Why did the Canterbury Earthquake insurance claims take so long to pay out? Part 2

May 17th, 2015 at 4:25 pm by kiwi in america

Yesterday I covered the first two important issues on this subject. Today I conclude this topic with the last two important issues:

3 – The requirements of the global reinsurers

With NZ contributing a miniscule 0.67% of premiums to the global insurance underwriting pool and yet necessitating one of the top 10 global insurance payouts in the last four decades, you can imagine that the global reinsurers were forced to look very closely at their exposure to the New Zealand market. It became quickly apparent that the already tiny premium pool was even smaller than it should’ve been due to the competitive market pressures mentioned in yesterday’s post. Not only was the premium pool tiny, but there were significant earthquake underwriting problems with the model in NZ.

NZ’s retail F&G insurers only carry between $5 and $10 million of the first portion of a large disaster claim – the rest is reinsured. Just as we pay premiums to retail insurers for the cover we seek carrying a portion of the risk ourselves via the policy excess, so retail insurers do the same. The first $5 million of an insurable event must be covered from the premium pool that the individual insurance company holds internally and above that, a claim is made on their insurance with the re-insurers. The re-insurers in turn charge the retail insurance company re-insurance premiums based on their accessed risk of that insurer’s portfolio of policies. The re-insurers spread the load amongst themselves by only taking a portion of a retail insurers’ risk so NZ insurance companies typically have treaties with a minimum of eight and sometimes up to fifteen re-insurers. The re-insurers in turn spread their risk load through the huge insurance syndicates that trade at Lloyds in London.

With such a massive claims event from such a small country (i.e. one that could take many decades to replenish the cost of the claims from future premiums), the only way a reinsurer could profitably remain doing business in such an earthquake prone country was to find ways to definitively quantify then cap the payouts and do everything legally possible to prevent a massive new round of claims in the event of another major earthquake. Two crucial decisions were taken by a consortium representing the reinsurers with the most exposure to the NZ market – decisions that if they could not be implemented, there were doubts as to whether they would stay in the entire New Zealand F&G insurance market AT ALL. A rushed visit to Brussels by the Insurance Council CEO and Earthquake Minister Gerry Brownlee reassured the reinsurers that NZ was worth keeping in their portfolio. The following two decisions were imposed externally by the reinsurers and would also have a dramatic impact on the claims management process and how long it would take to settle claims:

(i) The event had to finish.
Canterbury quickly became the epicenter of global seismologic research especially given the presence of what were considered new faults (e.g. the Greendale fault causing September 4 and the Port Hills fault causing February 22). Given the interrelated nature of the faults and the stress fracture points from the later quakes being triggered by the earlier sequences AND the huge number of aftershocks (1,500+ over 4 on the Richter scale, 63 over 5 and 6 over 6 – anyone who’s been through just a 4 will tell you it’s quite a good shake), the understandable rationale was: why should we (the reinsurers who are on the hook for the $29 billion of the insurable costs of the rebuild) spend those billions rushing to make repairs only to have a fresh earthquake sequence re-damage the repaired properties. Some of the early cosmetic repair work under the cap done by the EQC in early 2011 had to be redone as a consequence of the June 13 and December 23 sequences. The general reinsurance rule of thumb with serious earthquakes is that six months has to elapse without an aftershock above 5 before any major claim settlements could begin. The gap between quakes 5 or above for each of the five designated earthquake sequences commencing with September 2010 were: 3 months, then 2 months, then 4 months and then 6 months. It wasn’t until May of 2012 (after the December 23rd 2011 quake) that the reinsurers could formally declare the entire event over and begin the proper work of larger claim settlement. The claims ‘meter’ didn’t start running on the major claims in the eyes of the insurers until May 2012.

