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Govt announces will bail out AMI with NZ$500 mln support package if AMI's reserves are exhausted. Full details here. Your view?
By Alex Tarrant and Bernard Hickey
The government has announced a support package worth up to NZ$500 mln for quake-hit mutual AMI Insurance, which it said would give policyholders certainty and ensure an orderly rebuild of Christchurch.
However, a bailout could cost the taxpayer up to NZ$1 billion, depending on the extent and nature of claims that arise for AMI from the Christchurch earthquakes, Finance Minister Bill English said this morning.
The support package would be called on only as a last resort if AMI’s own reserves had been exhausted – "unless the Crown believes it is in the public interest to take control sooner," English said.
“This support package will give AMI the time to seek a market solution to the challenges it faces as a result of the two Canterbury earthquakes,” he said.
If the package is called on, English said the Government would invest up to NZ$500 million of equity in AMI, with the right to take ownership and assume control of the company if it needed to.
Christchurch-based AMI Insurance is New Zealand’s second-largest residential insurer with 485,000 policyholders and 1.2 million policies across the country. In Christchurch alone it has more than 85,000 policyholders with 225,000 policies – or about 35 per cent of the residential insurance market in the city.
“The Government has made it clear that helping to rebuild Christchurch is one of its most important priorities,” English said.
“That is what today’s announcement is about: providing certainty for AMI’s tens of thousands of policyholders in the aftermath of the two earthquakes and ensuring the rebuilding of Christchurch and the insurance claims process proceeds in an orderly manner."
English said AMI approached the government on March 9, saying it was concerned its reserves and reinsurance might not be sufficient to cover the total value of claims resulting from the Canterbury Earthquake.
Interest.co.nz inquiries directly to directors of AMI surprised many.
Regular readers will know Interest.co.nz have been following the AMI story closely.
“Since then [March 9], officials have been working closely with the company to gather information about what are complex issues and to consider the best option for taxpayers and AMI’s policyholders," English said.
“It was the Government’s judgement that a support package was necessary to give certainty to policyholders that their claims will be covered. This applies to all AMI policyholders – not just those in Christchurch. Because of uncertainty around the cost of earthquake damage, it is too early to tell whether AMI will have sufficient resources to cover all of these claims. The full extent of the claims AMI faces will remain unclear for several months."
AMI rating downgrade could have been worse
Meanwhile, in a press conference in the Beehive, English said after AMI approached the government on March 9, the government gave the company's management a letter of support to take to a meeting with its ratings agency, AM Best, two weeks later.
AM Best downgraded AMI's credit rating two notches from A+ to A- on March 24. See more here.
The letter was a "very light handed indication of support," English said, and did not outline such a proposal as released today.
"But it was required at the time to prevent a sudden and dramatic downgrade of the company," English said.
"It might have been a different situation [if the letter had not been provided]," he said.
Could hit taxpayer NZ$1 billion, not just NZ$500 million
Despite government giving itself the option to inject up to NZ$500 million in capital into the company, it could be hit with a bill of up to NZ$1 billion.
"There’s so much uncertainty here about the number of claims and the nature of those claims," English said.
"There’s a range of estimates that we’ve been provided with from the company and the Reserve Bank. They’re estimates of the excessive claims over the money available to meet them, and those estimates range from NZ$0 – that is the company may be able to meet all the claims, through to about NZ$1 billion more claims than they are able to meet," he said.
But there was a great deal of uncertainty about what the actual number was likely to be.
"The government support arrangement means for policy holders, it’s business as usual. So it is effectively a guarantee that any claims they make will be met," English said.
Incentive for commercial solution
Under the deal, government had the option to pay NZ$100 million of the NZ$500 million uncalled capital at any time to take full ownership and control of AMI, English said.
On the other hand if AMI called for any money, government could take ownership of the company if it chose to.
“So that puts a strong incentive on the current board and management that if they want to continue the business as it is now, then they need to find another commercial solution, such as someone else who will put capital into the company," English said.
