Insurers warn apartment owners risk being left high and dry in the event of a quake, as anecdotes of cash-strapped body corporates ditching their cover emerge

Insurers warn apartment owners risk being left high and dry in the event of a quake, as anecdotes of cash-strapped body corporates ditching their cover emerge

Stories are emerging of body corporates watering down or completely scrapping their earthquake insurance cover in response to sky-rocketing premiums.

Insurance Council of New Zealand (ICNZ) CEO, Tim Grafton, raised the issue at a briefing he arranged with journalists earlier this month. 

While he didn't know how widespread the issue was, business consultant and former lawyer and chair of a stakeholder group that helped the National Party with a body corp review it did when in government, Charles Levin, said he was aware of “more than one or two” of these cases involving apartment buildings in Wellington.

Keegan Alexander partner and insurance law specialist, Crossley Gates, hadn’t heard of body corps reducing their insurance cover, but agreed that as insurers make aggressive moves towards risk-based pricing, it would be more tempting to do so and problems could arise. 

Rising costs

IAG, the insurer that underwrites about half of the country’s general insurance, in April announced it was following Tower in applying risk-based pricing across all its brands. In other words, it’s charging higher risk customers more, and lower risk customer less (supposedly).

This means more policyholders can expect premium jumps as their policies come up for renewal in the next year.

Seismic strengthening is another cost weighing on body corps. And as risk-adverse insurers become more selective over who they insure, a failure to have adequate strengthening could mean cash-strapped body corps have little choice but to be under-insured.

Worse case scenario very bad

Body corps reducing or doing away with earthquake cover is problematic on a number of fronts.

Existing unitholders could be left in breach of their mortgage conditions, prompting their banks to reclaim their mortgages; prospective unitholders risk making dud investments; and well-meaning but incompetent body corp members could be left personally liable in the event of their building being under-insured.

There is an added complication. The Earthquake Commission (EQC) only covers an entire building if more than half of it is residential.

So, if a building that’s mostly used for commercial purposes is damaged in an earthquake, EQC will only cover damage to a residential unitholder’s unit. Any damage outside of this (foundations, lifts, carparks, etc) would fall to the private insurer. If there isn’t one, the liability rests with unitholders.

In another twist, the calculation EQC uses to determine whether a building is mostly residential or commercial has proven problematic in the past

In the case of Wellington’s Marion Square apartments for example, EQC in 2013 deemed it mostly residential, then in 2016 didn't - excluding all common areas used by residents in its calculation, leaving them to cover the $2.3 million excess of their private insurance bill.

While residents claimed EQC changed its formula, EQC said it simply made a mistake in its initial assessment of the building.

The bigger picture here is that the Government's policies to increase the supply of affordable housing and densify housing around arterial transport routes rely on apartments being attractive to both developers and buyers. 

Law unclear

Grafton, Levin, Gates and the Body Corporate Chairs’ Group president, Lyn Gillingham, agree issues around body corps’ insurance obligations stem from a badly written Unit Titles Act 2010.

They noted ambiguity caused by Section 135.1 of the Act saying, “The body corporate must insure and keep insured all buildings and other improvements on the base land to their full insurable value,” but not specifying what perils ought to be covered.

Gillingham said some body corps were therefore pushing the envelope to see if they could reduce their cover while still technically complying with the Act.

However Gates pointed out that most residential insurance policies in New Zealand cover all perils, but some commercial policies treat earthquake cover as an optional add-on.

Levin raised the point the Act doesn’t deal with the situation where a body corp can’t actually get insurance.

“The Act is written on the basis that A. Insurance is attainable and B. It will be taken out. So there is a problem with the Act in that it is not meeting current practice in Wellington,” he said.

He acknowledged there was no easy fix, but suggested the legislation include clauses to deal with quake-prone buildings and draw some lines in the sand around strengthening standards.

Being clearer around what body corps need to disclose to existing and prospective unitholders, and when, was another fix he advocated for.

