In a few short weeks (from 1 July), the Australian Government's Clean Energy Act [2011] will start taxing carbon emissions at the rate of $23 per tonne. This tax rate will be indexed to increase by 2.5% in real terms each year for the next 3 years.
 
 
In fact the Federal Government has passed 18 pieces of legislation that from their "Securing a Clean Energy Future" legislative package. The core feature of which is the Clean Energy Act.

In simple terms, under this Act permits will be purchased or allocated to businesses that will then be required to surrender sufficient permits to offset their emissions.

From 1 July 2015, the initial tax rate will morph into a full blown cap-and-trade emissions trading system.

The tax is to apply to Australia's large greenhouse emitters, namely:

  • stationary energy (including natural gas suppliers);
  • industrial processing;
  • resources; and
  • waste sectors

If you think about it, the vast majority of the materials that are used in the construction of a building, whether it be a home or commercial building, starts out as a resource (iron ore for steel; bauxite to aluminium, limestone to cement, sand to glass etc.), and then often using enormous amounts of energy, the raw material is converted into a product often in raw form.

Again, think of the energy to make aluminium. In fact, it takes over 15 kilowatts to make just one tonne. Steel, glass and cement all take huge amounts of energy. It is the same for the basic products, such as clay bricks and roof tiles, ceramic tiles and fittings. Plaster board, particle board/MDF, insulation and electrical cabling all start out as a resource and take energy to convert.

Some, products use even more energy to convert it into its final form. Steel sheet to corrugated roofing iron, extruded aluminum to window frames are just a few examples.

The tax is to apply in the first instance to Australia's 500 top producers. Many that fall within this group are the big industrial processors in the building materials industry: Boral, Blue Scope Steel, Pioneer, CSR etc.

Energy is also used at the building site while the materials have to be transported to the site from the manufacturer, often via a wholesaler or retailer including hardware stores. The Carbon Tax will increase the cost of electricity and fuel.

This is not the only legislation that will increase the cost of construction. On 24 November 2011, the Senate passed the Commonwealth Work Health and Safety (WHS) Bill and the Commonwealth Work Health and Safety (Transitional and Consequential Provisions) Bill without amendment. Several of the State Governments joined in some form on 1 January 2012. Western Australia and Victoria being the exceptions.

This legislation is also affecting the operating cost to the manufacturing, transportation and construction industries.

So what is all this going to cost?

I have worked with two of my colleagues at LMI Group, engineer Fergal O'Connell and financial analyst Angus Stewart, to arrive at our best guess as to the impact of the new legislation. I must stress that this has been an easy exercise and should be taken only as a guide.

To say there is a lot of uncertainty on the impact is a giant understatement. Many of the key players in the manufacturing and construction industry, as well as the major industry associations, were only able to provide limited help to us in our analysis. This, of course, makes it difficult for builders to quote a job until the actual increases can be determined.

At the same time, the Australian Competition and Consumer Commission Guide on the new Carbon Tax states that if required, industry participants must be able to show the link between an increased tender price and the impact of the Carbon Pricing Mechanism. It appears at first glance that this is designed to protect consumers from price-gouging, but I would urge insurance advisers to be careful on how they provide advice on the subject to their customers so as not to be caught up in this issue.

Further, some building material such as roofing iron have had recent increases, some significant, which are not reflected in the following calculations. The LMI team will closely monitor the situation and I will provide further updates through this blog as and when required, but at this stage our best estimates are set out below:

Domestic Buildings

We expect that for the average Australian home the cost of construction will increase by between $10,000 and $12,000. This equates to an increase of between 4.6% and 5.5% across Australia. For a variety of reasons, including the starting point being different in each state, we do expect to see some differences between the states and territories. I set out it Table 1 below LMI Group's Estimate of the Increase for Domestic Buildings as from July 1, 2012.

Table 1

 

Commercial Buildings

Turning to commercial buildings, this is even more difficult in view of the wide range of designs, functions, location, building materials used, and construction techniques. Other factors which may affect the cost moving forward include Government shielding arrangements and the possibility of moving to lower emission construction inputs or a move to more energy-efficient technology.

Using a modern office building as an example we estimate building costs will increase by 2.03%. See Table 2 below:

Table 2

 

For some buildings, it may be as low as 1.5% while with others it could go above 5%. Even the humble tilt slab factory/warehouse is expected to be at the higher end due to the increased cost of concrete.

Removal of Debris

Remember the Carbon Tax also applies to the waste sector and so removal of debris sums insured also need to be reviewed and if necessary increased.

Ramifications for Insurance

The changes brought about by the Carbon Tax and harmonisation of workplace safety laws should be top of mind for all insurance advisers. It is important for all insurance advisers to remind clients that their sum insured on buildings in particular but all property policies needs to be reviewed and if necessary increased each and every renewal and the next one in particular.

We at LMI Claims Services see far too often that the building is under-insured and this can cause problems even with a partial loss due to penalties imposed due to being under-insured.  Nearly half the time, the sum insured or declared value has not been increased for years. This exposes the Insured to uninsured losses to the point where it will not cover the cost of repairs after a major loss. Remember to use the under-insurance penalty calculators available through LMI RiskCoach and free through the Apple Apps store.

The 2012/2013 renewal period is going to be a tough one. Clients will be focusing more than ever on reducing costs. I saw only last week, an external accountant advised a business owner they could save money by shopping around. It took me over half an hour to explain that insurance was about protection and claims service rather than price.

At the same time, sums insured need to go up due to inflation and the legislative changes I have mentioned in this posting.

In states like Victoria and Tasmania the state government taxes on insurance have increased considerably making it all the more difficult.

Any advice provided to an insured needs to be documented as far too often the adviser is blamed for any uninsured losses.

Unless the insurance adviser is a registered valuer, they should not set the building value even if they have access to a building cost calculator. These must be regarded as guides only. Professional insurance valuation services, such as that provided by Andrew Nock Valuations, are recommended.

When a loss occurs, it is extremely comforting for the insured and their insurance adviser to find that the insurance program is going to fully reinstate the assets lost, damaged or destroyed. Conversely, it is extremely stressful when the program is not correct.

I end with a final reminder that the figures provided in this article are only a guide and will vary due to any number of factors.