2012 and beyond: Where to next for insurance in Australia?

My thanks to the American Chamber of Commerce for inviting me here today.

2011 has been one of the toughest years ever for insurers in Australia, punctuated by flooding, cyclones, earthquakes and bushfires.

It’s certainly been the most intense of my 13 years in the industry, however it’s also demonstrated the crucial role this sector plays.

IAG’s businesses, which include NRMA Insurance, CGU, Swann, SGIO, SGIC and The Buzz, have this year injected hundreds of millions of dollars in gross payouts directly to affected communities, helping individuals and businesses get back on their feet faster and minimising the impact on our economy.

It may seem counter-intuitive, but it’s difficult years like this that lead me to be very optimistic about the future for the industry.

2011 has been a significant year for Insurance Australia Group as well.

Following three years of hard work we’ve:

• Refocused the business on discipline and underwriting fundamentals;
• Substantially improved the collective underlying margin of our businesses in Australia and New Zealand;
• Delivered $130 million of annual cost savings; and
• Invested substantially in our workforce.

In June we announced our intention to shift our focus back to target profitable growth in our home markets of Australia and New Zealand, and to double the premium revenue generated by our Asia business in the next five years, on a proportional basis.

At the same time, over the past 12 months IAG’s businesses have handled over 150,000 additional claims, over and above our normal “business as usual” claims activity.

I’ve been exceptionally proud of how our people have risen to these challenges.

By their very nature, insurers are people who spend a lot of time thinking about the future – and it’s the future I want to focus on today.

I feel it’s timely to look ahead and consider the key factors and trends that will shape Australia’s insurance market over the next 12 months and beyond – and the priorities we must set in response.

From my perspective, there are three key priorities:

1. First, making sure that our communities are safer so we are better prepared for the next significant challenges Mother Nature throws at us.
2. Second, ensuring our product, insurance, remains relevant.
3. Third, keeping insurance affordable.

I’d also like to spend some time briefly outlining the key issues for IAG as we pursue our strategy in this changing environment.

1. MAKING OUR COMMUNITIES SAFER

The first priority is making sure we learn the lessons from our recent experience to make our communities safer.

If we don’t take action, we’re doomed to repeat this cycle of destruction, devastation, slow rebuild and lost productivity over and over again into the future.

December and January were not the first times that many of the areas around Brisbane, Ipswich, Toowoomba and Emerald had been severely flooded. It will also not be the last time. In these areas, it is not a question of if; it’s a question of when the next flood will come.

Notwithstanding this inevitable pattern, plenty of development – homes, sheds, businesses, even infrastructure like substations – was allowed to spring up in areas of unacceptable risk around Brisbane and Ipswich over the intervening drier years.

While it’s an admirable human quality to seek quickly to move on and rebuild, it is reckless to do this in a way that ignores clear historical records. We do a great disservice and potential harm to our community if we grow apathetic in our approach to rebuilding.

In recent times we’ve seen significant new areas of land being opened up for development in the rapidly growing areas around the north west of Sydney. Much of this region is located on the Nepean floodplain and has historically been subject to severe flooding.

We believe the planning authorities responsible for releasing these areas of land must ensure mitigation work is conducted prior to any new building, so it is not subject to flood if the outskirts of Sydney experience a wet summer similar to Queensland’s.

We see similar risks emerging in Australians’ rush to settle on the coast. This leads to high population densities in many low-lying towns near the ocean – increasing the community’s exposure to emerging risks like coastal erosion, storm surge and tropical cyclones.

The insurance industry is well placed to continue to play a leading role in encouraging action on adaptation, to make our communities stronger and better able to withstand catastrophes. There needs to be a focus on:

1. Increasing the woefully inadequate level of investment in mitigation infrastructure.
   Protective works could include barrages for unusual tides, levee banks, sea walls, properly maintained fire breaks and access trails, improved drainage and dams.
   Infrastructure investment has the double advantage of being a down-payment for future resilience and an economic generator.

2. Second, planning authorities must be a lot tougher and more transparent about their planning and zoning decisions. Development simply shouldn’t be allowed in areas of unacceptable danger.

3. Third, strengthened building standards will ensure we are adequately prepared for changing risks.

   Standards should consider:

   • ​​Construction from fire-resistant materials.

   • Higher up-lift in flood plains; and

   • Reinforcement for items like garage doors that often break loose, causing significant additional damage, cost and potentially injury.
     The improvement to building codes in cyclone-prone areas in north Queensland following Tropical Cyclone Larry meant that – notwithstanding its enormous size and destructive wind speeds – the level of damage incurred during Tropical Cyclone Yasi in February was surprisingly low.

