Overdue EQC review sparks uncertainty among re-insurers

Overdue EQC review sparks uncertainty among re-insurers

International re-insurers are speaking out about the uncertainty caused by the Government's silence on the future of the Earthquake Commission (EQC).

Two of EQC's 55 re-insurers, Munich Re and Swiss Re, say the scale of the 2010-11 Canterbury earthquakes took them by surprise.

The loss they incurred was 50% more than they had estimated - the disaster ending up being the third largest quake loss the global insurance industry has ever experienced.

Speaking in Wellington yesterday both re-insurers admit they got their modelling wrong, in assessing the risk of a quake in Christchurch.

They under-estimated the extent of damage caused by liquefaction, and didn't have a sound understanding of the soil quality and old buildings' susceptibility to damage.

Munich Re regional manager, Martin Kreft, says covering a major disaster in New Zealand, where a large portion of the population have insurance, is also relatively more costly than covering a disaster in a country where fewer people have access to insurance.

The level of penetration is high as personal insurance is largely taken care of by EQC, and the perception that New Zealand is low risk previously resulted in low commercial rates.

Swiss Re managing director, Mike Mitchell, says while insurers paid for 80% of the economic loss of the quakes in New Zealand, they only covered 25% of the loss of the 2010 quake in Chile.

Four years on from the Canterbury quakes re-insurers' re-vamped models are incomplete and they're in limbo.

The industry's still waiting for Treasury to complete a review of the Earthquake Commission Act 1993, that was meant to lead to legislative changes in late 2013.

The review, which was launched in September 2012, focuses on the types of property EQC insures, the extent of cover, pricing, and the financial management of the Crown's risk exposure.

Mitchell says, "There are some fundamental challenges that we face in New Zealand that make it very very difficult for us in the existing environment to have certainty... that's around policy, EQC, the interaction between EQC and the commercial insurance sector."

He says there's been a lot of discussion within the industry around whether the model that EQC has is the most sustainable one long-term.

Furthermore, he says limiting all policies to sum insured will reduce some of the uncertainty, and "increase the security of the sustainability of capital to the marketplace through the pricing cycles of re-insurance".

Kreft has asked the Government whether it wants to adopt a 'social' or a 'capital protection' model when it comes to insurance.

By 'social' he means what we have at the moment where EQC can put everyone in an average house after an earthquake

By 'capital protection' he means EQC essentially becomes a re-insurer to protect the Government's funds.

"If your primary driver is a social model - social protection of society - then the response of EQC, the response of insurers and the response of re-insurers will be very different to if the pure objective is to protect the Government's balance sheet", Kreft says.

"We can respond either way, but it's not up to us to dictate to New Zealand which way it should go."

New Zealand Insurance Council chief executive, Tim Grafton, is urging the government to use its learnings from Canterbury to clarify its position immediately.

He says the Council provided a submission to Treasury's review in mid 2013, and hasn't heard a thing since.

He says the Government needs to look at the level of EQC's cap, which affects insurers' liabilities and the amount of re-insurance or capital they need.

Grafton questions whether it needs to change, saying you can barely build a half a garage for $100,000.

Earthquake Recovery Minister Gerry Brownlee reportedly said the review is almost completed with a report going to Cabinet within a couple of months, recommending only minor changes.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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A very well-written article with some interesting quotes.  A couple of comments.  While it is disappointing that the Treasury Review is not quite completed yet presumably this must reflect that it is being done thoroughly and that is a good thing.
 
NZ must be one of the most modelled countries in the world but if the main shock was said to be a one in 2500 year event probability and the sequence a one in 10,000 to 20,000 is it not just the timing?  Reinsurers focusing on smaller but more frequent events.  It is the occurrence of the larger less frequent event that proves the value of reinsurance.  Both the liquefaction risk and soil quality in Christchurch was not exactly unknown; 20 years ago the Insurance Council commissioned a specific Christchurch soil map to try and categorise the better parts in an area where the overall ground quality was not good and subsequntly other mapping especially on liquefaction was done by the Territorial Authority.  Apart from Wellington the city of Christchurch might have been the best analyse region in NZ. 
 
The high earthquake insurance penetration in NZ does surely have a benefit compared to say Chile and some other places as in NZ there is then no anti-selection and the insured portfolio is closer to the average of all properties insured and uninsured.  The approximate number of unreinforced masonry buildings in Christchurch was known and publicised before the first earthquake.  Perhaps their existence was one of the reasons for the high percentage of demolitions undertaken compared to other parts of the world.
 
In the related article Mr Grafton is correct in saying "you can barely build half a garage for $100,000".  The $100,000 EQC cap was set 20+ years ago being close to the statistical modal dwelling being 1,000 sq ft at $100 a square foot.  No one seems to know why Government never revised it.  Did the insurers not want them to?  Or did Government not want to have to charge a higher EQC levy? 

The $100,000 EQC cap was set 20+ years ago being close to the statistical modal dwelling being 1,000 sq ft at $100 a square foot.  No one seems to know why Government never revised it.  Did the insurers not want them to?  Or did Government not want to have to charge a higher EQC levy?
 
Yes indeed - real estate socialism is a major policy pillar for any aspiring political party.
 
As the market has witnessed since 2007, the Government could dictate the conditions of real estate ownership, even when it was not the lender.  Today, it is in full control.  What would this government do when the defaults return?  There will be forbearance, credit counseling, tax credits, tax forgiveness, refinancing, principal reduction, anything but foreclosures.  In other words, real estate ownership may become a subsidy, or some form of government housing.  Would debt servicing be based on one’s ability to pay?  May be the principal will be adjusted based on market conditions?  What type of real estate market is that?
At the same time, it is the Federal Reserve that determines what is too high or too low.  Three rounds of QEs during the last 7 years have kept prices up, offsetting the free market efforts to correct imbalances of supply exceeding demand.  Going forward, if prices are pressured lower, the Fed may be out of ammo.  If price pressure is in an upward direction, the Fed may decide to raise rates.  What do I really own, when it is the government that determines the value of my asset? Read more