The insurance scene

One of the many new insights provided by the Canterbury earthquakes has been into the workings of the insurance industry. Natural disasters cause claims to cluster, as opposed to each claim being an independent random event, so insurance companies have to have special arrangements in place to deal with them. The conventional way insurers protect themselves against the accumulation of claims arising from one event is by purchasing their own catastrophe reinsurance.

The market for catastrophe reinsurance is made up, in the main, of global companies capitalised to the extent of several billion dollars, often domiciled in countries that allow the build-up of reserves without a heavy tax impost. A major reinsurer is Lloyds of London. Although consisting of many relatively small “syndicates” that act independently, Lloyds itself provides the financial security that enables these to operate.

Reinsurers’ income is derived from the premiums they charge and the earnings on the investment of capital and reserves. At the same time as investment returns fall dramatically, capital and reserves have been depleted by claims. Earthquakes in Japan and severe floods in Thailand have joined the Canterbury earthquakes and other less severe events to deplete reinsurers’ assets. So they have raised their prices, especially where they have paid out claims. Insurance companies pass on their reinsurance costs in the premiums they charge their clients, so insurance buyers here are seeing substantial premium increases.

Insurance companies are trying to control their reinsurance costs, and the liability they retain for disaster claims, in ways that are having an impact on their clients. Companies are being more selective in accepting applications for insurance; for example some will not insure buildings in Wellington that are not part of a national portfolio of properties, or will not insure buildings that were constructed before 1976 unless they have been brought up to the local authority’s earthquake strengthening requirements.

It is now common to have a “site deductible” imposed, of as much as five per cent. This means that, if a building is insured for $10 million, any claim will be reduced by $500,000. A new clause specifies that an insurance claim may not include upgrading required by local authorities if the building was not compliant with the council’s requirements before the earthquake.

When a claim is paid out by an insurance company, the amount of insurance available for the rest of the year is reduced by the amount of the claim. Companies used to reinstate the insurance to its full coverage amount automatically. Not anymore. The amount of insurance bought is no longer the limit for any single claim, it is the limit for the whole year, with all claims aggregating.

Insurance companies are still recalibrating their policy terms and conditions to cope with their new realities. Policy holders need to be aware of what different companies are offering, but shopping around might be problematic for some because insurers may be prepared to renew policies for existing customers but not take on new ones.

David specialises in insurance and reinsurance, disaster recovery planning and the financial aspects of disaster recovery, public policy and research administration. Contact David if you’d like to discuss insurance matters.