Robertson & Orr call for insurance premium transparency as risk-based pricing hits property values

Insurance

General insurers told to be more open-booked with their pricing and to self-review on conduct and culture; RBNZ Governor says it's too early to say whether insurance capital changes will 'lead to the kind of uplift we have proposed for bank capital'

5th Nov 19, 1:18pm by Jenée Tibshraeny

Finance Minister Grant Robertson and Reserve Bank Governor Adrian Orr are telling insurers to be more transparent around the way they price property insurance.

They accept insurers are making commercial decisions to use more granular data to more accurately charge policyholders for the risks they pose.

However, they’re urging insurers to be mindful of the wider economic effects of this move away from cross-subsidisation. In other words, the effect of unaffordable or unattainable insurance on property prices.

Addressing those at the Insurance Council of New Zealand conference on Tuesday, Robertson stressed insurance companies need to be more open about exactly what they’re looking at when they price premiums according to their new, more intense risk-based pricing models.

“We have a very uneven playing field,” he said, referring to how consumers don’t know nearly as much as insurers about what’s going in to their pricing models.

“I just can’t say more clearly that most of your customers just don’t understand this.

“In the case of my constituents in Wellington, they believe that when they [earthquake] strengthen their properties to 100% of code, or even 60% or 70% of code, that would help them with their insurance premiums. It’s not true. It’s not what you’re doing.”

As previously reported by interest.co.nz, there are at least a few body corporates in Wellington that have heavily watered down, if not ditched, insurance cover over their apartment buildings, due to premiums doubling or even quadrupling in price, or cover simply becoming unavailable.

Robertson said it was important consumers had good information about insurance costs and availability to help them manage their risks.

At the same time, he’s conscious that if insurance cover for property in riskier locations is subsidised, this sends the wrong signal around reducing risk by not building in certain locations, for example.

More detailed LIM reports an option

The Government's trying to figure out what it can do to promote climate adaptation/mitigation, while keeping property insured, but hasn’t made any decisions.

Robertson is considering ways of ensuring consumers have access to better information so they can mitigate risk.

The Department of Internal Affairs is looking at what risk information could be included in LIM (or Land Information Memorandum) reports.

Last week the Ministry of Business Innovation and Employment started consulting on a proposal to require financial firms and major listed companies to include an assessment of their climate-related financial risks in their annual reports.

The Government is also considering whether the EQC cap should be increased.

Robertson said that the Government’s interest in insurance markets will always be wider than price and efficiency. He said it has distributional, access, and equity obligations too, so warned of its “strong social expectations” of the industry.

Similarly, Orr said: “Orderly and well-articulated changes in insurance and pricing strategies are needed, so that all participants in the financial sector – and wider economy - can adapt their behaviour without creating unintended outcomes.

“The Reserve Bank will be monitoring the development of insurance risk-based pricing, to ensure we understand the potential wider economic consequences and any impact on New Zealand’s financial stability.

“We will comment on what we are observing to date in our upcoming Financial Stability Report on 27th November.”

General insurers to self-review on conduct and culture

Orr in his speech also clarified that the RBNZ and FMA wouldn’t do a conduct and culture review on the general insurance sector, like the ones they did on life insurers and banks.

Rather, the RBNZ has asked general insurers to do reviews themselves.

“A “nothing to see here” mentality is not, and never will be, a sensible response to such an array of serious findings in a sister industry [the life insurance industry],” Orr said.

He said the regulator would follow up with general insurers to track progress.

“How a firm monitors and addresses conduct and culture issues will be a part of our ongoing ‘business as usual’ supervision with all insurers. We will also monitor insurers to make sure their planned actions are implemented effectively.”

Too early to say whether capital rule changes for insurers will be as major as those for banks

Finally, Orr reiterated that the RBNZ’s review of the Insurance Act, which deals with solvency requirements, is resuming.

“It is too early to say whether or not our review of insurer solvency will lead to the kind of uplift we have proposed for bank capital,” he said.

“However, we do expect that the current ‘black line’ of a single regulatory minimum limit for solvency will be replaced with a more graduated series of thresholds - and varied regulatory response options - as we have proposed for banks.”

