Tower risks losing a chunk of the $50 million of emergency reinsurance it’s counting on to settle its outstanding Canterbury earthquake claims.
The New Zealand insurer on September 8 announced it has a “commercial dispute” with Peak Re - the provider of the additional expensive reinsurance, known as Adverse Development Cover (ADC), it took out in April 2015 to pay for the February 2011 quake.
While Tower assures it will be able to recover the ADC, Forsyth Barr analyst, James Bascand warns: “There is potentially $43.5 million at risk given Tower has already provisioned for claims above the reinsurance cap.”
As at March 31 2016, Tower expected the February 2011 quake to cost $449.8 million. It last week announced it expects to increase its provisions for the event by $16.2 million.
Yet including the ADC in dispute, Tower only has reinsurance cover of $375.4 million.
So with Tower already acknowledging it will have to dip into its own pockets to cover a bulk of quake claims, the impact of losing some of its ADC could be huge.
Bascand prices the risk at $43.5 million, as Tower paid a 12.5% excess on the $50 million of ADC.
Peak Re ‘caught off-guard’
So what’s sparked the dispute between Tower and Peak Re?
Approached by interest.co.nz for comment Tower declined. Bascand suggests Peak Re is trying to void its contract.
“Tower made its first cash call ($3 million) to Peak Re and has been rebuffed,” he says.
“We suggest that Peak Re has been caught off-guard by the speed at which the reinsurance has been called on and is attempting to reach some sort of settlement.”
Tower’s results show the insurer called on $39 million of reinsurance in the second half of the 2015 financial year. With Tower only calling on $4 million of reinsurance in the previous half year, it is likely most of this was the ADC, which it would have just arranged to receive.
Note that while Tower has accounted for receiving the ADC, it hasn’t physically received any of it.
“Feedback on Tower’s legal positioning suggests that its contract is robust, and that a Peak Re failure to pay its dues could have the potential of undermining the future business for the reinsurer,” Bascand says.
“Tower is unlikely to agree to a settlement, however additional legal costs may come to fruition.”
Is Tower’s solvency at risk?
Tower last week reported it has solvency of $11.7 million over the $50 million required by the Reserve Bank (RBNZ). This is assuming it receives the $50 million of ADC in dispute.
So at face value, Tower could breach the RBNZ’s solvency standards if the ADC is reduced.
Yet the insurer says that outside of the regulated insurance entity, Tower Limited holds $11.2 million of excess cash.
Additionally, Tower Limited has a $50 million standby credit facility which may be drawn at any time.
The RBNZ has refused to comment on whether it has any concerns around Tower’s solvency, saying it can’t comment on insurers’ individual affairs.
Bascand says Tower’s “solvency positioning remains robust, but further Canterbury earthquake cost inflation risk exists, which has the potential to eat into solvency capital”.
Seventh increase in quake provisions could be on the cards
Tower hasn’t ruled out further increasing its provisions for the quakes, having already done so on six occasions.
The insurance industry has received over 800 new claims from EQC over the past six months, as it accelerates its program.
Bascand explains: “Industry reports have recently indicated that the EQC may have to revisit up to 6000 properties where work it has conducted has not been done properly or potentially is insufficient.
“There is a likelihood that these reviews and extra work will push claims through the $100,000 EQC cap and thus into insurers’ hands.”
Tower still has 560 unsettled quake claims on its books. It’s settled 84% of its claims by value.
Bascand says the cost of operating as a “sub-scale insurer” is hampering the company.
“Large adverse weather or earthquake events at any time could weigh on Tower’s earnings and solvency.”
Share trading up
Uncertainty has seen Tower’s shares sink to a 12-year low, and trading escalate.
Tower’s share price rebounded slightly to $1.065 on Tuesday, following it announcing Perpetual Limited and subsidiaries will become a substantial shareholder, with a holding of 6.7%.
Meanwhile Tower’s share price sunk as low as $1.040 on Monday, as it announced Salt Funds Management reduced its shareholding from 13.3% to 11.1%, following it increasing its slice in the company on two occasions since May.
Devon Asset Management in July halved its shareholding in the company from 5.5% to 2.4%. Devon has been cutting back its involvement with Tower since March, when its shareholding sat at 13%.
ACC also increased its shareholding in Tower to 8.3% in May.
*This article was first published in our email for paying subscribers. See here for more details and how to subscribe.