Disasters highlight need to fix tax system
Australian Financial Review, 18 April 2009
The recent Victorian bushfires have drawn attention to the chronic underinsurance of property in Australia. Latest figures from the Insurance Council of Australia (ICA) indicate that as of March 24, insurers had processed around 93 per cent of all claims on residential property, including 1515 “total loss insured residential properties”. When compared with the 2029 properties reported and recorded as total losses, this suggest that around 25 per cent of properties in the fire-devastated areas were not insured.
This accords with previous experience. In 2005, a national survey conducted by the Australian Securities and Investments Commission found that approximately 200,000, or one in six, small business and 1.8 million, or one in five, home owners had not insured their properties, while 70 per cent of tenants had no contents insurance. Further, around 30 per cent of properties were insured for significantly less than their replacement value.
Underinsurance is a surprising phenomenon in Dorothea McKellar’s land of “flood and fire and famine” where natural disasters abound. Nowhere is this more true than in Victoria, which had extensive fires in 1939, 1944, 1969, 1977, 1983, 2003, 2005, 2006 and most recently in 2009.
Yet, despite the country’s propensity for natural disasters, the level of non-life insurance coverage in both households and businesses in Australia is low when compared with other developed economies. According to 2007 Organisation for Economic Co-operation and Development figures, our insurance density ratio (gross written premiums per capita) is about half that of the United Kingdom and about one-third that of the United States.
There is a high social and economic cost to underinsurance. Apart from the distress and dislocation of individuals, there is a substantial financial cost to government in assisting the uninsured. This presents a moral hazard problem, that is, the costs incurred by individuals who don’t insure are passed on to a third party, namely the public or taxpayers. With climate change and an increased incidence of extreme weather events, these demands on the public purse are only likely to rise. An important public policy issue, therefore, lies in understanding the dynamics behind underinsurance.
According to a commissioned study by the Centre for Law and Economics at the Australian National University, Non-insured: who, why, and trends, underinsurance is most prevalent among groups such as those who are at an earlier stage of life, those who are not in full-time work, and who are less educated, and among single parents and retirees with mortgages. For these groups, the cost of insurance may outweigh the benefits. They may, for example, have few assets; they may be more risk accepting; or in the case of wealthier individuals, prepared to self-insure. The perceived benefits of insurance may also be reduced by the expected availability of government assistance such as disaster relief. Alternatively, costs may simply appear to exceed benefits.
Affordability of insurance is therefore a major issue. The ICA contends that cost escalation in standard insurance premiums, due to the imposition of state-based taxes and fire levies, is a key factor behind underinsurance.
State taxes vary considerably and are highest in Victoria, where a basic home insurance premium of $100 rises to almost $150 when fire levy, GST and stamp duty are added. A business insurance premium loaded with these extra charges rises from $100 to almost $182 in metropolitan area.
Leaving aside GST, this is a 34 per cent rise over the basic premium for home insurance and a 65 per cent increase for businesses due to fire levies and state-based taxes.
Do these extra charges really stop people buying insurance?
In Non-insured: who, why and trends, John Tooth and George Baker found households to be quite price-sensitive when it came to insurance products.
They also found a strong correlation between the level of state levies and taxes on general insurance and the penetration of insurance products from state to state.
Modelling by Access Economics indicates that removal of stamp duty on general insurance would impose a net cost to government revenue of $1.7 billion, a similar order of magnitude to previous state tax reforms, namely FID and debits tax. Further, the efficiency gains from this reform would add 0.48 per cent, or $2.6 billion, to household consumption.
The inefficiencies of variable state taxes on insurance, with their non-neutral impact on the purchasing decisions of consumers, were highlighted in the 2003 HIH royal commission report and the 2006 report of the Taskforce on Reducing Regulatory Burdens on Business, titled Rethinking Regulation. In each case, recommendations to remove state taxes were rejected by state governments and understandably so. Taxes on insurance represent a significant contribution to total state taxes, ranging from around 10 per cent in Victoria to almost 3 per cent in the Northern Territory.
Consequently, while the flaws of this non-neutral and inefficient state tax regime on general insurance are acknowledged, their removal has moved to the too-hard basket. One can only conjecture that it is for this reason that insurance tax reform is a notable omission from the 2000 intergovernmental agreement between commonwealth and states.
State tax reform to improve the affordability of general insurance is much needed in the interests of economic efficiency and to increase the penetration of general insurance. It is hoped that the Henry review of Australia’s future tax system will find a creative means of replacing tax revenue streams from this source.