Macquarie Wealth Management analysts, in a June reported entitled ‘We’ve seen this movie before’, highlighted the potential impacts of stricter capital requirements on insurers.

They warned increased standards could drive some companies out of the New Zealand market, saying life insurers, as well as general insurers headquartered outside of New Zealand or Australia, would be hardest hit.

They said IAG, Suncorp and Tower - all of which are headquartered in this part of the world and dominate the general insurance market - “have the least to fear” because they have “strong excess capital positions at the group level”.

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22 Comments

by bw | 5th Nov 19, 1:35pm 1572914112

" there are at least a few body corporates in Wellington that have heavily watered down, if not ditched, insurance cover over their apartment buildings, due to premiums doubling or even quadrupling in price"

This is what happens when Disposable Income is sucked out of the economy by debt servicing. It's not that "premiums doubling or even quadrupling in price" is the problem, it's that property owners can not afford the increase in price - they don't have the disposable income to commit to that cost. If they did, they'd just pay up.
Discretionary Spending across the economy is going to be cut, and as it is the jobs depending on that expenditure will go, and so the Deflationary Cycle will accelerate.

by lastlegs | 5th Nov 19, 2:56pm 1572919018

yes,definitely.also the fire service levy is uncapped for commercial so it has jumped up,EQC levy increase as well so combined with GST the govt share of the premium helps to make it unaffordable.so any body,corporate or otherwise, will fail if the parasite burden becomes unbearable.

by Audaxes | 5th Nov 19, 3:31pm 1572921097

The cruel hoax of government sponsored central bank monetary policy is being exposed for what it is.

In March 2017, former Treasury and Federal Reserve (Fed) official, Peter R. Fisher, delivered a speech at the Grant’s Interest Rate Observer Spring Conference entitled Undoing Extraordinary Monetary Policy.

Wealth effect or wealth illusion? The other therapeutic effect of lower-for-longer interest rates is the wealth effect. By driving up the value of future cash flows with lower rates of interest, all manner of assets – stock, bonds, and houses – increase in value and, thereby, can stimulate our marginal propensity to consume. More simply put, the imperative was to make rich people richer so as to encourage their consumption. It is not so hard to imagine negative side effects.

There are the obvious distributional effects between those who have assets and those who do not. Returning house prices in California to their 2005 levels may be good for those who own them, but what of those who don’t?

There are also harder-to-observe distributional consequences that flow from the impact of lower-for-longer interest rates on the value of our liabilities. This is most easily observed in pension funds.

Consider two pension funds, one with a positive funding ratio and one with a negative funding ratio. When we create a wealth effect on the asset side of their balance sheets we also drive up the value of their liabilities. Lower long-term interest rates increase the value of all future cash flows – both positive and negative. Other things being equal, each pension fund will end up approximately where they started, only more so.

The same is true for households but is much more ominous, given the inequality of wealth with which we began the experiment. Consider two households: one with savings and one without savings. Consider also not just their legally-defined liabilities, like mortgages and auto-loans, but also their future consumption expenditures, their liability to feed and clothe themselves in the future.

When the Fed engineered its experiment to promote the wealth effect, the family with savings experienced an increase in the present value of their assets and also an increase in the present value of their liabilities. Because our financial assets are traded in markets and because we receive mutual fund and retirement account statements, we promptly saw the change in the value of our assets. We are much slower to appreciate the change in the present value of our liabilities, particularly the value of our future consumption expenditures.

But just because we don’t trade our future consumption expenditures on the stock exchange does not mean that the conventions of finance do not apply. The family with savings likely ends up where they started, once we consider the necessity of revaluing their liabilities. They may more readily perceive a wealth effect but, ultimately, there is only a wealth illusion.

