Crispin Hull | The vicious cycle that could see the insurance system collapse

The insurance costs run into billions. Both fires damaged or destroyed about 3000 residences. Then there are commercial buildings, vehicles and equipment. The health costs, too, add to the insurance bill, particularly in the US.

Usually, insurers love bizarre claims, such as dogs releasing handbrakes resulting in cars, trailers and boats rolling catastrophically into the ocean, or tradespeople tripping on ladders resulting in the collapse of a house.

These one-off events do not trouble insurers who can be seen in benign television advertisements happily paying out. For them, even single-house fires are workable

But they hate a widespread disaster affecting thousands, like floods, cyclones, bushfires or towering infernos.

They have several ways of minimising their losses and staying in business, but even these are now becoming strained.

The first is to raise all premiums across all categories of loss and, up to a point, across all geographic areas. Often, they rely on people just renewing without shopping around.

Secondly, they try to shift some of the costs to government, in all sorts of ways, especially mitigation against future events, like flood levies, fire breaks, and vegetation control.

Thirdly, they reinsure. Insurance companies reinsure with larger companies or a pool of insurers against a percentage of catastrophic loss. So XYZ Insurance might reinsure against, say, half or two-thirds the cost of a cyclone or a flood.

Fourthly, they tighten up on the payment of claims. The same insurance company seen happily paying out for the loss caused by a handbrake-operating dog, suddenly becomes Scrooge-like, quibbling over whether a property is covered at all; whether under-insurance means the owner is deemed to be, say, half insurer and therefore bear half the costs; or quibbling over the value of the loss.

Many people have a misguided idea of insurance. They think they insure an item of property, such as a house or a car, against any loss or damage.

They do not. They insure against loss or damage caused to the item by a defined event. Acts of war or terrorism, for example, are excluded. If a 16-year-old steals and crashes your car, you are covered. Not so if a terrorist does it.

One trick insurance companies play is to exclude classes of risk, like cyclones or floods, or charge more for that coverage, especially in areas where that risk is high.

More than anything else, though, insurers want people to stay insured - otherwise they do not have a business.

Estimates of the rate of non-insurance and under-insurance in Australia vary. The Insurance Council of Australia put uninsurance at nearly a quarter of households in 2007. People on lower incomes and lower property values are more likely to be uninsured.

That rate is probably higher now because premiums have gone up much faster than wages or inflation. Under-insurance is estimated at between 50 and 80 per cent.

And herein lies the seed of the destruction of the stable insurance system. As more people opt out of insurance, the pool of money to pay claims shrinks unless premiums are increased. But as premiums increase, people are more likely to opt out.

The system is made even more shaky by insurers charging more for things like floods or cyclones. The premiums become prohibitive for more people who opt out because they have to.

Prohibitive insurance premiums will perhaps do more than anything else to make people see sense about climate change and demand world action. Disasters fuelled by continued global heating could cause the insurance system to collapse.

The Maui fires, and those across Europe and North America should be a warning to Australia.

In 2003 Australia introduced a reinsurance scheme for terrorism. This was widened with a $10 billion government reinsurance fund for cyclones in the naive hope that this would reduce premiums in cyclone-affected areas.

Unsurprisingly, north-west Australia, which has the most brutal cyclones, has the highest uninsurance rate in Australia (40 per cent), largely because premiums are too high.

The theory is that government underwriting of reinsurance means insurance companies do not have to pay for it on the world insurance market and can pass the savings on to voters - sorry, I mean policy-holders.

But there is no government reinsurance fund for floods or fire.

Of course, higher insurance premiums also add to the level of rents as landlords pass them on.

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And a new climate-induced peril for the insurance industry has also emerged: rising sea levels. Australians love to build dwellings close to the coast, often too close. Some houses are already uninsurable. About one in 25 will be uninsurable by 2030, up to a quarter in some areas, according to the Climate Council.

Rising sea levels cause high tides that erode the foundations of some dwellings. The Central Coast of NSW has already lost dwellings to the sea.

As more dwellings become uninsurable, that is more money lost to the insurance pool. In turn that means higher premiums for everyone else and more people not being able to afford to be insured. The vicious circle will continue.

Some figures illustrate the extent of the threat climate change poses to the insurance industry.

Big events made worse by climate change each swallow $1 billion or more in insurance pay-outs at a time: Lismore floods ($1 billion), 2019 fires ($1.5 billion) Cylone Yasi ($1.5 billion), and the list goes on. The net profit of the insurance industry in Australia, on the other hand, is just $3.7 billion. And bear in mind a lot of that profit came from investment.

So, unless the world acts more drastically on climate change, insurance profits look about as secure as a Central Coast sea-cliff dwelling.