(ii) Ensuring durable earthquake proof repairs
Understandably the reinsurers did not want to be on the hook for another massive repair bill should Christchurch be struck again. The best way to ensure this would not happen was to make sure that rebuilt/repaired homes in the riskier parts of the city had deep and strong enough foundations done during the rebuild/repair process. Christchurch is a hodge podge of different land types with some areas far more prone to damage than others. It is why the western and northern parts of the city were relatively unscathed (more elevated drier clay laden and gravely soil) versus the east where the ground was closer to the water table, swampier and less stable. The land under suburbs immediately adjacent to the Avon and Heathcote Rivers was so unstable as to comprise the bulk of the residential red zone. In this area, the ground was deemed to be so unstable as to render it uneconomic to mediate possible future damage hence the settlement scheme.

Reinsurer requirements for stable repairs/rebuilds lay behind the re-designation of green zoned land into three subzones: Technical Category or TC1 (grey) being the most stable, TC 2 (yellow) being moderately stable and TC 3 (blue) being deemed the most unstable of land not zoned red. Repairs/rebuilds could commence on TC 1 and 2 designated properties but some 17,000 properties in the green zone were designated TC 3. Insurers would not begin to affect repairs or do a rebuild on properties zoned TC 3 until they knew precisely what type of soil the property was on so they could ensure the new foundations were strong enough to leave the repaired/new dwelling isolated from another large earthquake. This required soil tests to be done on every TC 3 section BEFORE the settlement of the claim could even commence by way of building work. Soil engineers don’t grow on trees and so a huge backlog of required tests built up and added to all the other issues that formed part of the suite of frustrating delays. I know several people in TC 3 hell and their lives have been miserable in their wobbly uneven cold draughty homes. Their plight is wretched and they all can share mind numbingly depressing stories about the massive runarounds their insurer and EQC have given them. It is of little comfort for them to hear that they effectively became the sacrificial lambs to preserve the right of all other kiwis to insure their homes, businesses and vehicles such was the knife edge that global underwriters teetered on in deciding on their continued exposure to the whole NZ insurance market. The protection from future claims inherent in the TC 3 process was the price that needed to be paid to keep the reinsurers in our market.

4 – Miscellaneous issues

Other issues that have impacted negatively on the claims settlement and rebuild process include:
* The Christchurch City Council’s consenting process as the rebuild gathered pace quickly came under massive strain. It was borderline efficient even before the quakes (I know because I built some apartments in 2004 before emigrating to the US). Despite the presence of CERA as a super agency given extraordinary ‘cut the red tape’ powers, the CCC’s consenting time frames and processes became even more bogged down as to impose a serious bottleneck particularly on the nascent commercial rebuild in the CBD. This culminated in the CCC having its consenting powers taken away from it by the NZ wide council consent accrediting agency IANZ and distributed to other councils with a proven track record in greater consenting efficiency.
* Staff shortages – an event of this magnitude was going to test the claims processing capacity of every insurer with exposure in the province. EQC had to increase its claims handling staff fifty-fold and private insurers, swamped with massive caseloads of claims, had to reallocate resources from other offices, bring people out of retirement and hire new staff and restructure their Christchurch claims handling processes to meet the load. This all took time. For a period of time, a raft of inexperienced even incompetent (and occasionally fraudulent) assessors and adjustors were wreaking some havoc with the lower end EQC claims. Millions of dollars were wasted on unnecessary paint jobs and smaller cosmetic repair work approved by the new adjusters rushed into the field but inexperienced with differentiating between earthquake damage and normal wear and tear. It has taken all the insurers, EQC, assessors, QSs, Fletchers’ approved contractors and others years to get up to speed in processing claims of this volume. These delays are common with any major global insurance event but they added on top of the ones unique to New Zealand detailed earlier.

The Christchurch earthquakes have been a massively traumatizing event for most of the population of the city even for those who did not face battles over claims over the cap. The problems of claims management by EQC, the insurers and Fletchers fill social media, blogs and other concerned citizen websites. This post is not to excuse the various mistakes made at various levels but merely to give some big picture context to the problems and to identify the combination of unique factors that have come together in somewhat of a perfect storm in Christchurch. Some could be ameliorated with procedural even legislative changes to the EQC and how it delivers the earthquake cover it offers but some is endemic to the global insurance market and those issues are beyond the ability of EQC, NZ’s biggest retail insurers and even the government to get around. It is hard to listen to the woes of those on the receiving end of all these issues and not be moved by their plight and to be sympathetic to their desire to blame simple scapegoats (EQC, the insurance companies and the government). Such criticism fit neat pithy sound bites so loved by the media. The truth is far more complex and cannot be described in a simple short sound bite hence this post.