But what happened to the family without savings? There were no assets to go up in the value, so there is no wealth effect – real or perceived. But the value of their future consumption expenditures did go up in value. The present value of their current and expected standard of living went up but without a corresponding and offsetting increase in assets, because they don’t have any. There was no wealth effect, not even a wealth illusion, just a cruel hoax.

by Millennial_Woman | 6th Nov 19, 12:36am 1572953809

Wow thanks for sharing! I have often wondered about this, but brilliant to have it put in writing by a central bank official, who's had an interesting career :)

by steven | 12th Nov 19, 3:17pm 1573525027

Its not a parasite burden ie you are suggesting its taking advantage of? so unfounded and un-reasonable? The cost reflects the true/actual risks, so yes this is a real burden, sure. If that destroys the business well in effect that business was the parasite on others, and that problem is corrected.

by steven | 12th Nov 19, 3:11pm 1573524690

So they over-committed assuming their overheads were fairly static. Same could be said for dairy, the new dairy farmers paid to much expecting high and even ever climbing payouts and when those collapsed started topping themselves. Funny thing but those who are risk adverse could survive this, except they get dragged down by those who cannot. Bugger as they say.

by Audaxes | 5th Nov 19, 2:14pm 1572916478

As previously reported by interest.co.nz, there are at least a few body corporates in Wellington that have heavily watered down, if not ditched, insurance cover over their apartment buildings, due to premiums doubling or even quadrupling in price, or cover simply becoming unavailable.

Hmmm... I guess with share and bond market investments posting record high valuations insurance companies are faced with the reality that more premium has to be committed to fund higher net present values of forward liabilities due to aggressive official interest rate cuts. The RBNZ has cut interest rates in half three times since July 2008.

...the iron law of investing is that a security is nothing but a claim on a future stream of cash flows. Valuation is a crucial determinant of long-term returns. The higher the price an investor pays for those cash flows today, the lower the long-term rate of return earned on the investment..

The corollary is also true. The lower the long-term rate of return demanded by investors, the higher the price moves today. So clearly, changes in investors' attitudes toward risk will strongly affect short-term returns. If investors become more willing to take market risk, it is equivalent to saying that they are demanding a smaller risk premium on stocks (that is, a lower long-term rate of return). Prices rise as a result. Now, the fact that current stock prices are higher also implies that future long-term returns will be lower, but that's part of the deal. Link

ACC is one of many examples where today's unfunded government forward liabilities have risen severely because of OCR cuts. Pensions are another. Serious amounts of capital will have to be raised to fill these funding abysses.

ACC has posted an $8.7 billion deficit for the year, with record-low interest rates taking a major chunk of out its long-term forecasts.

But the public accident insurer says that loss is just on paper and there's no need for entitlements to change after also running a $570 million cash operating surplus.

The corporation presented its 2018-19 financial results to Parliament on Wednesday, with a huge increase in its "outstanding claims liability" (OCL) producing its highest-ever deficit and overshadowing other results.

The OCL is the amount of ACC estimates all its current claims will cost over the next 100 years. Lower interest rates mean the fund has to invest more now to cover costs down the track. [my bold]

In the year to June, the interest figure the ACC uses to calculate its future costs dropped by more than 1 per cent – meaning that its predicted costs until 2119 blew out by $10.8 billion to $53b.Link

by GV 27 | 5th Nov 19, 2:58pm 1572919137

Is the argument Robertson is making that others around the country should pay more so Wellingtonians can pay less?

by imhenry | 6th Nov 19, 6:54am 1572976442

Better not be

by Independent Ob… | 6th Nov 19, 5:02pm 1573012956

That's the unavoidable implication.

by Ex Expat | 6th Nov 19, 10:18pm 1573031911

Stuff subsidising those that made poor decisions. I received my home insurance premium notice today, it has fallen 15% from last years cost.

by steven | 12th Nov 19, 3:08pm 1573524501

I think its the opposite for how the private entities see it. ie in the past low risk areas were subsidising the higher risk areas, this is being corrected, certainly my insurance has seen a huge jump like over 100% this month.

by Good Samaritian | 5th Nov 19, 3:13pm 1572920010

Might be time to self insure, or perhaps internalise the profit these external parties make.

NZ's deregulation of the banking and insurance industry never factored into the long term consequences of overseas profit extraction.