Still ‘not a priority’

Levin’s suggestions fed into a Bill, the Unit Titles (Strengthening Body Corporate Governance and Other Matters) Amendment Bill, which National MPs Judith Collins and Nikki Kaye recently unsuccessfully pitched to Housing and Urban Development Minister Phil Twyford. 

While it doesn't deal with insurance specifically, it proposes ways to strengthen body corps’ governance arrangements, increase professionalism, and ensure planning and funding of long-term maintenance projects are adequate and proportionate to the size of the complex concerned.

The Bill stemmed from a public campaign Kaye and Collins launched in 2016, before the Ministry of Business Innovation and Employment began working on the issue.

The pair gave it to Twyford in October. In November he responded saying it needed more work and wasn’t a priority.  

While he said he would address the issue “in due course when priorities and resources permit,” he declined interest.co.nz’s invitation to comment on body corps in light of concerns around insurance.

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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18 Comments

As the cost of premiums increases, and the unwillingness to pay out gets worse, insurance will become a thing of the past.

I still think insurance will cease to exist as an industry in my lifetime.

Hi Noncents,

Good if the banks also cease to exist. Utility companies and real estate agents as well......

And plumbers!

TTP

I think you are living up to your moniker with that call.

For insurance as an industry to cease to exist would mean that either the risk is passed onto taxpayers, or that legislation would have to be enacted to ensure any company in operation has large enough cash reserves to pay out the costs of a disastrous scenario. I know for example for the company I work for to win contracts with well known large companies (NZ and australian) we have to prove we have liability insurance for some ridiculous amount in case we somehow manage to do something stupid and burn one of their plants down or cause product contamination. Without insurance we would not be allowed on site, and no way the company has enough equity to payout that sort of $ figure from reserves.

I am not saying insurance is a bad idea, I just don't think it will survive.

Everyone will just accept the risks and start covering themselves.

"I know for example for the company I work for to win contracts with well known large companies (NZ and australian) we have to prove we have liability insurance for some ridiculous amount in case we somehow manage to do something stupid and burn one of their plants down or cause product contamination. Without insurance we would not be allowed on site, and no way the company has enough equity to payout that sort of $ figure from reserves."

It is precisely for this reason insurance won't exist. They insurance companies are taking on the risk - but as several companies found out (to their detriment) in the Japanese tsunami, Thai floods, and Christchurch earthquake (all in 2011). The risk is more real than their calculations have shown. Combine that with the fact that the value insured (globally) so greatly outweighs the premiums paid, or payable in future, that it is simply not viable.

Imagine something taking out Paris, London, New York, Tokyo, or Sydney? the losses would be in the trillions. Even an Auckland or Wellington would likely see the end of insurance in NZ.

Maybe a decline in for-profit insurance and a rise of co-op models again?

I don't think it matters on the model. If the money in is less than the money out - it doesn't work.

Depends how much of the money out is flowing out to the wrong places. The US spends twice what most other countries do on medical care because of its exploitative and regulatory-capturing for-profit insurance mode, for example.

Hmmm, so thinking about it.. Banks lending to uninsured property... will they not lend more than the land value of the property, or will they up their interest rates to cover the extra risk of something happening and the owners being underwater and decalring bankruptcy?

"New" policies for home insurance have been on hold in Wgtn for a while, but banks still appear to be lending.

My guess is the banks factor it in to their risk profiles. They make their money on the interest (and we already have much higher rates than anywhere else in the developed world). If they lose a few houses here and there, it is not the end off the world.

Looking around at the current market. Home owners generally have at least 20% equity on average. So even with sagging property prices, the banks don;t seem to be losing out. Mortgagee sales also don't seem to be increasing at this point in time. So as long as everyone keeps on paying the banks have no reason to worry.