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Why did the Canterbury Earthquake insurance claims take so long to pay out? – Part 1

May 16th, 2015 at 4:17 pm by kiwi in america

If you live in Christchurch, visit there regularly or know homeowners there, you will know that this question has consumed enormous emotional bandwidth for the longsuffering residents of the earthquake battered city. There are pressure groups (Red Zone Rebels), websites (www.insurancewatch.org.nz) and various Facebook pages devoted to attacking New Zealand’s retail insurers, the EQC, Fletchers and CERA for the various delays in payouts and a variety of issues to do with the rebuild. A book called “The Christchurch Fiasco” by Sarah Milne is an excoriating attack on insurance companies albeit from a left wing partisan perspective. An entire lengthy post could be devoted to the legitimate shortcomings of both the EQC and retail insurers – this post attempts to detail WHY the delays occurred and points to several factors unique to New Zealand and these earthquakes that have contributed to many of the problems Christchurch residents face. There 3 main factors at play:

1 – The scale of the disaster

This is a matter that almost all people can appreciate. Part of the problem of managing the disaster was the sheer scale of the disaster. Here are some key statistics that put it into some NZ and global context. The total all up cost of the rebuild of Christchurch (and surrounding towns) is estimated at $40 billion. Of this, approximately $30 billion is covered by insurance ($17B private insurers and $13B from EQC) with the remaining costs being mainly infrastructure rebuilds covered by local and central government. In terms of just the combined insurance expected payout, the next largest disaster in NZ was the Edgecombe/Bay of Plenty Earthquake in 1987 that did $271 million worth of damage. In USD$ terms, the combined damage of the five major earthquake events (4 September 2010, 26 December 2010, 22 February 2011, 13 June 2011 and 23 December 2011) makes the Canterbury quakes the 6th largest insurance event GLOBALLY since 1980. The only earthquake to exceed the Christchurch sequence in costliness is the 2011 Japanese quake and tsunami and it is hard to separate what portion of this event was the earthquake or the tsunami rebuild cost. The Northridge/San Francisco quake of 1994 cost about the same as the Canterbury quakes.

The total insured component of the rebuild comprises approximately 12% of the Gross Domestic Product (GDP) of the NZ economy with Treasury estimating the all up cost of the rebuild to top 20% of NZ’s GDP. To give some sense of comparison, the most costly disaster in terms of rebuild costs was Hurricane Katrina in 2005 in Louisiana and Mississippi costing approximately USD$200 million. As costly as it was, it represented only about 0.5% of US GDP. The Kobe quake in Japan in 1996 comprised 4% of Japanese GDP with the 2011 earthquake/tsunami costing 6%. Only the Chilean earthquake of 2010 came close at 10%.

A total of 1,240 commercial buildings were demolished in the Christchurch CBD (about 80% of the stock) and 12,000 residential homes have or will be demolished (8,000 of them comprising the residential red zone). Between Fletchers (the lead repair contractor) and other contractors, over 170,000 homes have been, or are waiting to be, repaired.

