts are significant on households but also on the lenders who finance their homes. The Australian Prudential Regulation Authority (APRA) undertook a Climate Vulnerability Assessment (CVA) with the five largest Australian banks to understand the impact of climate change on their balance sheets[10]. The CVA showed that climate change would result in bank lending losses, however in aggregate the participating banks were sufficiently well capitalized to be able to absorb them[11]. Naturally the CVA stress test results are highly sensitive to the input data and assumptions and so may not reflect the full extent of loss potential associated with more pessimistic climate scenarios.

The CVA highlighted significant regional impacts, with mortgage losses in specific parts of Queensland and Northern Territory significantly elevated because of increased climate risk, with the most impacted 20% of postcodes accounting for 75% of modelled mortgage losses[12]. Some participating banks predicted that they would change their lending criteria as losses mounted, including reductions in risk appetite by tightening loan-to-value ratios for new loans, underlining the potential for withdrawal of credit from some areas[13], which in turn may impact market values.

Role of insurance in identifying, valuing and transferring risk

Insurance plays a critical role in the management of climate risks, transferring risk away from households to insurers and on further to global insurance and capital markets. Mortgage lenders invariably require borrowers to take out building insurance as a condition of the loan, indeed APRA requires loan collateral to be insured at the outset and during the term of a loan[14].  The cost of this risk transfer is born by households through premiums and not by lenders, although lenders also obtain a significant benefit in protection of the value of collateral. This protection may fall away where households (particularly those in the lower socio-economic segment) are unwilling or unable to maintain full insurance over the property.

In theory, in a healthy and functioning market, insurers are better placed to manage climate risks than households or lenders, having the expertise and ability to average risk across a wider portfolio, and other insurance markets through reinsurance, as well as the ability to respond to emerging climate risks through premium pricing. APRA commenced a CVA process with the five leading Australian general insurers in 2023, building on the CVA process with major banks, to better understand the risks posed by climate change on the sector and the affordability of insurance to consumers; the results are due to be released in the second half of 2025[15].

Breakdown of the transmission mechanism – the Insurance protection gap

It may be trite to say, but insurance only operates as a risk transmission mechanism if households exposed to climate risks actually take out policies which adequately insure the risks they face.

There has been widespread concern about the gap between the amount of insurance (if any) held by households in areas prone to extreme weather events, and the physical risks they face. At a macro level, the ICA has estimated this gap in Australia at US$12bn, citing analysis from Swiss Re[16]. There is evidence to suggest widespread failure to maintain adequate property insurance in some of the most vulnerable communities in Australia; the Australian Competition and Consumer Commission (ACCC) found evidence in its Northern Australia Insurance Inquiry (ACCC Inquiry) that rates of non-insurance across northern Australia could be as high as 20%[17], and recently estimated that in some communities underinsurance could be as high as 60%[18].

The protection gap raises questions around the protection of collateral for the banking sector, including how diligently lenders check compliance with insurance covenants in loans during the loan term and the extent to which they are willing to enforce loan covenants where there is non-compliance. This feeds into the willingness of lenders to originate new loans in areas with significant rates of under insurance, with flow on impacts to market values.

Insurance availability

The ACCC has found evidence that some insurers avoided writing policies in northern Australia and others imposed more targeted embargoes on properties in cyclone-prone areas or applied restrictive underwriting guidelines, for instance only insuring properties built after a certain time (where building standards were known to be acceptable)[19]. That said, in its Northern Australia Insurance Inquiry the ACCC concluded that there was no significant shortage of property insurance for households in northern Australia, the issue was that it was unaffordable[20], although the end net impact remains the same.

Insurance affordability

The worsening affordability of property insurance in some parts of Australia has been an area of public and political focus for some time, prompting both the Senate Inquiry and the ACCC Inquiry, as well as the ongoing Insurance Affordability and Natural Hazards Risk Reduction Taskforce convened by the Australian Government[21].

The Actuaries Institute has highlighted the scale of the issue in its recent update to the Affordability Index, which indicates a significant worsening of affordability, particularly for those in the highest risk areas, noting that 5% of households in Australia with home loans, accounting for around $57bn in outstanding loan balances, were experiencing extreme home insurance affordability pressures[22], defined as households spending more than four weeks gross annual income on home insurance premiums[23].

Modelling from the Actuaries Institute shows that the weather-related natural hazards components of home insurance premiums may increase materially due to climate change (subject to uncertainty in climate projections), with disproportionately large impact on vulnerable households[24].

