There's an old saying that when the tide goes you discover who was swimming naked.

In the space of 8 months we've now discovered two large Canterbury financial institutions were swimming naked.

Unfortunately, they were so large and so naked the government has had to run up to them with towels made with over $2 billion of taxpayer money to preserve their modesty and the confidence of New Zealanders in their financial system.

South Canterbury Finance and AMI Insurance shared many things, besides the fact they were deemed 'Too Big To Fail'.

They both were founded and grew quickly within Canterbury's apparently conservative and cosy business community.

Despite that cloak of conservatism, both ran relatively risky growth strategies.

Both were sceptical of the media.

Allan Hubbard at South Canterbury Finance was renowned for not bothering or wanting to talk to the serious financial media.

AMI's John Balmforth simply refused to talk to us 3 weeks ago when we wanted to find out what AMI's capital position was.

It was only after we directly contacted board members did we get some answers, and then they were vague at best.

The surprisingly out-of-touch and remote responses we got from the directors betrayed an organisation that seemed not to have a disaster plan or any strategy for dealing with questions about its financial stability.

Both AMI and South Canterbury appeared not to have planned for disaster. They both did not charge enough for their products.

They both relied on shareholder structures dominated by management.

They both failed to put aside enough for a rainy day.

They both shared an old fashioned approach to corporate governance and public accountability.

They both shared a distrust for the capital markets and a reluctance to face rigorous and sceptical analysis from either those capital markets or outside players.

But most of all they were allowed to grow very fast with unstable capital roots by regulatory regimes that either did not exist or were dominated by a 'laissez faire' and 'light touch' approach that was naive at best and disastrous at worst.

Under capitalised and under reinsured

Firstly, let's look at the events leading up to the government's unprecedented and extraordinary decision this week to step in and put its financial heft behind AMI.

The February 22 earthquake was also extraordinary and unprecedented, but it was forecastable.

Insurers spend an awful lot of time modeling events such as earthquakes.

They take out reinsurance on the basis of the risk of a 1 in 250 year event or a 1 in 500 year event or a 1 in 1000 year event.

They calculate potential losses in such an event and take out insurance for that.

The more catastrophic and remote the event that is covered, the more expensive the reinsurance.

The Sunday Star Times calculated here AMI invested 3.7 per cent of premium income in reinsurance.

Other insurers exceeded 10 per cent, with Lumley General reporting 16.3 per cent.

AMI was renowned in the industry for offering the cheapest prices for general insurance and many grumbled/wondered if it had put aside enough capital for a rainy day.

Like many other insurers in New Zealand, it calculated it reinsurance by working out the potential losses from a 1 in 800 year event in Wellington.

But AMI's much higher market share in Christchurch exposed it to much larger losses if that event was in Christchurch rather than Wellington.

There was no regulator there to tell AMI to put aside more capital and take out more reinsurance for a Christchurch event.

We need to be tougher than the Australians

The Reserve Bank is taking over regulation of the insurance industry during the middle of this mess.

It was scheduled to announce new solvency requirements tomorrow.

Before the Reserve Bank's elevation to prudential regulator for insurance, the industry was essentially self regulating.

An insurer only had to be a member of the Insurance Council and have capital worth 20 per cent of its annual premiums.

The only saving grace is that most of the industry (State and NZI are owned by IAG, Suncorp Metway owns Vero and 68 per cent of AA Insurance, and Lumley is owned by Wesfarmers) is owned by Australian parents, who are regulated hard by the Australian Prudential Regulation Authority (APRA).

The exceptions are Farmers Mutual Group (FMG), which is thought to be well run, and AMI.

But the Australian rules may not be tough enough, given the solvency requirements don't take into account the risk of massive earthquakes and volcanic eruptions. Australia only has to deal with bushfire, floods, storms and the occasional smallish earthquake.

The Reserve Bank will no doubt be reevaluating its solvency requirements in the wake of AMI's failure.

Let's hope we learn from this and ensure our swimmers are well covered up.

There was no choice

Meanwhile those questioning the decision to bail out AMI Insurance need only look at the consequences of no bailout. There would have been chaos inside the industry and no doubt a massive bout of confusion and delay in Christchurch.

The government will no doubt hope a white knight comes along.

They may not be so lucky.

Many of AMI's policies are on monthly contracts and can be canceled easily. State, NZI, Vero and AA will no doubt aim to win AMI's market share naturally, rather than have to take on the risk of a set of assets and liabilities that are racked with uncertainty.