The New Zealand Earthquake Commission (EQC), a state-backed provider of earthquake insurance coverage, is seeking greater flexibility in its use of reinsurance, including the ability to issue catastrophe bonds as part of its risk transfer.
The government of New Zealand has released a number of proposals to reform the Earthquake Commission Act 1993, aiming to improve the coverage provided by the EQC, make it more financially sustainable and to resolve difficulties the EQC faced following the Canterbury earthquake losses.
Among the many proposals for reform is one specifically focused on the EQC’s access to reinsurance capacity and risk transfer products, seeking to expand its ability to protect itself using the widest range of risk transfer tools available.
The New Zealand Earthquake Commission is one of the world’s largest buyers of reinsurance protection, purchasing around $4.5 billion of reinsurance protection in 2014.
The EQC had utilised an element of non-traditional, or alternative, reinsurance capital in that purchase and is likely to again. But the Act which governs the EQC’s operation does not enable it to look to structures which are not traditional reinsurance contracts, such as catastrophe bonds, yet and now the Government is seeking to change that.
The Act allows for the EQC to purchase reinsurance protection, which will also enable some of that to come from collateralised markets such as the major ILS funds. However it does not explicitly allow the EQC to look to structural alternatives, or other risk financing instruments, such as catastrophe bonds.
The government of New Zealand says that it wants the EQC to look to alternative risk financing mechanisms, “where these offer a more efficient approach.” In order to explicitly allow this, the government wants to amend the Act to state that the EQC can tap into other types of risk financing tools, including cat bonds.
The proposal for discussion in the process of reforming the Act is whether it should enable the EQC to buy other forms of risk transfer, in addition to traditional reinsurance. This would include the use of instruments such as catastrophe bonds and perhaps also derivatives or swaps as well.
A New Zealand earthquake catastrophe bond would be a welcome development for the insurance-linked securities (ILS) market and its fund managers, providing another new diversification opportunity and also bringing a new sponsor to the market.
As well as reforming the Earthquake Commission Act to allow the EQC to sponsor catastrophe bonds, the New Zealand government also wants the EQC to be able to act as an agent in order to assist other state entities with their risk transfer needs.
As the EQC has established reinsurance market relationships and may add cat bonds to this, the government would like to be able to leverage this to help protect other state entities. That could allow the EQC’s reinsurance purchase to be expanded, to benefit these other state entities, while bringing more new demand to the reinsurance market.
As the New Zealand government seeks to ensure that the EQC can create the most efficient reinsurance and risk transfer program possible, the inclusion of catastrophe bonds as an option for it to use will likely benefit its program needs.
Whether it would actually find a cat bond the most cost-effective source of risk transfer would have to be seen, if or when any NZ EQC quake cat bond came to market.
However, from the point of view of creating a balanced reinsurance program, with diversified capital providers backing it, adding catastrophe bonds and their structural features into the mix could help the overall program to be made more efficient and flexible across a multi-year period.