NZ government to bail out insurer without enough reinsurance

February’s earthquake in Christchurch, New Zealand continues to have implications for the re/insurance market and the NZ government as it comes to light that an insurer, AMI Insurance, did not have enough reinsurance cover to back-up the volume of claims it’s experiencing from the disaster.

An NZ government spokesperson said they could end up bailing out the insurer with as much as USD$777m (NZ$1 billion) to enable it to make good its claims payments for the quake. They are making $500m in funds available as a reserve for AMI in case it requires it. AMI has $600m in reinsurance and $350m in cash which it is said will not be enough to pay its claims. It has already received claims for more than $600m.

This lack of reinsurance is surprisingly typical of insurers. Many would not have enough capital and reinsurance to meet the demands of rare mega-disasters and the resulting claims. They generally ensure they have enough reinsurance and capital to meet the demands of a 1 in X year disaster according to the risk models they use. This is where the capital markets can step in to provide additional cover through catastrophe bonds as part of a proactive risk management and reinsurance strategy. For smaller insurers the cost of issuance could be a burden but often it would be their reinsurer who would issue on their behalf. Sources in NZ financial circles who we’ve spoken to suggest that they feel insurers should be made to have enough reinsurance and risk transfer to cover all but the most devastating disasters, anything to prevent the burden being passed on to the government and therefore taxpayers.

Of course, forcing insurers to capitalise for the rarest of disasters is unpopular with the industry and unlikely to be feasible as they would have to pass on premium increases to their customers which would make insurance unaffordable in many cases. Perhaps the solution would be for governments to pass on the risk of insurers failing through the issuance of cat bonds or securities linked to specific potential catastrophes. It’s a debate that will run, and with Solvency II seeking to force European re/insurers to bolster or prove their capital adequacy for claims, these issues are likely to receive increasing scrutiny and attention.