Friday, 23 September 2011

Insurance problems

Christchurch is going to have to face higher insurance costs for a while. Earthquake risk here is now revealed to be higher than we had previously expected. We're now less likely to get major quakes than we were a year and a half ago, but we're probably more likely to get them than we had expected we were as of a year and a half ago. And so the risk payment goes up not because the actual risk has increased but because we have better expectations of the real risk.

John Pagani argues for the nationalisation of AMI, the big Canterbury insurer that had to be bailed out when it was revealed to have insufficient re-insurance for the series of major Christchurch earthquakes. And he makes some reasonable arguments: if the government's going to be liable for bad outcomes, it ought to have some hand in making sure it doesn't happen again. And, he's right that there are moral hazard problems with the big private insurers perhaps banking on the potential for bailout; I know that I didn't worry about checking into AMI's asset and risk structure because they had so substantial a Canterbury presence that, even if they tanked in an earthquake, there was no way the government would fail to bail them out.

But I'm not sure what problem nationalization solves. You can make a good case for that companies with exposure to concentrated correlated risks buy more reinsurance than those having a diversified customer base, and that regulations could be tighter around that. But whether AMI is private or public, it will still have to buy reinsurance on the global reinsurance market. And if that market has seized up, I'm not sure how changes in AMI's public or private status affects things.

I remain a bit perplexed about why people can't get new policies. You can't insure against a certain risk, but if the risk of another February hitting Christchurch is around 5%, you'd think reinsurers would be happy enough to issue cover at a fairly high premium. Some potential explanations:
  • Reinsurers fear being saddled with the costs of prior quakes in any new event if a full assessment of a property's prior damage hasn't been completed
    • But then, why is there difficulty in getting coverage for new builds?
  • Uncertainty over what portion of future claims will be covered by EQC if the EQC fund is exhausted,
    • But then, wouldn't we expect solution through better insurance contracts? 
  • Reputational costs of actuarially fair pricing would swamp potential returns
    • But reputation accrues mostly to the local agent, not the big reinsurer; for those, reputation is determined, I would have thought, by track record in paying out.
I think we need a fair bit better understanding of what's going on before we start nationalizing insurance companies. 

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