2. INNOVATION & RELEVANCE OF INSURANCE

Turning to the second priority I mentioned at the outset: a challenge for the insurance industry in the coming years will be to safeguard its ongoing relevance to its customers.

To do this, we must continue to be innovative and ensure we have products that adequately reflect new and emerging risks.

We must also ensure that our customers remain confident that our products offer the right cover and peace of mind. The expectations of some customers around the Queensland floods were not met. While there were reasons for many insurers being unable to offer flood cover in Queensland, the fact remains, a lot of people who thought they had cover did not.

At IAG, we’ve already announced our businesses are expanding flood cover to all home and contents customers across Australia and our businesses will have more to say about this in the near future.

IAG is supporting the government’s response to the Natural Disaster Insurance Review and will continue to be a constructive participant in its implementation over the next year.

In particular we support the moves to provide better access to and coordination of flood mapping data through Geoscience Australia.

We also support the government’s other initiatives to improve consumer understanding, including the standard definition for flood and the one page key facts statement that will clearly outline key inclusions and exclusions in each policy.

More broadly, IAG believes that we must proactively seek to understand how the risk environment is changing, so our products are appropriately designed and priced.

We have a dedicated internal natural perils team, which conducts detailed modelling of the likely incidence of the most severe type of cyclones and significant hail storms in coming years.

Interestingly, their modelling indicates that in the next four decades we are likely to see a 15% increase in the number of the most destructive category 4 and 5 tropical cyclones and that there will be an increased frequency of cyclones tracking extra degrees of latitude further south – potentially affecting the major population centres of Brisbane, the Gold and Sunshine Coasts and northern NSW.

Over the same time period they also project that hailstorms involving larger stones of up to 10cm (similar to the major Sydney storm in 1999) to double in frequency.

Through a sharper understanding of these evolving risks, we are able to plan for the future, offer our customers more relevant cover and ensure we are positioned to safely provide this cover.

A changing climate will present challenges at all levels of society, and the insurance industry must be right at the centre of the response. For this reason, IAG welcomes the recently announced inquiry by the Productivity Commission into the barriers to effective climate change adaptation.

The issues paper released by the Commission last month clearly acknowledges the role insurance can play in adapting communities to climate change.

In particular, the paper highlights how insurance creates efficient financial incentives to reduce exposure to hazards. Where there is a high risk, the premium to cover that risk is higher. Such a price signal is the best way to incentivise people, businesses and governments to take action to reduce their exposure.

While this is economically efficient, it does raise other practicalities, including affordability in the areas of highest risk, and that is the third priority I want to address today.

3. AFFORDABILITY OF INSURANCE

Customers will weigh up many factors when they are choosing their insurance – including what is covered by their policy. However, a key part of their decision is what they can afford.

For every customer there will be a price where they decide that, rather than paying the premium, it is preferable to drop out of the insurance safety net and effectively wear the risk themselves.

The affordability of insurance is an important social issue. Private insurance policies aren’t just a safety net for businesses and individuals; they are a safety net for the taxpayer. So when someone drops out of the safety net or is underinsured, there is a potential economic impact on the rest of us.

It’s been widely reported that insurance premiums will be subject to upward pressure in the coming year. This is partly due to the claims inflation you often see after major events as the demand for parts and labour pushes prices up.

However, a bigger factor will be how global reinsurance companies re-evaluate the risk of Australia and New Zealand and how this is reflected in the cost of the reinsurance local insurers like IAG purchase.

At the same time, we are seeing a combination of factors working to increase the concentration and price of risk:

• The population is becoming increasingly urbanised and concentrated into certain areas;
• Rising living standards mean larger homes with more possessions; and finally
• The incidence of severe weather events is expected to increase as a result of climate change.

Skilfully managing these increased costs will be an important competitive factor over the next one to two years.

At a company level within IAG, we are focusing on making our pricing increasingly more granular and dynamic – focusing on individual street addresses through geocoding and data on individual risk factors. This will ensure we are targeting the right risks for the right price.

However, at the broader public policy level there are two other ways to attack the affordability issue.

Firstly, a focus on the various mitigation and adaptation initiatives I outlined earlier will have a sustainable and long-term effect in keeping the cost of insurance down.

A second change that would deliver both immediate and ongoing results would be the removal of inequitable state government taxes from insurance.