Investigation into management
AMI’s situation in Christchurch was “pretty unique,” English said.
“There’s a combination of circumstances here where the company has a concentration of policy holders in Christchurch, compared to other centres in New Zealand; Christchurch has had two major earthquakes in six months; the company is a mutual, which means it can’t go and raise capital easily – it has to essentially sell itself if it wants to get capital into the company," he said.
All those factors had combined to put AMI in its current situation.
"Now at some stage we’ll need to go back and have a look to see whether the management have run the company prudently, whether they’ve complied with industry standards and the regulation," English said.
"Up to now there’s no indication that they haven’t, but clearly the Crown’s getting alongside the board and management here and in another few months we’ll have a much better understanding of how it’s run," he said.
'No talks with other companies'
English said there were no indications other insurance companies were under difficulty.
“The Reserve Bank and the Treasury of course are taking a close interest in the insurance sector, and I can confirm we’re not in talks with anybody else,” English said.
Labour Party leader Phil Goff said Labour supported the government's move.
“But this support package must only be a backstop. The Government will need to ensure that there are safeguards in place to protect the long-term interests of taxpayers," Goff said.
“Kiwi taxpayers are sick and tired of bailing out the private sector, including finance companies which were often reckless and greedy. Those companies capitalised on the good times raking in profits, but when they started making losses and going bust, it’s left to the poor taxpayer to rescue them. That sticks in my throat and the throats of most other New Zealanders," he said.
“AMI is a different situation that has come about through extraordinary circumstances. Action had to be taken to protect the interests of the 485,000 AMI policyholders throughout New Zealand, especially those affected by the disaster in Canterbury."
Meanwhile Green Party co-leader Russel Norman said the government's underwrite of AMI made the need for a temporary earthquake levy more compelling.
“The Green Party supports the Government’s move to underwrite AMI Insurance to give certainty to policyholders, especially those in Christchurch needing to rebuild their homes and livelihoods,” Norman said.
“Giving ourselves the option of a preferential shareholding in AMI is the most prudent way to bail out the company and will ensure the interests of taxpayers are best protected. However, John Key’s Government can no longer continue to keep borrowing indefinitely to pay for the mounting cost of rebuilding Christchurch," he said.
“We have to have to be prepared for more bad news from the Christchurch earthquake, so the Government needs to design a fiscally and economically resilient response. Putting it all on the credit card isn’t really a plan and will simply leave us less able to deal with future shocks.”
See more of the government's statements below:
“Ministers have decided to act now. This provides a financial backstop for policyholders so the rebuilding of Christchurch is not jeopardised by potential solvency or liquidity issues and so confidence is maintained in the insurance sector.
“AMI has confirmed it will seek an alternative commercial arrangement to replace the Government’s support facility as soon as possible. The Government’s actions give the company time to do that.
“The alternative of doing nothing would likely have been severe, potentially leaving many thousands of AMI policyholders without the insurance cover and financial resources needed to rebuild.
“It would also have led to long delays in processing claims, other claims being only partially met and many of AMI’s customers in Christchurch not having insurance cover for future risks.
“With AMI having about 35 per cent of the residential insurance market in Christchurch, a significant proportion of residential repairs and rebuilding in the city will be funded by insurance payments to AMI customers.
“This is an unusual situation requiring a special response.
“In considering options, the Government has been acutely aware of the need to protect the interests of taxpayers, who are already facing significant costs from the Canterbury earthquakes and finance company collapses.
“If Government financial assistance is needed, the Government will take every possible step to minimise the cost to taxpayers,” Mr English says.
“Events such as this show the importance of getting the Government’s finances back into good shape as soon as possible. The Government remains committed to returning to budget surpluses and this arrangement doesn’t alter that commitment.”