Just another politicians short term tactic to get reelected; yet Roger Douglas still thinks its a good idea. Guess thats what you get when you elect a failed pig farmer into power.

by imhenry | 6th Nov 19, 6:55am 1572976524

OWE your last statement is a bit mean

by Andrewj | 5th Nov 19, 3:33pm 1572921188

I've accepted the fact that sometime in the future it will be very difficult for me to get insurance.
Insurance companies invest your premium and in the future payout if something goes wrong, many models were built on a %7.6 return at %1 many of these companies can hardly cover costs. Banks will probably somehow insure those with mortgages in house, by adding to the interest. The insurance model has been destroyed by the ZIRP of central banks.

It must be killing pension funds but we are at the smile, act casual, say nothing stage.

Sometime in the future our expectations will be lowered, we will all shoulder more risk, perhaps the answer is for the govt to add $300 to all rates and the country self insures houses to an amount of say 400 to 500k.

by profile | 5th Nov 19, 6:25pm 1572931526

Those poor, suffering reinsurers - "The data show that direct economic losses from weather and climate-related disasters have declined (based on a linear trend) over the past 30 years from slightly under 0.3% of global GDP to slightly under 0.2% of global GDP.
The first half of 2019 generated the lowest catastrophe insurance loss for more than a decade.” Muir-Wood labelled 2019 “the year of the kitten.”

by linklater01 | 6th Nov 19, 9:37am 1572986221

Audaxes,

Perhaps you can enlighten me on this, In this paper,there is a paragraph which reads: "A negative side effect however,of a very large central bank balance sheet is that the high level of central bank liabilities,held as assets by commercial banks,will tend to crowd out other forms of lending by commercial banks on the asset side of their balance sheets. This is likely to have dampened credit creation from what it might have been".

Why? Surely the purpose of QE was to stimulate credit creation by the banks to enhance the productive economy?

by SmoKey | 6th Nov 19, 8:09pm 1573024150

Banks may feel that investing in Central Bank liabilities is less risky and gets regular return to boost their profits and balance sheet health. They may therefore shy away from lending to risky commercial, industrial and personal lending and play it safe.
QE is when the Central Bank buys the securities of Banks and thus gives the Banks more money to lend and boost the economy. But in practice it has worked to divert funds to real estate, stock markets and to vested interests to make rich richer in the last decade or so.
The net effect of both strategy has been that production has lagged and productive assets have not been built/bought, thus dampening economic growth in the west.
The moral of both stories is : The Cental Bank proposes, but the Commercial Trade Banks dispose.

by Independent Ob… | 6th Nov 19, 1:55pm 1573001755

Is there not a clear contradiction here from Orr and Robertson? On the one hand; you cheeky insurers need to hold more capital (i.e. be more conservative and make more money), but on the other hand; stop hurting our constitutents with your naughty risk-based pricing (i.e. stop your conservative approach and stop making money).

Meanwhile, the impact on house pricing in earthquake-prone regions is an appropriate market response to the value at risk of those properties. Can't argue with the logic of encouraging transparency for customers, but in general the risk-based pricing models are the primary differentiator from one insurer to another (and therefore are of massive intellectual property value to each insurer) so the ideal solution is for customers to shop around.

The only real market solution is for the EQC to become insurer of last resort (i.e. for the big events) and the general insurance market to look after all the smaller events. That way the EQC can get a good consolidated reinsurance price and the general insurers have less risk to price in to their premiums (and the less impact there will be on property prices). Not sure why this isn't being discussed more broadly because clearly the current EQC model is part of the problem not part of the solution.

by pmb2 | 8th Nov 19, 2:55pm 1573178134

Not sure what increased transparency will achieve. So, if all insurance companies take full page ads in the Dominion Post telling Wellingtonians that their premiums are increasing because of earthquakes they'll somehow be in a better position??

by steven | 12th Nov 19, 3:06pm 1573524367

Well if it was "all else being equal" then OK, but it isnt. I think the idea is there is relative risk from CC or earthquakes and hence instead of a blanket insurance premium for one geographical area we will see staggered and even some un-insurable areas.

by steven | 12th Nov 19, 3:03pm 1573524209

The second you try and publish something so a future investor / buyer is more aware of the risk, the value of the asset falls to its "true value" then that badly impacts the present owner who takes the loss on the price correction.. That just screams litigation, I think this happened in Kapiti when they tried to put CC risk on the docs?