You are highlighting the rort that insurance has become Noncents. When calculating premiums, insurance companies factor in the risks of major disasters, so a part of any premium you pay includes a portion for those 1:100 - 1:1000 year events. The problem is the insurance companies call nay money not paid out in any one year as profit, and wipe it off the top, starting again for the next year. What they should be doing is putting those funds aside to let them pool and build for those major catastrophes. Instead they rely on re-insurance to cover them. What needs to change, and I believe it will only happen through regulation, is that their profiteering ways must be limited and they must be forced to retain funds to cover those events. Like the banks capital requirements, they should have to demonstrate that they have the resources to fully cover all the risks they have accepted, and if they rely on re-insurance, the the re-insurance companies will need to put that assurance up. Most if not all insurance companies will consider what i suggest as blasphemy, but they sell a product that they are literally unable to stand behind to Joe Public. This needs to change.

Exorbitant premiums will cause the Government to take a closer look at the industry and hopefully see the light.

The Unit Titles Act has needed a lot of work and changes for a long time. Notice that Phil Twyford was the Minister that scrapped the needed changes. Another sign that he has no idea about anything related to housing, and another thing that he stuffed up. He's Labour's Brown Midas.

Yes, as soon as I saw PT's name in the mix, I thought 'approaching fustercluck'.

It's piquant, innit, that at the very time denser living is being assumed for everything from public transport to buried infrastructure, the practicalities of actually providing it at any economic price are being chipped away, block by block....

Assumptions matter.....

Disregarding perceived greater natural disaster risks insurance premiums have to rise as interest rates continue to fall to compensate for higher security prices paid to invest the float.

Buffet explains:

Insurers receive premiums upfront and pay claims later. ... This collect-now, pay-later model leaves us holding large sums -- money we call "float" -- that will eventually go to others. Meanwhile, we get to invest this float for Berkshire's benefit.

Link

Hussman explains:

Our view is that no form of investment risk is always worth taking without regard to valuations, fundamentals, economic conditions, or market action. The strategy of buying and holding index funds for the long run is essentially a strategy that says that market risk is always worth taking. Yet 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

Insurers warn apartment owners risk being left high and dry in the event of a quake, as anecdotes of cash-strapped body corporates ditching their cover emerge

Yes, so the insurers are essentially saying "You can't do without us!" And they're right. And they know they're right. And they like it this way.

Insurers remind me of councils; You have to have their product, there's little to no choice about who to get it from and you have to pay the price they ask.

Stop importing people, let the population decline, problem solved, no need for these things. I would rather live in a tent than own an apartment, to be honest.

I've lived in both houses and apartments for different periods and in different countries. I used to favour houses strongly but now lean slightly toward apartments. But it depends on a bunch of factors.

For me, it starts with still, at my age, enjoying the feeling of grass under my bare feet

Here are responses to questions I put to Rainey Law partner, Jeanne Heatlie, that provide more info:

What are body corps' disclosure requirements in terms of informing current and prospective apartment owners of the insurance that's been taken out? 

For future owners, the only time they would be entitled under the Unit Titles Act to get insurance information seems to be if they paid for additional disclosure and then they would only be provided with the prescribed information in section 35(f) of the Unit Titles Regulations 2011, which is

(f) the following details of every current insurance policy held by the body corporate:

(i) the name of the insurer; and

(ii) the type of policy; and

(iii) the amount of the current premium; and

(iv) the amount of any excess payable under the policy;

The obligation is on the owner to provide the information. However in practice it is the body corporate manger that has access to the information and provides it on behalf of the owner. Owners and body corporate managers should in my view be concerned to point out any limitations on the insurance cover. By not doing so it could be argued that there is a representation by omission as it would in the circumstances be reasonable for a purchaser to believe that the body corporate had complied with its obligations under the UTA.

Current owners are entitled to be given the insurance policies under Section 206(b) but there is no obligation on the body corporate to proactively supply this information to owners. More fundamentally however, owners should be made aware if there is any issue with the body corporate’s ability to obtain the type of cover contemplated in the UTA. I would recommend that owners be advised of the position at a General Meeting of the body corporate and that any issues be minuted. This provides owners and prospective purchasers with information on which they can make decision about their risk.

If I went to buy an apartment and the body corp didn't have quake cover, would that be something I could expect to be explicitly told?

Not necessarily, although as I’ve said, I believe it should be disclosed at least as part of the additional disclosure regime.  A purchaser must of course do their own due diligence and would be well advised to ask the question.