AMI POLICYHOLDER SUPPORT PACKAGE – AT A GLANCE
The policyholder support package will be used only as a last resort if the company’s own reserves have been exhausted – unless the Crown believes it is in the public interest to take control sooner. This would involve the Government investing up to $500 million in AMI, with the right to take ownership and assume control of the company.
The full extent of the claims AMI faces will remain unclear for several months – it depends on the scale of damage in Christchurch, which is still highly uncertain.
However, it is possible that the company could face losses in excess of $500 million – or indeed, they could be less. If the loss were to be greater than $500 million, the Crown would stand behind the claims.
Under the policyholder support package:
· The Crown’s policyholder support arrangement of up to $500 million provides the company with a platform from which to explore further recapitalisation options.
· AMI has paid the Crown a $15 million up front establishment fee for the support package.
· AMI has issued convertible preference shares to the Crown, but the Crown has not yet paid for them. AMI tells us that if payment is required, it may not need to happen for two years.
· Payment of up to $500 million will happen only if AMI’s own resources are depleted below the level that is prudent for an insurance business, or if the Crown decides it is in the public interest to make a payment.
· In exchange, the Crown could take ownership of AMI and have control of the board.
· If the arrangement is called on by AMI, it can later exit the support arrangement by repaying the Crown, along with any dividends owing.
The support package for policyholders will:
· Provide a financial backstop for policyholders so the rebuilding of Christchurch is not jeopardised by potential solvency or liquidity issues.
· Preserve AMI’s existing contracts, including its reinsurance arrangements.
· Provide flexibility for AMI and the Crown going forward.
The unpaid convertible preference shares issued to the Crown:
· Are a last resort – the shares will be paid for only if the company exhausts all other options – or if the Crown believes it is in the public interest to take control sooner.
· Give the Crown the right to any dividend payments, ahead of ordinary shareholders. This is what the “preference” part of the shares involves, having preferential treatment ahead of other shareholders.
o Other shareholders won’t get any dividends while the Crown has a shareholding.
o Dividends paid to the Crown will be at the official cash rate plus an additional 5.5 per cent.
· Allow the Crown to take ownership of AMI, if necessary, by making a partial payment of $100 million. The convertible preference shares allow them to be converted to ordinary shares in AMI.
Fee paid to the Crown
· AMI has paid a $15 million fee to the Crown for this support arrangement. The fee is not refundable, even if the Crown never pays AMI for the shares. AMI will reimburse the Crown for the costs of developing and implementing the support arrangement.
If it becomes clear that AMI can pay all likely claims by policyholders, or if AMI arranges other appropriate sources of capital, AMI will:
· Redeem the shares it has issued to the Crown, if they haven’t been paid for, or:
· If the shares have been paid for, AMI will repay the Crown along with any dividends owing, and then redeem the shares.
Managing the risks
The Crown will soon appoint a director to AMI’s board and an observer to key governance or management meetings. If at any stage the Crown makes a payment for the shares, or if AMI breaches certain conditions, the Crown can replace all of AMI’s directors. AMI has also agreed that its service levels will meet or exceed industry standards and that it will comply with prudential requirements established for insurance firms by the Reserve Bank.
MEDIA QUESTIONS AND ANSWERS
1. Why has the Government taken this step?
The Government’s support package for AMI policyholders is designed to ensure that policyholders’ claims are all paid in full, and that the rebuilding of Christchurch is not jeopardised by worries about potential solvency or liquidity issues. The Government will continue to closely monitor AMI’s performance to ensure these objectives are being met. The Government’s focus will continue to be the rebuilding of Christchurch, ensuring the claims process proceeds in an orderly manner and that confidence in New Zealand’s insurance sector is maintained.
2. How much will this cost the Government?
AMI has agreed to pay $15 million to the Crown for this support arrangement. The Crown will invest up to $500 million if it has to pay for the shares AMI has issued, which would provide the company with a platform from which to explore further recapitalisation options.
The full extent of the claims AMI faces will remain unclear for several months – it depends on the final cost of damage in Christchurch, which is still highly uncertain.
