NZ Earthquake Commission cap rises, more reinsurance required

The New Zealand Earthquake Commission (EQC), the state-owned residential property disaster insurance entity, has had its cap limit on residential building cover increased by 50% to $150,000, which will see it take on more risk and so perhaps need to buy more reinsurance.

New Zealand’s EQC provides limited residential insurance cover for those affected by natural disasters such as earthquakes, landslides and tsunamis. Any homeowner with a private insurance policy that includes fires is covered and the EQC pays up to its liability limit, or cap, after which the claim is passed on to the private insurance market.

The EQC has extended the liability it will take on from each policyholder, by increasing the liability cap on residential buildings to $150,000 plus GST, up from the current cap of $100,000 plus GST. That 50% increase means that the EQC is effectively increasing the amount of earthquake exposure it holds, hence a need for additional reinsurance is likely at future renewals.

The EQC purchases reinsurance on the international market each year and in 2017 it paid around $165 million in reinsurance premiums for $4.8 billion of reinsurance cover, above a deductible of $1.75 billion.

The EQC’s earthquake reinsurance program was tested by the Canterbury earthquakes in 2010/11, which saw the Commission benefiting from $4.2 billion from its reinsurers after the event.

Also announced in the reform measures on the EQC was the fact that it will no longer provide contents insurance cover, previously it had provided $20,000 of limit to each policyholder.

But it is the increase in the EQC cap to $150,000 which could drive reinsurance purchases higher, as this is for buildings cover and the largest source of its exposure to earthquake risks as a result.

The New Zealand EQC has investigated the catastrophe bond market in the past, as a potential source of reinsurance cover. As its exposure increases, thanks to the 50% increase of the cap, it’s possible that cat bonds could reappear on the agenda in years to come.

Another change, which has been less well received, is that the EQC will now accept claim notifications for up to two years after a natural disaster event has occurred, a big increase on the current three-month time limit for claims notifications.

This has raised some concerns over how claims will be apportioned between events for reinsurers, which can create difficulties in recovering monies from reinsurers when multiple quakes occur within a two-year period, given the difficulty in establishing which event caused the claim.

The EQC may have to shift its reinsurance buying strategy to purchase some aggregate protection as a result of this, in order to ensure it can recover from its reinsurers should multiple quakes strike the country during a two-year period.

Catastrophe bonds could perhaps help the NZ EQC here, either structured on a parametric trigger and per-occurrence basis to provide a rapid payout for a defined quake event, or perhaps as a layer of aggregate coverage to capture the issue of multiple quakes in one two-year claims period.

In fact a rolling two-year aggregate cat bond could be an interesting structure for the EQC to consider, should it look to the capital markets for reinsurance as its liability cap exposure rises.

The increase to the cap limit for EQC residential building cover is expected to come into force on July 1st 2019, so the Commission has some time to prepare its approach to the reinsurance markets.

The Minister Responsible for the Earthquake Commission Megan Woods said that these reforms are being announced now as they can be implemented before a wide-ranging inquiry and review of the EQC. That inquiry could lead to calls for the EQC to provide more backing for residential property owners, perhaps drive it to cover commercial risks as well, and mandate it makes greater use of private risk transfer markets to support those goals, so reducing any potential for a taxpayer burden.

There is a concern that policyholders will end up paying significantly more for the changes, although that has yet to be confirmed. The use of efficient reinsurance capacity to back the EQC risk pool could help to keep pricing down for consumers, something the ILS and cat bond market could have a hand in supporting.