Policy considerations

Policy responses to support communities exposed to extreme weather events span physical harm reduction, more effective insurance risk pooling and potentially explicit subsidy. Risk mitigation is essential, as the marginal utility of insurance as an efficient risk transfer tool erodes when the transaction becomes a ‘dollar-swapping’ exercise of premiums and claims once peril events start to occur too frequently. There is, of course, a longer-term imperative to confront the causes of climate change, a focus for the ICA in coordinating efforts of the insurance industry to reduce its carbon emissions through its Climate Change Roadmap[25], as well as its broader policy advocacy[26].

Land use planning and building standards

Development of land, which is prone to extreme weather, in particular floods, is an ongoing issue across much of Australia, with a growing urban population and immediate pressure to promote housing affordability.  The Parliamentary inquiry into insurers responses to the 2022 major flood claims (Flood Inquiry) recommended that governments at all levels commit to prohibit new developments in high flood risk areas (i.e., 1 in 100 year or more), as well as consider initiatives to promote disclosure of risk information at property level and regulatory measures to discourage banks from loaning for further development in high-risk areas[27].

The ICA has gone further in its platform report for the 2025 Federal Election[28] and suggested that governments establish a managed relocation program to address legacy construction in high-risk areas through buy backs with a $10bn budget, in addition to investing in delivering new flood defence infrastructure and undertake other flood mitigation programs as part of a $30bn package to be implemented over 10 years[29].

Related to land use planning is ensuring residential building standards reflect the risks that will be faced by households in an era of climate change. The authoritative Australian Rainfall and Runoff guidelines[30] was recently updated, with amendments to the Climate Change Considerations chapter to take account of climate change experienced to date and the latest climate science[31]. This will likely impact new development and zoning practices, although there is an inevitable tension for policymakers who are under significant pressure to build new housing to confront growing housing affordability issues.

Risk pools

The Australian Government tasked the Australian Reinsurance Pool Corporation (ARPC) with forming the Cyclone Reinsurance Pool (Cyclone Pool) in 2021 with the aims of improving insurance availability and affordability for cyclone-affected communities, mainly in northern Australia[32].  Communities faced withdrawal of insurers and significant increases in premiums, given heightened risks of cyclone activity.

The Cyclone Pool commenced on 1 July 2022 and by the end of 2024 all applicable insurers had joined[33]. There are some early signs from ACCC monitoring that the Cyclone Pool is expanding access and affordability of insurance in regions facing higher risk of cyclones[34].

The Cyclone Pool has a particular focus on cyclone events and covers wind, rain, rainwater runoff, storm surge and flood arising from them; it doesn’t, for instance, cover flood events more generally, or events arising more than 48 hours after the end of a declared cyclone. The Senate Inquiry recommended that the Cyclone Pool be expanded to cover ‘all natural disasters’[35]. Similarly, the Flood Inquiry recommended that the Australian Government consider establishing a government reinsurance arrangement for flood risks[36]. Indeed, the idea of a government-supported flood reinsurance pool is longstanding; it was recommended by the 2011 National Disaster Insurance Review (NDIR)[37]. Some of these issues were canvassed by the recent report of the Parliamentary Joint Select Committee on Northern Australia in its final report on the Cyclone Reinsurance Pool; the committee did not make any recommendations on them, although it did underline the importance of the upcoming legislated review of the Terrorism and Cyclone Insurance Act 2003 (Cth) (TCI Act) this year in considering these points. The Committee also recommended this review be published given the public interest in it[38].

The ACCC Inquiry observed that a reinsurance pool was usually a response to lack of availability of insurance, whereas reinsurance was readily available in commercial markets and property insurance in northern was available, albeit expensive[39]. The ACCC observed that a reinsurance pool could conceivably reduce premiums to insureds through removing the reinsurance profit margin, increasing bargaining power with retrocessionaires and encouraging more competition amongst primary insurers, although the extent of savings in premiums was uncertain without an explicit government subsidy[40].

Instructively, early signs following TC Alfred indicate that the Cyclone pool is acting as intended in terms of providing reinsurance support to local insurers, with preliminary ARPC modelling estimating that total losses covered by the Cyclone Pool of around $1.7bn[41]; time will tell if and how it cushions against post event rate increases.

Explicit subsidy

There is a clear equity issue arising from the concentrated impact of extreme weather on specific communities, particularly given their socio-economic disadvantage, when the causes of climate change manifest across the broader community. In concept that seems like an appropriate situation for government subsidy, which effectively shares part of the risk with the broader Australian community.

A government subsidy of reinsurance premiums through a reinsurance pool has been suggested on several occasions, including by the NDIR (for flood risks) and 2015 Northern Australia Insurance Premiums Taskforce (NAIPT) for cyclone risks[42]. Evidence was heard by the Senate Inquiry recently advocating for direct government subsidy of insurance premiums in affected communities[43].

