A closer look at the Government's decision to transfer risk from private insurers to the state natural disaster insurer, EQC

Homeowners shouldn’t bank on their insurance premiums falling, on the back of the Earthquake Commission (EQC) doubling the amount of cover it provides in the event of a natural disaster.

The Government on Thursday announced the building cap on EQC cover will double to $300,000 (plus GST), meaning the state insurer will cover the first $300,000 of building damage caused by a natural disaster, leaving residential property owners’ private insurers to cover anything above this level.

The cover is provided for earthquakes, tsunamis, volcanic eruptions, hydrothermal activity and natural slips.

The move will see private insurers transfer a significant amount of risk to the state insurer. Accordingly, EQC levies will increase from a maximum of $345 per dwelling per year to a maximum of $552 per dwelling per year.

However, insurers won’t necessarily cut their premiums by the equivalent amount, accordingly to Finity Consulting insurance pricing expert, Simon Young.  

He said global reinsurance markets are imperfect, meaning a fall in risk won’t necessarily translate to a corresponding fall in premiums insurers pay the reinsurers that insure them.

What’s more, he noted New Zealand’s main general insurers, IAG and Suncorp, are part of large Australian-owned companies, which buy reinsurance in bulk. The risk posed by these companies’ New Zealand customers is only one element factored into the premiums reinsurers charge insurance companies.

Young said transferring more risk to EQC could see higher-risk property owners in the likes of Wellington pay lower premiums, but Aucklanders should brace for higher premiums, as EQC levies are set to rise.

Private insurers collect these levies on behalf of EQC by tacking them onto the premiums they charge for fire cover. All new insurance contracts will include the new EQC levy from October 1, 2022.

Insurance Council of New Zealand (ICNZ) CEO Tim Grafton said he had “no doubt” insurers will be “fair” and “respond accordingly” to the EQC change.

However, Grafton said it was difficult for him to comment on what individual insurers will do.

“I can’t comment as an industry body because I’ll probably get the Commerce Commission knocking on my door,” he said.

“But clearly, there has been a substantial transmission of risk from private insurers to EQC… I think you can draw your own conclusions.”

Asked whether he expected insurers to lower their premiums, Minister Responsible for EQC David Clark told interest.co.nz, “Yes, in short - overall. Obviously there’ll be a few overs and unders.”

Clark said that as private insurers move towards more risk-based pricing (rather than spreading the cost of risk more evenly across policyholders), some homeowners will struggle to secure affordable cover.

He said this could see people end up in poverty and ultimately burden the Government.

While people might struggle to rebuild a house for $300,000, this at least aligns more closely with the cost of building a house than $150,000 - the level set in 2019.

“It’s probably not quite as much social insurance as when the scheme was conceived in the beginning, when it roughly was the cost of replacing a house, but it moves us closer to that,” Clark said.

He couldn’t provide a ballpark figure around how many homeowners were struggling to get affordable insurance. In other words, he couldn’t define how bad the problem was the Government is trying to fix with a social insurance approach.

He said homeowners “at the margins” in flood or quake-prone areas are the ones battling to get affordable cover.

Clark couldn’t specify how exposed the Crown’s balance sheet would be, by so much risk being shifted from private insurers to the public purse.

Currently, there is only $200 million in EQC’s Natural Disaster Fund. This is the fund levies are paid into. The fund was depleted following the Canterbury and Kaikoura earthquakes.

EQC also has nearly $7 billion of reinsurance cover. However it needs to pay the first $1.75 billion of costs in the event of a disaster before it can tap into this cover.

If there was a major earthquake in Wellington tomorrow for example, the Government would need to make up the difference between the $200 million and the $1.75 billion to access the reinsurance cover.

If the reinsurance cover wasn’t enough, the Government would again need to come to the party.

Neither Clark nor EQC could say how much reinsurance would be required once the building cap is doubled to $300,000, and what the excess would be.

An EQC spokesperson said these details were yet to be worked through ahead of the entity engaging with global reinsurance markets in 2022.

The spokesperson noted, “Losses following a natural hazard event are not linear, so doubling the cap will not require a doubling of the amount of cover we need to purchase.”

Both Clark and Grafton were confident in EQC’s ability to secure reinsurance. Being a government-guaranteed entity, they noted it was attractive to reinsurers.

“Currently we will have reinsurers that are providing cover both to EQC and to private insurers. What they will be seeing will just be a reallocation of who bears that risk,” Grafton said.

“So, for them, the New Zealand risk itself remains unaltered. It’s just that one entity will carry more of that risk than a range of private insurance companies.”

Grafton wasn’t surprised the Government decided to increase the building cap to $300,000.

He said it was a matter of trying to balance a community-based social policy with a risk-based approach.

He feared a cap of say $400,000 would’ve created too much of a moral hazard, as people would’ve made risky investments knowing EQC would have their back in the event of a disaster.

“There isn’t a perfect answer to any of this,” Grafton concluded.

Clark said, “We think we’ve struck a balance here, so there will still be price signals in the market.”

He didn’t buy the argument that increasing the cap would effectively see the typically less wealthy renting class de-risk the wealthier property-owning class.

Clark argued both the rich and poor live in parts of the country prone to natural disasters.