Disasters bode ill for insurance fund

By Steve Hart

A big earthquake hitting Wellington would send EQC's reserves into the red, writes Steve Hart

Reinsurers probably hadn't banked on the extent of the damage from the Christchurch earthquake. Photo / NZ Herald
Reinsurers probably hadn't banked on the extent of the damage from the Christchurch earthquake. Photo / NZ Herald

The Earthquake Commission is preparing for the worst as its re-insurance premiums are likely to rise in light of our earthquakes, the Australian floods and the tsunami in Japan.

Of the $6 billion the EQC had in its natural disaster fund, just $3 billion remains. If the one-in-900-year quake hits Wellington, the fund will be wiped out and sent $3.7 billion into the red.

Ian Simpson, chief executive of the EQC, says the fund's strategy is to have enough re-insurance and assets to cover the Wellington event which has a median cost of about $6.7 billion. Right now there is a shortfall.

"The strategy was always to cover that event, and then for the fund to re-grow over a 20-year period," says Simpson.

"The decision that needs to be made now, given the position we are starting from, and given that costs are going to rise for re-insurance, is if that timeframe of 20 years is acceptable."

Simpson says the $90 million it gets every year from the compulsory levy on insurance paid by homeowners only covers the costs of running the commission.

"Basically all of that is spent on the re-insurance, the Crown guarantee fee, the running costs of the commission and on the normal attritional losses we face - such as the Hawkes Bay type of event that happens every year," he says.

"We were always growing [the fund] based on investment returns. But our investment returns will be half the size because the fund is half the size. Plus we will be using some of those investment returns to subsidise the increased costs of the fund."

What happens next, says Simpson, depends on the analysis that is done to grow the natural disaster fund to the target $6 billion.

"We are just waiting for Treasury to do the analysis," he says. "I don't think there is a crushing need to get cash into the fund immediately. But there is a decision to be made about how fast the fund should re-grow. Is 20 years too long, too short? We have not got a view on that at this stage."

Simpson is reluctant to talk about the increased costs the EQC may face from international re-insurance companies.

"We are right in the middle of those discussions for our renewal, starting June 1," he says. "We have had a very wide range of quotes from the market and we are in the process, with our brokers, so I don't even want to give even a broad indication of where that might come out."

Simpson says the EQC typically only deals with A-rated insurance firms, but has used BBB-rated firms in the past. In all, 50 firms provide insurance to the organisation.

"Using anything less that A- is very rare for us, we try to keep the overall credit rating at A+," he says.

Re-insurers have three levels of payout: the expected losses that are budgeted for, significant losses where the premium they have earned for the year is paid out in claims, and material losses, when insurance company shareholders take a hit.

"At the end of the first quarter of this year, the market was saying it is facing significant losses," says Simpson. "They are already paying out the premiums they were expecting to retain.

"That is before the US hurricane season begins, and we have already had a hint of what that is going to be like over there. It is going to be a challenging year for the re-insurance market.

"They are looking at the [natural disaster] models and it is fair to say that while a size 6 earthquake is in the background of all the models, they probably had not banked on the Christchurch earthquake causing as much damage as it did."

Simpson can't comment on whether the fund's insurance levies will rise in response to the recent payouts and predicted rise in insurance costs. That decision rests with the Government.

"It comes under the Earthquake Commission Act and as far as I know that decision has not been made yet."

Simpson says he is not worried that the EQC will be caught out by a natural disaster in Wellington.

"Recent work done by GNS, which looked at the likelihood of a quake there, appears to show there is a slightly reduced probability of an earthquake going off there," he says.

"That's not to say it won't happen, there is always a chance it will, but if we were capitalised to handle two Christchurch earthquakes, followed within six months by a major Wellington earthquake, then nobody could afford the EQC levy.

"We are designed to cope with a certain level of risk, the Christchurch events are within that level because we still have funds left - so we will rebuild and go forward."

So far the EQC has received more than 305,000 claims from all the earthquakes and associated aftershocks since the first event on September 4 last year. This includes more than 121,000 from the February event.

The commission received a spike in claims in the final weeks before the September deadline last year and is expecting a similar situation this time. The cut-off date for claims related to the February event is currently May 23.

People who cannot access their property to make a complete claim, must lodge a claim by May 23 anyway.

The 5.3 aftershock that hit Christchurch on April 16 is being treated by the EQC as a new event for insurance purposes. People whose properties suffered new or worsened damage need to make a new claim. They have until July 18 to make a claim for that event.

- NZ Herald

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