How do we cover earthquakes?

This is a republishing of an article originally published on pundit.co.nz. It is here with permission.

Suppose you are exposed to a danger that you cannot protect yourself from. You can allocate a capital amount that will cover the loss in the event of an event. But if the loss is your dwelling from the earthquake, you will have to give up its entire value, effectively doubling the cost of the house even though the probability of complete annihilation of the house is low (or that’s what you hope).

Instead we use insurance to cover the emergency. In general, there are two types of insurance that are sometimes relegated to two states (illustrative, but not entirely historically accurate).

One involved a group of Swiss farmers who agreed that if any of them suffered the loss of a cow, the loss would be shared among them all. Note that such social engagement can only work if the trauma does not affect a significant portion of the group.

The second type of insurance is said to have led to the development of Lloyd’s of London. It involves paying someone a fixed amount to risk an event. The counterparty covers so many similar events and bets that only some of them will happen, with the expectation that the total claims will be less than the fixed amounts paid to them; If it doesn’t, they lose. They usually, often a company, would make a bunch of such a gamble in the possibility that there wouldn’t be an earthquake in Wellington at the same time as an earthquake in San Francisco and Tokyo. It is possible that the insurance company will not be able to cover its losses and go bankrupt. (AMI got government help to prevent it from collapsing when it was severely exposed to the Canterbury earthquake. The world’s largest insurance company, AIG, had to be nationalized by the US during the GFC.) In that case, the insurance company would lose its cover.

It’s a lot more complicated than that, but the important thing here is that there are these three responses: self-insurance, co-insurance (or social) and shift insurance. Among this “stake” and “shift” are important policy choices (although there is an excess of individual insurance it is “subjective”).

In 1993, the New Zealand Earthquake Commission Act radically changed its earthquake insurance, altering the balance between engagement and shift. I focus on housing – there have also been changes in commercial buildings – and I simplify.

Previously, the core of protecting a dwelling from earthquake recovery was a participatory scheme in which the New Zealand government covered the risks. Insurance fees were paid to the Earthquake and War Damage Commission; If there was damage, EWDC paid for it. If the EWDC had insufficient reserves, the government (taxpayers) covered the deficit. So the remaining individual earthquake risks were shared across the entire New Zealand community.

After 1993, only the first $100,000 in damages was covered by the renamed Earthquake Commission (EQC) for which insurance was paid. (The government recently raised the level to $300,000. $100,000 in 1993 purchased about $200,000 to build the buildings today.) The rest of the earthquake protection must be purchased from private insurance companies. Basically, since 1993 there has been a rebalancing from participation to transformation – the privatization of earthquake protection.

(EQC also covers other major disasters such as natural landslides, volcanic eruptions, hydrothermal activity, tsunamis, and the impact of storms and floods on residential land.)

There were many reasons for the change. The minister in charge of the bill was Ruth Richardson so that there was a neoliberal-minimal state element among them. (The change was discussed by the Rogernomics government.)

Termination of participation status was taking place in other policy areas. Richardson Shipley’s “welfare state reform” marked a return to charitable assistance that preceded the Pensions Act of 1898, New Zealand’s first major social insurance.

The idea of ​​social insurance, with certain burdens being shared across the country, hardly appears in today’s discourse until Labour. When was the last time you used Nash’s book “Young, Old, and Sick Will Be the First Call of the State”? The exception is the proposed social insurance for the unemployed who have been laid off. One is shocked how mainstream criticism is from the bottom line who see the fee as a tax, not a way to share the burden of adjustment across all workers. (I suppose they wouldn’t object if private insurance did, but he won’t.)

Another justification for the 1993 earthquake legislation was the Treasury trying to reduce its exposure because it felt the taxpayer was overcommitted. She was concerned that she might not be able to fund other costs associated with a major disaster, such as welfare payments and restoration of government facilities.

In the aftermath of the Canterbury earthquakes, the Key-English government chose to fund the reconstruction from existing revenue rather than levying a special tax, for example on income tax, justified by the nation-wide sharing of the burden. This could have been the traditional welfare state’s approach. (The result has been that public spending has shrunk; we are paying the cost of the social damage this day has caused.)

My point is that the government’s role is to do things that the private market cannot effectively do. There were private insurers willing to sell earthquake insurance – risk bearing – so there was a case of changing the balance from one stock to another. Note that insurance companies do not take on all the risks but transfer some of them by reinsurance with other companies abroad, as the EQC does.

Thirty years later, the system is not working well. The Canterbury and Kaikoura earthquakes have indicated that devastating earthquakes are more likely than previously thought. The quake-quiet period seemed to be over; There is increasing uncertainty about the future risks of these catastrophes and reinsurers are becoming more cautious. (Climate change is another source of increased uncertainty.)

The situation is further complicated by the fact that there are only three significant private insurance companies, which means that the market is not fully competitive and may run less smoothly.

In any case, private earthquake insurance is becoming increasingly expensive. For example, apartment buildings in Wellington of certain ages and heights are experiencing extraordinary increases. In one case I’ve seen, private earthquake insurance costs since the Kaikoura earthquake have increased more than eightfold.

It is not the fault of private insurance companies; They can’t find a cheap reinsurer. The risks since the Canterbury earthquakes have become more uncertain. They may be able to find a reinsurer but not at an acceptable price while the local insurance company may be concerned about being too focused – as the AMI experience has shown. The best approach in such conditions is prevention, but retrofitting old buildings can be very costly.

Perhaps we should reconsider the 1993 decision. Should we shift the balance, back to greater use of risk-sharing across the country rather than relying on moving it all offshore?

Insurance is a complex area. We have made several inquiries about running an EQC but not a single one as we have looked at the self-participation transfer equilibrium. Hopefully we can move on to it before the next great earthquake.

* Brian Easton is an independent scientist, economist, social statistician, public policy analyst, and historian. He was Economic Listening columnist from 1978 to 2014. This is a republishing of an article originally published on pundit.co.nz. It is here with permission.

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