It is certainly possible that the company could face losses in excess of $500 million – or indeed, they could be less. If losses were to be greater than $500 million, the Crown would stand behind the claims.
3. How will the Government pay for this?
Ministers have agreed to a $500 million appropriation so the shares can be paid for, if necessary.
4. What influence will the Government have over the company in return for this support package?
We will appoint a director and an observer to the company, who have the right to attend meetings, and a legal contract has been put in place requiring AMI to meet industry service standards. At any time, with the payment of $100 million, the Government can elect to take control of the company.
5. What does this mean for AMI policyholders – in both Christchurch and the rest of New Zealand?
For AMI policyholders in Christchurch and throughout New Zealand, it means that they can be sure that their insurance claims will be processed and paid in the normal manner. This will allow them to get on with the task of repairing or replacing their insured homes, cars and goods, and rebuilding their lives. For AMI policyholders who don’t currently need to make claims, it means they can be assured that their insurance will still be there if they need to claim on it.
6. How did this situation arise?
This is the result of the two Canterbury earthquakes. As far as officials are aware, AMI has complied with statutory requirements.
7. How long has the Government known about AMI’s problems?
AMI initially approached the Government on 9 March 2011 with concerns that it may not be able to meet all its obligations from its reinsurance and reserves. Since then, officials have been working closely with the company to gather information about what are complex issues and to consider the best option for taxpayers and AMI’s policyholders.
8. If AMI arranges new capital from elsewhere, is there likely to be any cost to the Crown?
AMI will seek to raise the capital it needs elsewhere. If AMI arranges other appropriate sources of capital, it will redeem the shares it has issued to the Crown, and if the shares have been paid for, AMI will also repay the Crown along with any dividends owing, and then redeem the shares.
9. Given all the uncertainty, what is the best case/worst case scenario?
The best case is that AMI can meet all claims from its reserves and reinsurance while remaining within prudent capital limits, or another private-sector solution can be found. The policyholder support package has been put in place because there is some uncertainty about the likely level of claims. If the support package is called on, the Crown will invest up to $500 million in AMI, which would provide the company with a platform from which to explore further recapitalisation options.
The full extent of the claims AMI faces will remain unclear for several months – it depends on the final cost of damage in Christchurch, which is still highly uncertain.
10.When does the Government expect to know whether AMI will need money from the Crown?
This is currently not known. However, it could take up to 18 months before we have clarity about whether support funding is needed.
11.What is the state of the wider New Zealand insurance industry?
The Reserve Bank’s assessment so far is that the bulk of the mainstream insurance sector is sound and functioning well. Policyholders can be confident that New Zealand’s insurance industry has sufficient reinsurance and reserves to cover households insured in the retail insurance market.
12.Will the Government provide similar support for policyholders in other insurance companies?
The Government would need to assess each situation on a case by case basis. In general, the Government does not get involved with supporting companies, because risks should be borne where they are best managed - by market participants.
AMI is in an unusual situation – it’s a significant insurance company with a large proportion of its customer base in Christchurch - requiring a special response, which is not the normal course of action for an insurance company facing issues. There is no need for broader intervention in the insurance industry and no compelling case to handle commercial failures other than in the normal commercial manner
12.Why didn’t the Government provide similar assistance to Western Pacific Insurance policyholders?
Western Pacific faces different issues and is of a different scale and significance to the rebuilding of Christchurch. In this case, there is no compelling case for taxpayer intervention and this commercial failure will be handled in the normal commercial manner.
13.Why didn’t the Government simply accept that AMI might fail and use EQC as a backup to look after policyholders?
EQCcovers the first portion of a residential earthquake claims limit of $100,000 for houses and $20,000 for household contents, plus GST. AMI’s obligations are for residential claims that exceed EQC’s coverage.
14.Can the Crown pay less than the $500 million maximum capital into AMI?