2 – NZ’s unique insurance environment

There are a number of features that are unique to New Zealand when it comes to earthquake insurance. The impact of the EQC has been huge. New Zealand’s EQC is unique in the world. There is no other private sector or government sponsored earthquake insurance scheme that offers such widespread affordable cover for earthquakes ($100,000 on residential dwellings and $20,000 for domestic contents) for what was a premium of only 0.15c per $100 of the insured’s Fire and General insurance premiums up to a maximum of $180 per annum. Premiums were a tenth of those currently charged by the California Earthquake Authority, probably the only scheme in the world remotely close to the EQC. Consequently only about 30% of home owners in California have earthquake coverage and with a $500,000 cap, many high value homes would be significantly under insured. NZ’s EQC model has had three significant impacts on the Christchurch earthquake claim settlement process:

(i) Effect of EQC on NZ retail insurer behaviour
By taking the first $100k of earthquake risk, it meant NZ retail Fire and General (F&G) insurance companies effectively had a $100k excess if they offered earthquake insurance cover to full replacement. Since not all homes are destroyed in an earthquake merely damaged, it was likely that, at least for residential homes, the vast majority of claims would be handled by EQC. The presence of such extensive affordable earthquake cover resulted in market behaviour that took NZ earthquake insurance on offer far beyond what other earthquake prone first world countries’ insurers offer. It led to a product war between retail insurers as they out bid each other in terms of the top-up earthquake coverage they offered. I worked for a retail insurer for 7 years from the late 80’s to the mid 90’s. When I first commenced my employment, we would only offer top up earthquake cover from the EQC $100k to the indemnity value of the property included in your dwelling policy. The indemnity value is the depreciated value of the home. If you wanted full replacement earthquake cover, you had to pay an extra premium for the difference. Then we were able to offer full replacement to a specific sum insured for earthquake as part of the policy for no additional premium. Finally, due to competitive pressure, we were offering full replacement for earthquake to full replacement based on the m² of the dwelling (so-called open ended full replacement cover).

The effect of this product bidding war was to leave NZ retail insurers (and their international reinsurers) with a sizable underwriting shortfall from the premiums received for earthquake cover in comparison with the coverage offered. This gap can be best illustrated by the situation faced by AMI Insurance post quakes. By buying a higher than normal percentage of the dwelling and contents insurance market in Christchurch with lower than competitor premiums, once the claims were totaled up and the reinsurance added, the company was insolvent and had to be effectively bailed out by the government who took the Canterbury quake claims portion of AMI into Southern Response, allocated the reinsurance claims amounts taking the whole disaster off their balance sheet effectively recapitalizing AMI and allowing it to continue to trade unencumbered by the quake claims.

(ii) International insurable percentage comparisons
The extensive and cheap cover offered by EQC meant a significantly higher percentage of properties in NZ were covered for earthquakes. This was not only in terms of the percentage of properties that actually had earthquake cover but the percentage of each properties’ replacement value that was covered for earthquake damage. Munich Re (one of the world’s largest reinsurers) calculated that fully 75% of the Canterbury earthquakes’ losses were insured. This figure is distorted by the various Category C and D commercial buildings that could only be insured for indemnity value which, for say a 70 year old un-modernised building, meant effectively its land value only. The affordability and accessibility of residential dwelling earthquake cover in NZ meant that a whopping 97% of homes in Christchurch were insured for earthquake most technically for full replacement. To give you a sense of what a massive global outlier this is compared to other 1st world countries’ earthquake claims: for the 1994 Northridge, California earthquake, only 35% of the losses were insured. The percentage was a measly 19% for the 1996 Kobe quake in Japan.  Thus the presence of EQC created a massively greater per capita insurable event than was possible in any other country.

(iii) Legal interface and apportionment issues
The presence of EQC has resulted in yet another unintended consequence – that of the confused and blurred legal boundaries between its cover and that offered above the EQC $100k by private insurers. Of all the problems that have arisen with claims in Christchurch, this one has had the most severe and debilitating impact. The confusion began with the very first quake in September 2010. The EQC and private F&G insurers all have their own policies, procedures and interpretations. Whilst the private sector insurers differed somewhat from each other, most of the differences lay in the wording of their respective policy documents.

