By Jenée Tibshraeny
New Zealand’s largest general insurer is popping more panadol to soothe its Canterbury earthquake hangover.
IAG New Zealand Limited has bought $900 million of expensive reinsurance, known as adverse development cover (ADC), to help pay for the 2010/11 Canterbury quakes.
The purchase has been revealed in the company’s annual results for the year ended June 30 2016, which were published on the New Zealand Companies Office website this week.
The fact IAG NZ has bought so much more reinsurance, so many years after the quakes is significant, as it shows the extent to which it expects the total cost of the quakes to increase.
ADC of $900 million is also a significant amount, relative to the $4.4 billion of regular reinsurance cover IAG Group Limited has exhausted for the February 2011 quake.
IAG sells insurance under brands including NZI, Lumley, State and AMI.
The issue is, there’s a lot of uncertainly around how much the remaining quake claims will cost.
As at June, IAG had paid $5.7 billion towards settling 93% of its quake claims.
Yet with the outstanding claims being the complicated ones, settling the remaining 7% will be costly.
IAG NZ’s annual report notes: “the actuary has emphasised the level of uncertainty in the earthquake claims cost estimates, especially with regard to the appointment of claims costs between the multiple events.”
It also recognises there’s uncertainty around the fact over-cap claims are continuing to trickle in from the Earthquake Commissions and the “impact of future legislative reform and legal judgements arising out of the Canterbury earthquake events”.
The reinsurance web
Digging into the detail of the ADC, IAG NZ’s chief financial officer Alistair Smith told interest.co.nz the $900 million of cover bought by IAG NZ “is an internal cover between IAG NZ and IAG Re to indemnify IAG NZ”.
It's been bought in concurrence with IAG Group buying $600 million of ADC in the same period, as report in its annual results to the stock exchange in August.
Smith explains the $600 million of cover bought by the Group “is an external cover placed between IAG and Berkshire Hathaway to indemnify the IAG Group”.
Warren Buffett’s Berkshire Hathaway became involved in IAG’s affairs in July 2015, when a deal was struck for IAG to cede 20% of its gross written premium, in order to have Berkshire Hathaway recover 20% of its claims.
IAG NZ has also received reinsurance from Berkshire Hathaway further to this partnership.
The $900 million of ADC bought “internally” comes from the “captive reinsurance operation” set up by the Group.
IAG NZ in its results explains: “This operation acts as the reinsurer for the Group by being the main buyer of the Group’s outwards reinsurance programme.
“The reinsurance operation is intended to manage reinsurance and earnings volatility and the IAG Group’s exposure to catastrophe risk.
“The operation retains a portion of the intercompany business it assumes and retroceded (passes on) the remainder to external reinsurers.”
The pinch with this arrangement is that the “captive reinsurance operation” is largely based out of Singapore.
This means the bulk of earthquake reinsurance passes through Singapore, where it’s taxed at a low rate, before being transferred to IAG NZ as capital.
Accordingly, IAG NZ does not pay tax on these funds in New Zealand.
With a bulk of the reinsurance being booked as capital, rather than revenue, it also puts a dent in IAG NZ’s profit, reducing its tax expense. For example, IAG NZ's deferred tax asset was $467 million in the year to June.
See this story for more on this reinsurance set-up with Singapore.
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Interest.co.nz has updated the story to clarify IAG NZ has bought $900 million of ADC in 'concurrence', not in 'addition', to the $600 million of ADC bought by the Group.