The ACCC Inquiry found that subsidising reinsurance premiums through a reinsurance pool could reduce premiums across the board, although it was not the most effective way to target finite government support for those households who needed it most[44]. The ACCC indicated that a direct subsidy to households which took account of their income and insurance premiums, would be the most effective way to assist those households impacted most by insurance affordability in affected areas[45].

The Productivity Commission strongly recommended that Australian governments avoid subsidized insurance schemes in its 2023 Advancing Prosperity inquiry report, fearing that it would encourage the wrong behaviors, effectively ‘subsidising the movement of individuals, households, and businesses into harms’ way’ and increases the overall cost of adapting to climate change[46]. The ACCC observed that subsidizing insurance in affected areas masks the true risks of a property and can dampen the incentive for homeowners to undertake mitigation works[47].

Significant investment in climate modelling needed

Before risk can be managed it must be assessed to an appropriate degree of robustness. Modelling of the impact of climate risk is an emerging area. While there is growing confidence in the modelling of systemic impacts of climate change particularly with the advent of improved computing power and understanding of climate science, there remains significant uncertainty about the impacts of climate change on individual communities. The difficulty of modelling the multiplicity of physical factors which influence the impact of extreme weather on a particular location combines with a relative lack of empirical evidence to support findings.

APRA observed the uncertainty of climate modelling in the CVA, noting that amongst the big 5 banks participating some showed no losses attributable to climate change scenarios, others showed loss rates three times higher than historical rates, highlighting the need for further investment by banks in climate modelling[48].  It should be noted that beyond APRA, climate stress tests around the world conducted to date have generally resulted in benign impacts, and this speaks to fundamental challenges in climate scenario assessment methodology often deployed in these stress tests[49]. Analysis undertaken at a more granular property, rather than postcode level does not necessarily produce more accurate results due to inherent upper limit to predictability due both uncertainty in underlying current risk levels and climate projections, making it difficult to set a consistent and reliable baseline of risk.

The Australian Bankers Association has endorsed the need for greater scenario modelling, with a focus on specific local scenarios in the nearer term (3-5-year horizon) to allow for more targeted analysis, in contrast to contemporary models with a 30-year horizon which are often not specific to Australia[50]. It is, however, important to note that tests within a 10-year horizon will be within the bounds of El Nino/ La Nina cycles and natural fluctuations in weather.  There is still merit performing near term stress tests to compel regulated entities to better understand risk baselines and consider second order impacts such as plausible reactions of various key stakeholders such as industry, government and communities following climate catastrophe events.

Finally, climate risk information should be freely available to the public. The Inquiry recommended that comprehensive disaster risk mapping is established and is accessible to the public[51]. An example of clear and widely acknowledged open-source peril data is earthquake and flood hazard maps[52] maintained in Japan which are often used by buyers during the purchase of property. The Hazards Insurance Partnership is a positive development, an initiative bringing together Australian Government and the insurance industry to enhance cooperation, including through streamlining data exchange between government and industry and development of centralized data assets[53].

Conclusion

Insurance plays an essential role in supporting policymakers and exposed communities adapt to climate change, both in pricing and spreading risk. The effectiveness of this transfer mechanism depends on the availability and affordability of insurance in affected communities.

Significant work is already being undertaken to explore ways to improve insurance affordability in exposed areas and the report of the Australian Government’s Affordability and Natural Hazards Risk Reduction Taskforce will be a key event, as will be the legislated review of the TCI Act due in 2025[54].  More work is needed to explore connection between credit, insurance, and the resilience of climate-impacted communities.

Managing and reducing property exposures in existing high hazard zones will be challenging, but at the very least steps should be taken to prevent further new development into high hazard zones. Banks could work alongside Insurers to come up with adaptation financing/ funding of resilient infrastructure such as levies to ensure sustainability and affordability of general insurance, which also then has positive co-benefits to the community, banks, and businesses.  For regions where adaptation measures are considered too costly, managed retreat should be considered and the ICA has put forward a significant policy proposal for the 2025 federal election.

Finally, communities, insurers and policymakers will be flying blind without significant further information in climate data and modelling, particularly at a more granular community level. It will be interesting to see how the Hazard Insurance Partnership can push this forward.

[1] Report of Inquiry into Impact of Climate Risk on Insurance Premiums and Availability (Senate: 2024) [Link] Ch 2.

[2] State of the Climate 2024 (Bureau of Meteorology and CSIRO: 2024)  [Link], p 2.

[3] Uninsurable Nation: Australia’s most climate-vulnerable places (Climate Council: 2022) [Link], p 8.

[4] Insurance Catastrophe declared for Tropical Cyclone Alfred (Insurance Council of Australia: 9 March 2025) [Link].

