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

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 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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