Insurance Climate Vulnerability Assessment

1. Insurance CVA

Figure 1: Insurance CVA process map

1.4.1 Climate Scenarios

The initiative explores potential changes to general insurance affordability in Australia under two future climate scenarios developed by the Central Banks and Supervisors Network for Greening the Financial System (NGFS).⁷ The scenarios published by the NGFS are not forecasts or predictions of future climate outcomes, but instead explore possible futures under different climate-related assumptions: the scenarios should not be interpreted as an official forecast. In addition, the assumptions included in these scenarios are not intended to provide an indication as to likely future policy developments or responses from APRA or other government agencies.

The two scenarios used in the Insurance CVA have been selected from a wider range of NGFS scenarios to explore two different potential climate futures. One is a high emissions scenario, aligned to the NGFS Current Policies Scenario, which includes severe but low-probability, high-impact physical climate risks and limited transition risks. The second is a lower emissions scenario, aligned to the NGFS Delayed Transition Scenario, which results in moderated physical climate outcomes but elevated transition risks. A third scenario was also modelled which assumed no further physical climate change or climate-related policy changes: this baseline scenario provides a basis against which the impact of climate change under the two NGFS scenarios can be assessed.

For both the lower and higher emissions scenarios, APRA sought guidance from and consulted with experts and relevant organisations to adapt the NGFS scenarios to better align with the Australian context and the Insurance CVA’s objectives.

1.4.2 Co-Design Process

Throughout the Insurance CVA, APRA has engaged with a range of organisations, including the Participants, to ensure that a diversity of insights and expertise were available to inform the design decisions taken in the initiative. For the overall design, APRA engaged with the five participating insurers through the “co-design” process facilitated by the ICA, the peak industry body for general insurers in Australia. This approach facilitated the development of a practical design that met the objectives of the initiative, while leveraging the knowledge and experience of industry. 

Through the co-design process, APRA identified the guidance and inputs that the Participants would require to complete the affordability projections. APRA was then able to engage leading insurance⁸, geospatial⁹, and other experts¹⁰ to provide the information necessary to completing the Insurance CVA.

The co-design process facilitated the comparability of the Participants' modelling by establishing agreements on how to handle modelling decisions such as the scope¹¹, coverage level, competition, and how other product features would be treated to maintain existing relative insurance market conditions to 2050. APRA acknowledges that numerous other factors, beyond those modelled, could also impact insurance pricing. However, the common parameters provided to the Participants ensure clarity of climate-related insights and enable comparability across different modelling approaches, time steps, and climate scenarios.

APRA engaged an independent economic modelling consultancy, Oxford Economics, to provide macroeconomic modelling to support the Insurance CVA. The macroeconomic modelling built on, and extended, the economic modelling conducted by the NGFS for the two future climate scenarios, as well as for the baseline scenario.

1.4.3 Macroeconomic Modelling 

The modelling provided a more detailed, Australia-specific set of economic parameters for use by the Participants, including different measures of interest rates, inflation, and financial asset price projections relevant to projecting future premiums and household incomes. For the high emissions scenario, Oxford Economics included an economic damage function that considers effects due to temperatures trending away from long-run means, as well as climate change-attributed changes in the volatility and likelihood of extreme weather events.¹²

1.4.4 Physical Risk Guidance

1.4.4.1 Risk Drivers

APRA worked with leading scientific agencies and experts, including the Bureau of Meteorology (BoM), the Australian Climate Service (ACS), and the Commonwealth Scientific and Industrial Research Organisation (CSIRO), to provide physical risk guidance and support the Insurance CVA. The Insurance CVA includes all physical risks typically covered by general insurance, including both non-climate driven natural perils, such as earthquake and volcanic eruption; and the climate-sensitive weather perils of cyclone (including cyclone-related storm-surge), flood (including non-cyclone storm surge), storm and hail, and bushfire.

For climate-sensitive weather perils, guidance¹³ was provided to the participants by APRA which included high-level measures of the change in frequency and intensity across the different geographies of Australia. All other natural perils (such as earthquakes), together with other risks (e.g. house fire) are included in future premium price modelling as an “Other Peril” category.

Some weather extremes affected by climate change are not typically priced into insurance products and premiums, such as sea-level rise, water scarcity, and heat stress. While such risks can impact the financial interests of households, the insurance market does not typically provide an explicit price signal, and therefore these risks fall outside the scope of the ICVA.

1.4.4.2 Reinsurance

Reinsurance for weather related perils is currently provided by the Australian Reinsurance Pool Corporation (ARPC) for cyclone reinsurance, and by commercial providers for non-cyclone reinsurance. Reinsurance costs are included in the insurance premium modelling carried out by the insurers. 

For cyclone reinsurance, the ARPC provided reinsurance guidance for cyclone risk to the participants; including for damage from associated flooding that is incurred up to 48 hours after a cyclone has ended. For non-cyclone reinsurance, the attachment point for insurers’ reinsurance remains at the same return period as their 2024 arrangement throughout the projection period. In projecting reinsurance premium, insurers will calculate the ceded annual average loss (AAL) over the projection period to 2050, and apply the uplift factor (that is, the margin above the ceded AAL) that is used at the 2024 starting point and maintain this throughout the projection period.

1.4.5 Premium Price Projections

The Participants generated premium price projections using a combination of the external inputs provided by APRA and their internal modelling assumptions. 

Premium is defined as the cost to be paid by a customer for a combined home and contents insurance product. The premium is comprised of multiple inputs, including expected claims costs from climate-related perils, reinsurance costs, expected non-climate related claims costs (e.g. earthquake, house fire, theft), taxes, and all other costs (e.g., claims handing costs, financing costs, profit margins, commission costs).

1.4.6 Income Projections

APRA engaged Oxford Economics to model the potential evolution of household income to 2050 for the two climate scenarios, and the baseline scenario. The modelling approach combined macroeconomic variables with region-specific economic influences to derive estimates of household employment income across Australia to 2050.

1.4.7 Affordability metric

The Participants will calculate an insurance affordability metric that expresses the cost of insurance premiums in relation to the number of weeks of income required to cover annual premium. This metric is intended to provide a straight-forward measure of affordability which captures the impact of changes in both physical and transition climate risks. As the frequency and severity of weather perils change into the future, the change in physical climate risk will affect premium prices; at the same time, transition climate risks will impact the broader economy, which in turn can impact household income.

2. Next steps

APRA expects to receive the affordability metric results from the Participants in the first half of 2025 and intends to publish a report based on the results later in 2025. The report will support an improved understanding of potential future general insurance affordability challenges. It is intended to provide stakeholders including governments, policyholders, the community, and insurers, a more informed view of how general insurance affordability may evolve over the medium term in response to the physical and transition risks arising from a changing climate.

Footnotes