Insurers are increasingly using granular data on risk exposures and historical claims experience to price risks more accurately. A consequence of this greater 'risk-based pricing' is increased selectivity, differential pricing and changes in levels of coverage for insurance contracts, says the Reserve Bank of New Zealand in its May 2019 Financial Stability Report released earlier this week.
The report says that risk-based pricing will enable insurers to make targeted responses as they change their assessments of the risks of climate change to coastal property, areas prone to flooding, and more frequent extreme weather events.
Risk-based pricing results in higher insurance costs for some, and a transfer of risk from insurers to affected households and businesses, and institutions that lend to them. This is likely to reduce the value of assets negatively affected by risk-based pricing, and weaken the financial positions of the assets’ owners. A rapid and disorderly change in the provision of insurance could also reduce competition and efficiency in the insurance market.
The impact of risk-based pricing in New Zealand is likely to be amplified by the high concentration of the general insurance sector. High concentration reduces the capacity for other insurers to insure risks affected by risk-based pricing, the report says.
Affordability
Some of the impact of risk-based pricing has already occurred. A greater appreciation of earthquake risks in New Zealand following the Canterbury and Kaikoura earthquakes has caused some insurers to change the price and coverage of some home and contents insurance contracts to better reflect the underlying risks of properties they insure. This has caused a decline in the affordability of home and contents insurance for relatively risky properties.
Currently, it is expected that a small proportion of insurance customers will face materially higher prices, and very few will be unable to obtain full insurance cover. But the precise impact on the overall availability and price of insurance is uncertain, reflecting limited information on reinsurance costs for New Zealand and insurer strategies.
The Reserve Bank is engaging with insurers and reinsurers to better understand the evolving position in more detail. It is likely that risk-based pricing will become more widespread in New Zealand over time. Owners of particularly high-risk assets should be aware that their insurance costs are likely to rise and the level of cover that they can obtain may become more limited in the future.