There is broad agreement that these taxes are among the most inefficient and distorting taxes in our system, yet they have proved extremely stubborn.

Insurance taxes add over $4.25 billion each year to insurance policies in Australia. They can add an extra $40 on top of every $100 of premium in NSW, a burden magnified by the tax-on-tax-on-tax effect of levying the insurance stamp duty and GST on top of the premium and fire services levy.

Insurance taxes have also been found to contribute to the worryingly high level of underinsurance and non-insurance in Australia. Replacing these imposts on insurance customers with a broader, more equitable source of revenue would have an immediate positive effect on the affordability of insurance policies.

To this end, I am encouraged by recent National Tax Forum, which asked Treasurers of NSW and Queensland to review State taxes and called for rapid action on the insurance tax burden, to make a substantial contribution to the affordability of premiums.

PRIORITIES FOR IAG

Turning my focus closer to home, I also wanted to look at some of the priorities for us at IAG, particularly as we pursue our strategic priority of profitable growth in this changing environment.

Our Australian businesses continue to perform well. Direct Insurance has been delivering solid results and the turnaround of CGU, is well underway with objective being to restore double-digit margins after some challenging years.

In New Zealand, there has been some recent speculation about the impact of the recent earthquakes on the insurance market of that country. I must say that I view much of this commentary as overblown – we continue to view New Zealand as a very viable market.

Our New Zealand business is performing very strongly in the face of the earthquakes and we are comfortable reinsurance will continue to be freely available to the larger, diversified players like us.

While IAG will always be predominantly an Australian-based insurer, we also recognise that, in order to continue growing profitably, we can’t constrain our view to our largely consolidated home markets.

Much has been said about the gravitation of economic activity toward Asia and the dawn of the “Asian century”. President Obama emphasised his focus on the region during his recent visit.

IAG has identified substantial medium-term growth opportunities for our business in the region, and we believe we are ideally positioned to capitalise on them. These are markets characterised by relatively low levels of insurance penetration, rapidly growing wealth and geographic proximity to Australia.

In addition to partnering with trusted local brands to capitalise on rapid market growth, IAG adds value through our specialised insurance expertise and experience.

A key strategic priority for us over the next five years is to expand our existing footprint in Asia so it grows to represent 10% of Group revenue on a proportional basis – compared with around 4% today. We’ll achieve this via a number of initiatives in our target markets:

• In India, where the premium pool is growing by 15-20% each year, we have partnered with the country’s largest bank – the State Bank of India and are now writing a number of product lines. We’re very excited about our partner, who gives us access to their 100 million customers and network of 18,000 branches; and have the option to increase our stake in the joint venture to 49% (from 26%) once India lifts its foreign direct investment caps.

• In China, we announced our intention to take a 20% equity stake in Bohai Property Insurance in August this year. Bohai is strategically focused on a very important economic development region in China’s North East, has strong government support, a well-known brand and a solid distribution network, all of which give us a good competitive position in that market.

• In Malaysia, we have had a successful joint venture with AmBank Group since 2005 and we’re looking at opportunities to increase our presence in what is an attractive and consolidating market.

• We also have a long-established presence in Thailand, where we are predominantly a motor insurer, and have produced attractive returns over an extended period. We believe the recent floods in Thailand could provide a trigger point for industry consolidation and we would look to participate in this.

• Finally we’re already undertaking market entry work in our other identified target markets of Indonesia and Vietnam.

CONCLUSION

To conclude, in recent years our company and the insurance industry more broadly have been comprehensively stress-tested by the combined challenge of the global financial crisis and recent national disasters.

IAG’s capacity to deliver substantial improvements in its performance during this period demonstrates:

• Our robust business model and stable of brands;
• The solid platform we have built over the past 3-4 years through discipline, and a strong focus on the fundamentals; and
• Our capacity to adapt and be innovative to meet the changing needs of our customers.

The stress test has also provided a powerful demonstration of our industry’s crucial role. Imagine what affected towns around the country would look like – not to mention the effect on the national economy – without the $20 billion that has flowed from insurance claims payments to get families and businesses back on their feet.

In addition to the $20 billion that would need to come out of the government’s bottom line, there would be the multiplier effect of higher welfare costs and a huge impact from lost productivity as economic activity in these regions ground to a halt.

Notwithstanding the significant challenges of the past few years, Australia continues to benefit from a healthy, competitive and profitable insurance industry.

These factors give me cause to remain deeply optimistic about what the coming years hold for our sector, and IAG’s position in that future.