Caught between the state and the insurance market

We are fortunate to have the Earthquake Commission (EQC) and the considerable body of expertise built up over its long history, particularly in recent years with the Canterbury earthquake sequence. However, EQC’s coverage does not include climate change induced flooding or wildfire damage to residential buildings or, arguably, to land.

We are also fortunate in having a ‘high penetration’ of insurance; compared with most other countries we have a larger percentage of the public whose residential buildings are insured. This means insurers are free to craft premiums so that owners in areas at high risk of flooding, for example, are subsidised by owners whose properties are not vulnerable to this type of risk. For now, at least, risk is spread across the population in the New Zealand insurance market.

However, at least one major insurer has announced it will move to a system of individual risk rating for flooding with the likelihood individuals with properties vulnerable to this risk will see their premiums go up. This is a new direction and probably the prelude to ‘insurance retreat’ where it won’t be possible to get cover for certain dwellings – a side effect being the owners of those dwellings may not qualify for EQC assistance either.

There is a general perception that insurers will, but more importantly, should be at the forefront of our national climate change defence and, so far, the state has chosen to keep its own role opaque.
There is evidence of state ambivalence in our National Adaptation Plan but particularly in the fact that assistance for climate change risk is not included in the Natural Hazards Insurance Bill. The Bill is designed to ‘modernise’ the Earthquake Commission Act 1993 with, among other things, a change in the name of the present Commission to the ‘Natural Hazards Commission’.

There are important distinctions between the role of EQC and the insurance market in providing the people of Aotearoa with a measure of security for natural disasters.
 

Insurance is based on a contract between an insurer and an individual, such as those whose property is at risk. The insurer’s obligation is to ‘indemnify’ or, in lay terms, ‘compensate’ the insured for loss. The risk is measured and priced in the form of a premium. Insurance is a business so it needs to make a profit, in very simple terms, by ensuring premium income exceeds claims and operating expenses.

It is only incidentally that insurance reduces risk, by reducing premiums for risk reducing measures taken by the insured or increasing it to reflect heightened risk. In a more sophisticated market, a bonus could even be provided for adaption such as raising the height of a building or even moving it to a safer spot. In short, insurers measure risk; reducing it is not central to their job.

EQC does not provide insurance as commonly understood. The EQC Act talks about ‘insurance provided under this Act’ but the word is used very loosely. EQC has a statutory requirement to assist in carefully defined cases, but it does not have an insurance contract with an individual and the aid it can provide has little to do with the risk presented by a particular residential building. In contrast, it does have a duty to facilitate research and education on reducing damage by natural disaster. The state, through EQC, provides financial assistance, partially funded by a levy which only has tenuous connection to the risk for which the state is willing to render assistance.

Hence, the roles of the state and of insurers are quite different and it is not useful for either to assume the other will provide the security the country needs. The state will lose the confidence of the public if it is perceived to have no long-term strategy; insurers will lose what public confidence they have left which will erode our healthy levels of insurance cover.

There is a final distinction between the state and the insurance market to be made here. Insurance is, by definition, against ‘fortuities’ – that is, things that may happen rather than things that will happen. Climate change induced flooding is a present and continuing reality. This contrasts with the natural hazards covered under our EQC legislation, such as earthquakes and tsunamis.

We can say with confidence there will be major flooding next winter in Tairāwhiti but not that there will be a major earthquake next year in Wellington. Nevertheless, there is still room for insurance to creatively address the gap between both, at the somewhere-in-between; in the way that life insurance exists because, while death itself is certain, insurers are very good at measuring the risk of its timing. In the face of climate change, we need more innovative thinking from the government and the insurance market.

This distinction between the predictable and the unpredictable may explain why the Natural Hazards Bill does not include climate induced flooding and wildfire. They are conceptually different risks from those in EQC’s portfolio. However, they are not so different to justify yet another Crown entity.

In my opinion, the state needs to take advantage of the expertise of EQC and the insurance market. There are numerous options lying between ‘it’s the state’s responsibility’ and ‘it’s the insurers’ responsibility’. A hybrid system is called for where insurers are encouraged to stay in the market for as long as possible, with the state working actively across party lines to provide ‘safety net’ security for the public, and to use the tools it has and may acquire through the RMA reforms to require adaptation by the public.

It will, however, take more than Number 8 fencing wire to sort this one out.