[5] Ibid

[6] Home Insurance Affordability and Socioeconomic Equity in a Changing Climate – Green Paper (Actuaries Institute: August 2022) [Link], para 5.1-2.

[7] Ibid, para 5.3.

[8] Note 1, paras 3.24-3.39.

[9] Lismore land values halved following 2022 floods (PointData: March 2024) [Link]

[10] Information Paper: Climate Vulnerability Assessment Results (APRA: 2022) [Link].

[11] Ibid, p23.

[12] Note 10, p23.

[13] Note 10, p24.

[14] Prudential Standard APS 220 – Credit Risk Management [Link], Attachment A.

[15] Insurance Climate Vulnerability Assessment – Information Paper (APRA: 2024) [Link].

[16] Submission to Inquiry on the Impact of Climate Risk on Insurance Premiums (Insurance Council of Australia: 2 July 2024) [Link], p 2.

[17] Northern Australia Insurance Inquiry – Final Report (ACCC: November 2020) [Link] p 269-70.

[18] Insurance monitoring – Third report following the introduction of a cyclone and cyclone-related flood damage reinsurance pool (Australian Competition and Consumer Commission: September 2024) [Link] – p 21.

[19] Ibid, pp 75-77.

[20] Note 17, p146.

[21] Ministerial media release: Insurance Affordability and Natural Hazards Risk Reduction Taskforce (Australian Government: 31 May 2024) [Link]

[22] Home Insurance Affordability and Home Loans at Risk (Actuaries Institute: 2024) [Link], p 22.

[23] Ibid, p 4.

[24] Note 6, para 4.1.

[25] Climate Change Roadmap: Towards Net-Zero and Resilient Future: 2024 Update (Insurance Council of Australia: 2024) [Link].

[26] For instance, Getting to Net-Zero – Policy Recommendations for federal and state governments (Insurance Council of Australia: 2023) [Link].

[27] Flood failure to future fairness – Report on the inquiry into insurers’ responses to 2022 major flood claims (House of Representatives: October 2024) [Link], p 311.

[28] Advancing Australia’s Resilience – Policy recommendations for the next Australian Government (Insurance Council of Australia: February 2025) [Link], p 8

[29] Ibid, p 6.

[30] Ball J, Babister M, Nathan R, Weeks W, Weinmann E, Retallick M, Testoni I, (Editors), 2019, Australian Rainfall and Runoff: A Guide to Flood Estimation, Commonwealth of Australia.

[31] FAQ: Update to Climate Change Considerations Chapter in Australian Rainfall and Runoff: A  guide to Flood Estimation (Department of Climate Change, Energy the Environment and Water: 2025) [Link]

[32] Ministerial media release: More affordable access to insurance for Northern Australians (Australian Government: 4 May 2021) [Link]

[33] ARPC Announces full participation of mandated insurers in cyclone pool (ARPC: 2 January 2025) [Link]

[34] Insurance monitoring – Third report following the introduction of a cyclone and cyclone-related flood damage reinsurance pool (Australian Competition and Consumer Commission: September 2024)[Link], pp 5-7.

[35] Note 1, Recommendation 4, p58.

[36] Note 27, Recommendation 70, p310.

[37] Natural Disaster Insurance Review – Inquiry into flood insurance and related matters (The Treasury: September 2011) [Link], p 62-64.

[38] Final report of Inquiry into the Cyclone Reinsurance Pool (Australian Parliament – Joint Select Committee on Northern Australia: March 2025) [Link] p 57.

[39] Note 17, p 159.

[40] Note 17, pp 160-2.

[41] Update on ex-Tropical Cyclone Alfred (ARPC: 25 March 2025) [Link].

[42] Note 17, p 157.

[43] Note 1, p 46.

[44] Note 17, p165.

[45] Note 17, p 177.

[46] 5 Year Productivity Inquiry: Managing the climate transition – Inquiry report volume 6 (Productivity Commission: 2023) [Link], Recommendation 6.1, p 6.

[47] Note 17, p 181.

[48] Note 10, p 22.

[49] Pui and Werner, Financial Risks of Climate Change: Piranhas or Red Herrings, UNSW Press, 2023

[50] Climate Risk and Capital Thought Leadership Paper (Australian Bankers Association: 2023) [Link], p 10-11.

[51] Note 1, Recommendation 1, p56.

[52] https://www.j-shis.bosai.go.jp/en/, https://disaportal.gsi.go.jp/index.html

[53] Hazard Insurance Partnership – Terms of Reference (National Emergency  Management Agency: ) [Link].

[54] Terrorism and Cyclone Insurance Act 2003 (Cth) s 41.