The real friction and problems arose from so-called ‘over the cap’ claims or claims where repairs or rebuild costs were likely to be above the $100,000 ceiling of an EQC claim. Private insurers would not take responsibility for any claim at or below $100,000. What happens when there are differing views as to what the repair/rebuild costs would be? The EQC has a vested interest in the costs being greater so that some of the burden of restoring the property as per its policy provisions is shared with the private insurers and the private insurers had a vested interest in making sure as few claims as possible were over the cap and thus exclusively the responsibility of the EQC. The highest percentage of the residential rebuild cost is tied up in the homes that were either destroyed or the most damaged. There are 4,000 homes in Christchurch not in the residential red zone that were completely destroyed and thus not covered by the government’s buyout scheme – and some 25% of the red zone home owners opted to take only the GV on the land payout leaving their insurer to cover the rebuild cost on a new section elsewhere in the city. Tens of thousands more homes required more than $100,000 to repair them. When there was a difference of opinion over the true cost of repair, agreement had to be reached as to who would manage the claim via a complex process known as the ‘Joint Review’. Each side hired Assessors then Quantity Surveyors and Contractors and then sometimes lawyers were needed to determine this with each step of assessment taking months leaving hapless policyholders in a hellish insurance ‘no man’s land’.

Had the EQC scheme been a behind-the-scenes wholesale provider of just the first $100k of earthquake cover who would have only dealt with the retail insurers effectively as their under the cap earthquake re-insurer, policyholders would’ve had only one entity (their retail insurer) to deal with. Had the legal boundaries between the two insurers been more clearly spelled out in legislation, it would’ve spared millions of wasted man hours and likely more millions in needless litigation costs borne by policyholders forcing the courts to define these boundaries. Sadly, it took a major earthquake to properly test these boundaries – boundaries that were never really tested in prior events where EQC claims were made.

Deciding on what to do with over-the-cap claims was further complicated by the issue of apportionment; i.e. which of the five officially EQC designated separate earthquake events was responsible for what damage. With assessors and QSs already overloaded with the sheer volume of claims, this apportionment added to delays in assessing claims because each event was subject to the $100k cap and it took until a landmark High Court case in September 2011 for the EQC to accept this and then begin negotiating with the retail insurers on a case by case basis as to who paid for what.

Part 2 tomorrow covers: The requirements of the global reinsurers and Miscellaneous issues

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A rare letter from the Chief District Court Judge

June 13th, 2014 at 9:00 am by David Farrar

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Hat Tip: Whale Oil

It is rare for the Chief Judge to write a letter to the editor. She is obviously concerned that Labour’s policy paints a false picture of the situation in Christchurch,

The key aspects if her letter are:

  • A specialist list has been in place since February 2012
  • Earthquake cases get priority over other civil cases
  • Court cases get before a judge within 55 working days
  • Of 76 cases filed, 43 have been disposed of of which only 1 went to a full hearing
  • Of the remaining 33, 17 are on track for a negotiated settlement
  • 10 further cases may be negotiated also

So basically there are possibly only six cases that may go to a full trial at the District Court.

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Replacement or fixed value insurance?

May 27th, 2014 at 12:00 pm by David Farrar

The Dom Post editorial noted:

Home insurance used to mean “total replacement”. If your house got blown over, you’d get a new one, as close as possible to the original, no matter the cost.

In the wake of the Christchurch earthquakes, with their mammoth reconstruction bill, insurers have moved to put a cap on how much they will pay out homeowners. That’s defensible – they, and their international reinsurers, have been badly burned by the quakes, and they need a better idea of their liabilities.

But it’s how they’ve handled the change that’s the problem. The onus has fallen on homeowners to determine exactly how much cover they need. Clearly that’s a specialist task that most people can’t manage.

Yet, if they get it wrong, they could be in real trouble, caught hundreds of thousands of dollars short of rebuilding the house they once owned.

To be fair, insurance companies do send out a rough suggestion for a figure. But what’s most alarming is that these “default sums” are consistently too low, at least according to valuers and quantity surveyors.

Putting aside what level the fixed value is, I think that may be the way of the future.

We’ve seen with Christchurch that total replacement is a recipe for years of delays, arguments and dissatisfaction.

The benefit of fixed value is if your place gets totalled, then bang you just get a cheque for the value insured, and all sorted in hopefully a few weeks.

