Australia's actuary warns of potential threat to the financial system due to the existence of a significant insurance deficiency.

The Australian financial landscape is facing a significant challenge due to the increasing unaffordability of insurance premiums, a problem that has been on the rise for several years. According to recent assessments, approximately 1.6 million households in Australia have insurance premiums that would exceed a month's gross income, a figure that represents a 15% increase from the latest assessment in 2024.

This trend is particularly concerning in light of the geographic variation across the country, where the risk could be even higher in some areas prone to extreme weather events.

The unaffordability of insurance premiums is not just a household issue. Many small businesses in Australia use residential property to secure business loans, which could be affected by the increasing insurance gap. Banks will need to conduct more thorough assessments when making home loans and potentially deny loans for homes that are uninsurable.

The potential consequences of this crisis could be severe. If loans with unaffordable insurance were to go under, it could cause a crisis for the banking system in Australia. To prevent this, there is a need for banks to give out loans for adaptation measures, such as building resiliency in communities, including low-income areas.

One solution to facilitate loans for adaptation measures is to issue green adaptation bonds. These bonds would free up public money for building resiliency in the community.

The issue of insurance unaffordability is likely to increase as extreme weather events become more common in Australia and the world. Climate change is making things worse in all regions, reducing the benefit of diversification.

Insurance companies may reduce their appetite for property risk due to increased extreme weather events. In the long term, some risks may become uninsurable. Sharanjit Paddam, an actuary at Finity, expects some fluctuations in the rate of increase of insurance unaffordability but believes it will increase in the long term due to increasing emissions.

The best solution, according to Sharanjit Paddam, is to find adaptation solutions, especially for housing. Major Australian banks such as Commonwealth Bank, Westpac, ANZ, and NAB have active climate risk assessments integrated into their home loan processes, and there are regulatory guidelines from the Australian Prudential Regulation Authority (APRA) mandating banks to consider climate risks in their lending practices.

To help people understand the risks associated with climate change, mandatory disclosures are needed. This year, Australia's mandatory climate disclosures go into effect, aiming to surface the impact of climate change on the financial system.

Policymakers need to ensure that finance is used efficiently to solve the problem of climate change. Approximately 3% of bank loan assets are likely to have unaffordable insurance, equating to roughly AUS$60bn in loans. With the right strategies and policies, it is possible to mitigate this risk and build a resilient financial future for Australia.