Virtual Summit Shorts: A grand proposal for uninsurable risks

Three people walk into a bar.

The first is an insurer, who sits at the bar and bemoans to the bartender “You know how hard it is to cover flood risk? The tail of that risk is just too fat!”

The second that walks in is a consumer who lives on a floodplain, who sits at the bar and (with total justification) wails to the bartender “How am I supposed to afford flood insurance? The fair premium is just too high!”

The third person is the government (yes, a person is a whole government, just go with it), who leans on the bar in all their bipartisan glory and declares to the bartender “I can’t keep stepping in after a flood event happens, something must be done to ensure the availability and affordability of flood insurance. The government debt is just too high!”

And then an unexpected fourth person called Corona runs in and makes the situation even worse for everyone.

I’m sorry to get your expectations up but there’s no punchline to this joke. Because this isn’t a laughing matter (also because I couldn’t think of a good punchline – insurance humour is very niche ok?). But importantly in this situation, the bartender is Richard Hartigan. And while politely ignoring and waiting for the fourth person to just leave already, he actually has an idea on how to solve the three people’s common problem…

With many uninsurable risks, there are normally only two options: coverage at a steep price, or no coverage at all.

And in most cases, ‘coverage’ comes with a litany of exclusions – it may not cover damage from flood, vermin, gradual deterioration, forgetting to secure your home, pets, terrorism, nuclear contamination, or smiting from a heavenly being.

But what if there was a third option, a ‘middle ground’?

What if insurers offered coverage with no exclusions, and it included the tail end of the risk but not 100% of it?

The concept is simple. Up to a certain threshold, there is full coverage. But when the loss exceeds that threshold, the insurer only has to pay out a portion of losses. Typically, this would only happen when there is a large collective loss event, such as a flood that affects a significant number of homes.

The benefits are obvious:

• The wailing insured gets simple, affordable coverage in most cases, and still gets some coverage when there’s a large collective event.

• The bemoaning insurer doesn’t have to deal with squabbles over what is or isn’t included, and covers all relevant losses, including those from Black Swan events. But their exposure is effectively capped when there’s a large collective event.

• The proud government sees insurance elevated to a product of good value and is more affordable. Huzzah!

The last point is important – ‘more affordable’ means that the affordability crisis isn’t solved (those most at risk will still be paying more), but it is somewhat alleviated (it essentially co-insures the tail risk).

But when it comes to insurance, wouldn’t having only partial tail coverage impact what is arguably the most important time that insurance is needed?

Such as, oh I don’t know, maybe when there’s a large collective industry loss event and many people are at risk of losing their entire home?

One answer is “yes and no” – for many, this partial coverage is better than no coverage, which is often the case when insurance isn’t affordable. Plus, there’s no reason why the industry (and even the same insurer) can’t offer different types of policies – the ridiculously expensive policy with full coverage, the more affordable policy with exclusions, and the new policy with partial coverage above a threshold. Consumer, take your pick.

Another answer is “it depends” – if this idea is taken further, the focus then shifts to the threshold itself:

• Will insurers compete on having the better (i.e. the higher) threshold? I struggle enough thinking about whether picking a higher deductible on my car insurance is worth the saving in premium. I don’t think I’d be able to pick the threshold above which I’d want partial coverage to kick in! So it then becomes vital for industry, particularly consumer choice bodies, to educate consumers on what thresholds are reasonable, and how there are more differentiators than just the dollar threshold offered (for example, a smaller insurer may not be able to offer as high a threshold as a larger insurer, but they may be able to offer better service).

• Is it better to have a single threshold across all these types of policies? It would make the consumer’s role a lot easier. But government legislation would be key in this situation, and this may also involve sharing losses between insurers.

And let’s not forget the public pressure that consumers and the media put upon insurers and government at times of large industry losses. Despite the upfront understanding of only partial payouts above the threshold, insurers may end up being pressured to pay more, or government may still be pressured to step in to cover the remaining. Despite whether or not this threshold is agreed in policy wording in advance.

What was most interesting was that elements of this proposition drew parallels to other initiatives that countries have deployed. Some of these that were discussed included:

• The Terrorism Reinsurance Pool in Australia, where the government has the ability to declare a reduction percentage in payouts if the scheme’s capacity is exceeded.

• The Earthquake Commission in NZ, where the government covers some of the lower layers of risk.

• The Japanese Earthquake Reinsurance Co., which retains a portion of the liability and cedes the rest back to private insurers (based on market share) and the Japanese government through reinsurance treaties.

• Private health insurance in Australia, where the health insurers share the costs of policies written for certain ages of policyholders.

It’s clear that this idea comes at a time when governments of countries all over the globe are still struggling with how to deal with uninsurable and unaffordable risks, and therefore Richard’s proposition is one that is likely to see further discussion in years to come. Hopefully sooner rather than later, because the sooner that tangible steps are taken to address this crisis, the sooner that the three people at the bar can just enjoy a drink.

Thanks again to Richard Hartigan for his very thought-provoking and discussion-generating session.

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