The insurance companies needed to put more work into this – less television advertising and more accurate calculations to help people set their cap right. Most people aren’t inclined to pay for a professional valuation, but they will still be devastated if they can only rebuild themselves half a house.

Some industry figures suggest that people, especially older people in large houses, might deliberately under-insure themselves, and accept a smaller house if disaster strikes.

Or a house in a different suburb.



What would happen to “KiwiAssure” if there was another earthquake?

November 3rd, 2013 at 11:00 am by David Farrar

Gerry Brownlee has pointed out:

Canterbury Earthquake Recovery Minister and Minister Responsible for the Earthquake Commission Gerry Brownlee says Labour’s policy of establishing a state-owned insurer is no different than its other half-formed ideas – it’s emotive, shows a hopeless grasp of economic realities, and raises questions Labour won’t be able to credibly answer.

“Labour might hate private insurance companies, but the reality is they’re paying for $20 billion of the Canterbury rebuild – twice New Zealand’s annual corporate tax take,” Mr Brownlee says.

“The fact of the matter is you can only undercut insurance competitors if you’re prepared to take greater risk.

“Two insurance companies were doing that when the Christchurch earthquakes struck – both of them New Zealand owned – and they both collapsed.

“The reason insurance businesses tend to be internationally owned and operated, by big companies, is because they’re able to hedge their risk across a range of markets.

“Labour’s insurer would be completely exposed to the New Zealand market, which every citizen knows is at major risk of incurring heavy losses from natural disasters.

And guess who would be bailing them out – the taxpayer.

Insurers who are primarily covering just one country do run a very significant risk of collapse should disaster strike. And reinsurance can only go so far.


Insurance in Wellington

March 14th, 2013 at 10:00 am by David Farrar

Alastair Thompson writes at Scoop:

Sources tell me that insurance chiefs from the biggest reinsurers in the world are now pricing Wellington as “ground Zero for earthquake reinsurance risk” in the world. Not the Asia-Pacific. Not the ring of fire. The world.

And as a result practically speaking earthquake reinsurance cover is not practically available for commercial property in Wellington.

Yes some policies are being written on some buildings (usually ones which are up to code and have blue chip tenants) for 400% to 600% premium increases.

My apartment’s building insurance has already doubled and off memory it is at 80% of code!

In the Wellington commercial property market full insurance is a condition of all the mortgage business. Full replacement earthquake insurance is a standard term and condition.

In NZ most companies which carry business interruption insurance also need to have earthquake interruption cover to satisfy the conditions of the bank credit facilities. These often include warrantees around the quality of the building that business is being conducted out of – including the existence of earthquake insurance cover.

So what does this mean?

It means that the Wellington CBD property market is frozen. The only purchasers are ones which are buying with cash. There are hundreds, possibly thousands, of distressed mortgaged unit title and company share owners in the city.

It means rentals are falling and landlords are getting creative.

A good description of the problem.

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Why bother getting insurance?

February 18th, 2013 at 1:00 pm by David Farrar

Homepaddock highlights this policy from NZ First:

All Christchurch uninsured red-zoned land owners who accept the current Government’s 50 per cent compensation offer will get the other half should New Zealand First become part of the next coalition Government.

Ensuring these landowners are treated fairly and receive the full rateable value of the land will be a bottom line in any coalition negotiations.

Very unwise for a party on 4% to start laying down non-negotiable policies two years before an election.

Ele points out:

The party obviously doesn’t understand that what it regards as treating these landowners fairly would be treating insurance companies, their staff and shareholders, and taxpayers most unfairly.

This would kill the insurance industry because no-one would bother insuring their properties if they knew the government would pick up the pieces after a disaster.

This policy passes all the risk and costs from private property owners and insurance companies to the government which means taxpayers.

Exactly. The precedent would be horrible. You’d be mad to ever get insurance again.

Now remember that NZ First has said this is a non-negotiable bottom line policy for any future Government.

Isn’t MMP great!

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