Convergence trends help NZ Earthquake Commission on reinsurance

The New Zealand Earthquake Commission (EQC), provider of natural disaster insurance to residential properties and administrator of the NZ Natural Disaster Fund, acknowledges that the ILS and convergence trend has helped it when buying reinsurance.

The NZ EQC is one of the largest buyers of catastrophe reinsurance in the world, having purchased $4.5 billion of reinsurance protection in 2014. The EQC has been benefiting from the reduction in reinsurance pricing around the world, its 2014 renewal which was significantly larger than its 2013 purchase, actually cost the commission about the same price.

The reinsurance programme is seen as critical to allowing the EQC to operate efficiently and to keep earthquake and other natural disaster insurance coverages priced at acceptable levels for residents of New Zealand. The reinsurance programme also reduces the risk to the NZ government or Crown, meaning that the EQC has to call less on it for financial support after events.

The EQC suffered in its reinsurance renewal in 2011 and 2012, as the reinsurance reacted to the disasters in Christchurch and increased the rate-on-line the EQC had to pay. The reinsurance market also removed the multi-year protection that the EQC has benefited from, forcing it to buy one-year reinsurance contracts which left it perhaps more vulnerable to price fluctuations at future renewals.

However, with the convergence of the capital markets and reinsurance well underway by 2012 and insurance-linked securities (ILS) investors presence in the reinsurance market being felt, it was perhaps not such a bad thing that the EQC got to renegotiate its programme in 2013.

Rates dropped in 2013, as the increasing flow of capital market capacity, along with the highly capitalised traditional reinsurance market helped to drive rates down. This stopped the rate increases that the EQC had been facing. Then in 2014 the EQC had it’s most successful renewal yet, increasing its protection and improving its terms for the same cost as it had paid the year before.

“The continued improvement in terms partly reflects an increase in the capital available to the global reinsurance market as capital markets and hedge funds seek higher-yielding investments in the current low-inflation environment,” the NZ EQC said in a recent briefing to the incoming minister.

It continued; “However, EQC’s continued access to reinsurance without any erosion of coverage (e.g. by excluding perils such as earthquakes or excluding specific geographic areas or regions) also reflects reinsurer confidence in New Zealand’s management of financial risks associated with natural disasters.”

Maintaining the confidence of the international reinsurance market, in order to continue to have access to the best quality capital and best priced reinsurance products, is a key aim of the NZ EQC.

“The cost and security of risk capital available to New Zealand can influence the rate of reinstatement and ultimate size of the NDF, and the level of insurance premiums that must be paid by EQC’s customers,” it writes.

Maintaining access to “Adequate, cost-effective reinsurance and other forms of risk transfer in global capital markets,” is reiterated throughout the document to the incoming minister, demonstrating the important role that the convergence and ILS trend has played in the EQC’s financing.

Again, the EQC reiterates; “Maintaining the confidence of international reinsurance and risk capital markets in New Zealand’s ability to manage the risks associated with natural disasters and EQC’s ability to resolve insurance claims efficiently is critical to the current approach to managing Crown financial risk from natural disasters.”

The ability to resolve claims is of course also key should the NZ EQC ever become a catastrophe bond sponsor. With any such bond likely to be structured on an indemnity basis, investors in the ILS space will be keen to see evidence of excellent claims management and practice before they will be willing to support any such cat bond deal.

It’s also clear that the NZ EQC recognises the importance of having robust exposure and hazard data in New Zealand, items that will be crucial to any successful catastrophe bond issue in the country.

The EQC also cites as a critical factor; “Flexibility and technical expertise to adapt EQC’s reinsurance programme in response to reinsurance market trends and constraints.”

The EQC says; “Building strong long-term relationships with global reinsurers and risk capital markets is critical to EQC’s current approach to managing the financial risk to the Crown associated with providing disaster insurance. Reinsurers must be confident that New Zealand is competently and effectively managing natural disaster risk and the cost of insurance claims if EQC is to secure access to adequate reinsurance at a reasonable/competitive price, and without certain perils, assets or geographic areas being excluded.”

The letter to the incoming minister also makes it clear that there are issues that the NZ EQC needs to resolve in order to keep the insurance market functioning internally in the country. A number of different proposals are likely to be considered, including risk pooling or a co-insurance scheme, instead of the first-loss approach that the EQC currently takes.

With the New Zealand Earthquake Commission having tapped the capital markets for some non-traditional reinsurance cover at its latest renewal for the first time, there is a strong likelihood that the ILS and collateralized reinsurance markets will figure even more in the next one.

With every improvement in the data on earthquakes and disasters in New Zealand, iterations of risk models and strengthening of the EQC’s own internal claims processes, the commission is likely to find that the ILS and capital markets become ever more attracted to its reinsurance programme, which should help it to benefit increasingly from the reinsurance convergence trend in years to come.