Yes, the Crown can pay less. AMI may not need payment for all of the convertible preference shares that it has issued to the Crown.
15.What is a convertible preference share?
A convertible share is a form of company equity that can be changed into a different type of share. A preference share entitles a shareholder to dividends ahead of ordinary shareholders, usually at a rate specified when the share is issued. With the support package for AMI policyholders, in certain circumstances the Government can choose to convert its preference shares into ordinary shares, giving it ownership of AMI. The dividend is payable at the official cash rate plus a 5.5 per cent margin.
16.If the shares can be redeemed by AMI and possibly even without any dividends, isn’t this just a free loan?
No, this support arrangement provides AMI with equity capital as a last resort and for a fee. It is not a loan.
17.What fee will AMI pay for this arrangement?
AMI has paid the Crown a $15 million fee to have this support arrangement in place.
Here is AMI's statement:
AMI is pleased to confirm the arrangement with Government announced today by the Minister of Finance. It is designed to give our customers full confidence in the company following uncertainty about how much AMI will have to pay out in claims following the destructive February 22 quake AMI Insurance Chief Executive, John Balmforth says.
The final amount of AMI’s exposure from the quake remains uncertain. Although the flow of claims has slowed significantly in recent days, the final tally and cost is not known.
“An accurate estimate on the final financial commitments for the second quake are probably still a couple of months away. There are simply too many unknowns at this stage.
“Uncertainty about the final claims tally has translated into uncertainty about AMI’s ability to pay. We could not allow such concerns to mount and it was for this reason that we asked Government to stand behind us during this difficult period. We are very grateful that they have done so,” he says.
“We will not draw down on the capital facility from Government unless we have to. The 22 February event has tested our reinsurance levels, but we have over $350 million of reserves. Time will tell whether these will be sufficient. But even if we exceed our reserves, with the support from Government our customers can be sure they will be paid and the business will continue as usual.
“We are particularly grateful for the speed with which Government has been able to move on this matter. This is a commercial arrangement with Government. Our intention is to seek an alternative arrangement from the commercial sector to replace the Government support facility, but that requires more time. By stepping in now Government has given us time,” he says.
Details of the arrangement have been made public. The issue by AMI of convertible redeemable preference shares allows a capital injection from Government up to a maximum of $500 million. AMI’s objective is to obtain a replacement facility if required, as soon as possible. Options could involve sale of part of the company to a commercial partner or investor.
AMI has had to pursue this line of action because its position is different from the other large insurers in the New Zealand market. It is a mutual company owned by its customers. It does not have access to shareholder funds as do most other companies. When AMI requires additional capital, as it may do in these circumstances, it must raise it in different ways than, say, a publicly listed company.
AMI’s catastrophe reinsurance was purchased at a level beyond that predicted by a variety of independent earthquake impact models. The damage from the 4 September earthquake was consistent with those predictions and well within AMI’s resources. There was no evidence that an extension to AMI’s reinsurance cover above NZ$600 million for the second event was warranted. However, the occurrence of a second earthquake in the same area, resulting in a much higher level of damage, was unprecedented and has made heavier demands on AMI’s resources.
AMI has further reinsurance cover of $1 billion to meet a third event and additional back-up cover to meet a fourth event should they occur before 30 June 2011. Further arrangements are being negotiated for the period after that date.
“This is a robust and successful company. We do not see any long term risk to our business or our customers. We have moved quickly to secure this arrangement with Government to reassure our customers of our ability to meet claims,” Mr Balmforth says.
“We believe that a stable insurance market is critical to the rebuild of Christchurch. We are committed to its restoration both as an insurer and as a good Canterbury citizen,” he says.
AMI is the largest New Zealand-owned fire and general insurer with a network of 73 branches, two contact centres and 22 agencies. It has 830 staff and in 2010 produced a sound profit performance of $31 million.
(Updates with English's comments on other insurance companies, comments from press conference, AMI's comments)