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What this report is about

In September 2005, we released a report on home building underinsurance Getting home insurance right (the 2005 report). The 2005 report comprehensively examined the causes of home building underinsurance in light of the devastating Canberra bushfires in 2003, where over 400 homes were destroyed.

This report examines what steps insurance companies had subsequently taken to tackle the causes of underinsurance since the release of the 2005 report.

Research included:

• meeting with the major insurers to discuss any improvements made or planned since the 2005 report,
• surveying the practices of 16 insurers,¹
• comparing web-based calculators offered by insurers in 2005 and 2006 to determine the extent of any changes,
• researching the websites of the Insurance Council and the Insurance Disaster Response Organisation, and
• discussing the effects of Cyclone Larry with the Insurance Council and the Cyclone Larry Taskforce.
We also surveyed insurers about their experience following Cyclone Larry in Queensland in early 2006. This report explores the issues arising from that disaster, particularly the extent of underinsurance.

Acknowledgements

• We would like to thank those insurers who responded to our survey and discussed this topic with us and the Insurance Council and the Cyclone Larry Taskforce for their assistance.

¹ For details of insurers and products surveyed in 2006, see the Appendix.

Executive summary

Why consumers are underinsured

The 2005 report identified several reasons for underinsurance:

• Most home building insurance policies pay only the ‘sum insured’ on total loss. This amount is based on an estimate of rebuilding costs.
• Nearly all standard home building policies placed the onus on the consumer to calculate rebuilding costs and left the consumer to carry the risk of getting it wrong.
• Consumers generally relied on their insurer for help, however, only a small number of insurers provided consumers with reliable tools for estimating the cost of rebuilding their home.
• The sum insured may have been sufficient to cover rebuilding costs when the policy was taken out. However, rebuilding costs may change at a greater rate than annual increases in the sum insured, resulting in the consumer becoming underinsured over time.
• A sum insured that will meet the cost of rebuilding a home in a one off total loss will not cover the surge in building prices that occurs after a mass disaster.

How insurers are helping consumers to reduce the risk of underinsurance

The 2005 report challenged the insurance industry to change some of its practices in order to reduce the risk of underinsurance. The industry has embraced this challenge and developed a range of initiatives over the last 12 months addressing underinsurance. The most important changes are summarised in Table 1.

² 15 of the 16 insurers surveyed were the same insurers from the 2005 survey.

The most significant of these changes is the introduction of policies providing broader cover for consumers such as a total replacement policy and an extended replacement cover policy.³

Other changes include:

• insurers are using higher indexation rates to increase the sum insured on renewal of a home building policy,⁴
• most insurers have implemented education strategies to communicate with consumers about underinsurance and the need to be adequately insured,⁵ and
• the average sum insured in the 2006 survey was $225,858, representing an increase of 7.9% from the average sum insured of $209,322 in 2005.

However, while many insurers who participated in the review have actively engaged with the issue of underinsurance some insurers have made no or minimal changes to their practices. So,in case you're an employer and going to hire someone, pay attention to the student job search as this category is less conservative and more flexible when it concerns the new tendencies of business in general and insurance, in particular. For example, some insurers only offer a cost per square metre calculator to estimate a sum insured. This leaves consumers at risk of being underinsured, either because the calculator ignores building features which increase rebuilding costs, or because the dollar figures have not been updated and do not reflect current costs.

We will continue to work in these areas.

³ This adopts our recommendation to consider the viability of such policies: see 2005 report, p. 46.
⁴ This adopts our recommendation to ensure increases in sums insured at renewal accurately reflected changes in building costs: see 2005 report, p. 38.
⁵ Half of the insurers surveyed in 2006 take the opportunity to educate consumers about underinsurance just before renewal. This adopts our recommendation: see 2005 report, p. 38.