The Christchurch earthquakes have had a devastating impact on the city and its inhabitants.
The quakes are also a major blow to the Earthquake Commission and its ability to insure future natural disasters. EQC's Natural Disaster Fund will be depleted by this week's catastrophe and New Zealand house owners face the prospect of having either limited earthquake insurance or paying much higher premiums to protect their properties against the ravages of nature.
EQC, previously known as the Earthquake and War Damages Commission, was established in 1945. This was in response to a number of earthquakes including Murchison in 1929, Hawkes Bay in 1931, Pahiatua in 1934 and Wairarapa in 1942.
The organisation, which was restructured under the Earthquake Commission Act 1993, insures residential property against damage caused by earthquakes, volcanic eruptions, natural landslips, hydrothermal activity, tsunamis and the fires caused by these.
EQC does not cover commercial property or any other forms of property.
The commission is funded through levies paid to insurance companies by house owners, which are then passed on to it. The cost is 5c per $100 of cover up to a maximum of $69 a year, including GST. EQC received $86 million from this source in the June 2010 year (see accompanying table).
Uninsured residential property owners are not covered by EQC.
EQC insures homes, personal possessions and land against natural disasters as follows:
It covers the first $100,000, plus GST, on houses.
EQC also pays the first $20,000, plus GST, on personal possessions.
It covers land damaged within 8m of a home. This coverage is uncapped.
Natural disaster claims above these amounts are met by private insurers. A 2008 briefing to the Minister in Charge of the Earthquake Commission looked at the sustainability of the Natural Disaster Fund, which is operated by EQC to fund future disaster recovery.
The report said that the average cost of claims had been $45 million a year over the past 66 years and a 1-in-600-year earthquake in Wellington would cost $5.9 billion.
The Christchurch quakes have shot these predictions to ribbons.
Before this week EQC had received 181,702 claims associated with the September 4 Christchurch earthquake and its five large aftershocks. These can be broken down as follows;
42,387 or 23.3 per cent of the claims have been settled.
36,443 or 20.1 per cent of the assessments have been completed.
43,431 or 23.9 per cent of the claims are still being assessed.
59,441 or 32.7 per cent of the assessments have not yet started.
As of Friday last week EQC had paid out $745 million and has estimated that its total payout from the earlier Christchurch earthquakes would be between $2.75 billion and $3.25 billion. Private insurance claims are estimated to be around $2 billion, giving a total cost of about $5 billion.
Before this New Zealand's biggest insurance claim was $192 million for the June 1987 Bay of Plenty earthquake.
Unfortunately this week's Christchurch quake was even worse than the earlier ones and early estimates are that it could cost an additional $10 billion or more, making a total of $15 billion for all the Christchurch earthquakes.
The latest calamity seems to have had a bigger impact on commercial property than residential property.
It is difficult to assess the total cost to EQC but it could be $3 billion for the early quakes and up to $4 billion for this week's disaster, making a total of $7 billion.
The $7 billion is in excess of the 2008 prediction that a 1-in-600-year earthquake would cost EQC about $5.9 billion.
It also shows how dramatic the Christchurch quakes have been as the organisation's 2010 annual report stated: "The commission currently has the capability to cover a 1-in-1000-year event" and there is "no doubt" in "the ability of EQC to meet its claims liabilities".
The earthquake cost estimates are approximate only because most Christchurch insurance brokers and assessors are looking after their families and are not in a good position to report back to insurers.
EQC is required to meet its obligations as follows:
1. The first $1.5 billion of claims are paid out of the Natural Disaster Fund which totalled $5.9 billion at the end of last June.
2. The next $2.5 billion is met by reinsurers, which received premiums of $38.8 million from EQC in the June 2010 year.
3. The remainder is paid from the Disaster Fund and when this runs out the Government must meet the rest of EQC's obligations.
This week's quake is a separate event as far as EQC's reinsurance is concerned and, as a result, the sequence of obligations outlined above begins afresh. Thus the first $1.5 billion of claims is paid out of the Disaster Fund and the next $2.5 billion by reinsurers.
Thus if the claims associated with the September quake remain at $3 billion and the latest quake costs no more than $4 billion then the Disaster Fund will be depleted by around $3 billion with reinsurers paying out the remaining $4 billion.
But no matter what way one looks at it, EQC faces a challenging future because the Disaster Fund will shrink to around $3 billion or less when $7 billion is considered to be a more appropriate level for the fund.
EQC will have to rebuild its Disaster Fund and, in order to do so, will have to substantially increase its maximum levy of $69 a year.
The other issue facing house owners throughout the country is that international reinsurers are expected to reassess the risks associated with New Zealand.
The January 1994 California earthquake - which struck 30km northwest of central Los Angeles, claimed 57 lives and cost US$20 billion - had a huge impact on earthquake insurance. In the aftermath of the quake the insurance companies quickly realised that they had failed to appreciate the vulnerability of residential building to major earthquakes.
Insurance premiums were raised dramatically and little more than 10 per cent of Californian homes are now fully insured against earthquakes, although there are cheaper "mini-policy" schemes that give limited coverage.
Insurance premiums in earthquake-prone Japan are also much higher than they are in New Zealand.
Our international reinsurance rates, for EQC as well as private insurers, can be expected to rise significantly.
An increase in EQC premiums and private insurance premiums is expected to have a negative impact on the housing market because it will reduce net returns for residential property investors.
The important point is that New Zealand has been hit by two major earthquakes and EQC was well prepared in terms of reinsurance but its annual earned premiums are too low, the Natural Disaster Fund should be bigger and it didn't have the resources to quickly assess the 181,702 claims associated with the earlier Christchurch quakes.
There will also be huge costs associated with the damage incurred by commercial property and infrastructure. Commercial property insurance premiums will also rise as will the cost of insuring company-owned infrastructure, particularly electricity and water assets.
But a large amount of public infrastructure, particularly roads and pathways, are uninsured and the Government will have to pick up the cost of repairing these. In light of this it would not be a major surprise if the Government introduced some sort of an "Earthquake Levy" to help fund its Christchurch reconstruction expenditure.
Disclosure of interest; Brian Gaynor is an executive director of Milford Asset Management.