Tuesday 5 July 2011

Christchurch insurance

American readers may be surprised that we in NZ have been able to insure against earthquake damage. But all insurance comes with fine print.

When we decided to buy a house back in 2005, insurance was one of the first things on our minds; we wanted a place near the beach and tsunami risks were salient. After a lengthy phone call with our home contents insurer, AMI, we found that while full replacement cover would cover the rebuilding of our house in case of disaster, it wouldn't cover us were the land itself to disappear. The buildings are insured, but the land itself is not. AMI would build us a house of similar size and quality were the Brighton and SouthShore spit to disappear, but we'd have to buy the land on which to build it.

We consequently consulted with a geologist about the best spot to buy conditional on wanting to be near the beach; she warned us against being too close to the Estuary as a substantial tsunami risk came from the backwash after the initial wave. She circled the general neighbourhood that seemed least risky. So we bought our place on about a meter and a half rise from the road and protected from the Estuary by a park and school on the other side of the road; we comforted ourselves with that if anything serious enough to wash away the sand spit on which we live ever happened, the government wouldn't be able to constrain itself against bailing out folks who lost their land.

And now the worst's happened, but not for us. We're in the green zone where houses are damaged but the ground is fine. I have no clue how long it will take for the Earthquake Commission (who cover the first $100k damage to the house) and AMI (who will cover damage to the fences, pool, sidewalk and drive) to assess the damage and provide a quote, but eventually the house ought to be made right.

The government is, as expected, bailing out folks whose land can't be salvaged by providing two options. The government will either buy out the property at its 2007 assessed value (the last property tax assessment), or will buy out the land and let the owner deal with the insurance company for the house. Honestly, if somebody offered me the 2007 value of our house right now, I'd be tempted even though I hate moving and love our house; property values have dropped since then. There are more than a few folks who have wound up in a bit of a bad spot though: while the government has declared their land as non-remediable, their insurers say the house is repairable and so will only pay enough to cover repair rather than rebuilding costs. They could take Option 1, but that may not be sufficient to rebuild or buy elsewhere; if assessed section value is low relative to capital improvements, Option 2 can be a problem.

We'd always figured that, worst come to worst, we'd suffer uninsured losses on the section.

In other insurance news, the national government has become the insurer for quake-affected city councils; insurers aren't keen on providing coverage where the risks are as high as here. I wonder whether some kind of conditional bond issue could work. The government could put out a bond issue that would see the principal value of the bond cut in response to specified events, then auction off the bonds on the international market. It wouldn't be a cheap way of insuring, but it would be interesting to see how the markets would price those risks. How much would you pay for a New Zealand bond promising $100 in three years if no further earthquakes of magnitude 6.0 or up in Christchurch, but whose face value would drop $5 for each tenth of a point on the Richter Scale above 6 for any further events?


  1. They're called "catastrophe bonds" or "disaster bonds", and are common.

    They are nice for fund managers as the default risk is quite idiosyncratic. In some cases they could be cheaper than reinsurance to issue, in fact ReInsurers are the biggest issuers of such bonds.

    How much would you pay for an iPredict contract that paid a dollar given a 6+ earthquake?

  2. No wonder NZ'ers love property - it's pretty much a risk-free investment. Lost your share value - that's your problem. Lost your land - that's the taxpayers problem.

  3. Actually the EQC (funded by a levy included as part of house insurance) covers damage to the land under the house and within 8 meters of the house. The cover is either the value of the land or the cost of repairs, whichever is lower. I'm guessing that, in the case of the red zone, the value of the land is the lower of the two; since you'd really need to remove all the houses to remediate the land properly.

    Obviously the government is topping up the difference between the land valuation and EQC's maximum exposure of $100k.

    For people who believe their ratings valuation is too low there apparently will be an appeal process with CERA to get the valuation redone(process yet to be defined).

    I'd just note that there is similarly an appeal process for local government ratings valuations when they are done - so if you thought your ratings valuation (meant to be a commercial valuation) was too low back in 2007 you could have appealed it then, of course that would mean your rates go up.....

  4. @Alfred: I'd pay a fair amount for such a contract, and not just as a hedge. Cool that such things are used; it seems obvious enough that I couldn't have been the first to think of it.

    @hefe: Not quite. Invest with a crazy old guy who lives frugally and the government will bail you out for that too.

    @Duncan: I didn't know that the EQC levy covered the value of the land rather than simply the cost of repairs; I'd worried about the case where a tsunami would make the sand spit disappear entirely.

    Nice point on valuations. When our 2007 valuation came in, I thought it higher than what market price would likely be ($65K more than what we paid for the place in 2005), but didn't bother appealing. But if downwards appeals are a one-way bet...