Much has been said about moves to more risk-based pricing and the affordability of insurance. Media reports fan flames of outrage predicting insurance will no longer be affordable or available.
Beneath the headlines, it may be time to ask just how much risk gets shared across government, private insurers and the insured and how much effort should be put into reducing property risks given Lloyd’s ranks New Zealand as the second most exposed country to natural catastrophe losses.
New Zealand remains the envy of the world with the lowest protection gap for residential property. Arguably, a major reason for this fortunate position is that the EQC scheme meets the first loss up to a $150,000 cap (from July 01, 2019) with its costs borne by a flat levy irrespective of the size, value or location of the residential property. This is the polar opposite to risk-based pricing and allows for the private market to provide cover above that cap.
Originally conceived as covering the cost of a modest home, the cap now functions as meeting first loss. It is entirely legitimate for the government to decide how much risk it takes on and noteworthy that, from 1993 until recently, successive governments have chosen not to increase the Crown’s risk by ceding more to the private sector without changing the cap.
Risk-based pricing, on the other hand, prices to reflect risk, meet operating and compliance costs, and achieve a sustainable return given the nature of the business. Importantly, it sends a signal to encourage resilience.
The private market operating above the EQC cap is competitive, and each competitor has a different assessment of its appetite for risk that reflects their cost structures, share of the market, regional exposure and other factors. So, we see a range of prices from full pricing of earthquake risk, for example, through to offers from those willing to take on more risk at a lower price.
This dynamic could change. Should more market players fully price the risk, the remainder would not want to be the last ones in the market not doing so. At that point, the highest risks could become unaffordable for some. New Zealand is a long way from that position. It should, though, send a very blunt message about the need to lower risk.
The response to risk-based pricing, though, is often not to reach for those solutions but instead to look for some intervention. A former Chief Executive of the EQC, David Middleton, has called for the cap to be raised to at least $400,000 or for there to be no cap at all, a move that does nothing to reduce risk but transfers a lot more to the government. Raising the cap would reduce private sector exposure, placing downward pressure on their premiums while blunting the risk signal.
If that kind of option is seriously entertained, then it carries the implicit assumption that no matter the risk nor the cost to the Crown, everyone should have their loss substantially or even fully restored by the government if necessary. That’s a social policy decision for governments to make and weigh up against how sustainable it is for the Crown to underwrite that much risk.
There are also some calls for EQC to be expanded to cover climate change issues like sea-level rise, a phenomenon that is not random but certain. Furthermore, without uncertainty, no transfer of risk takes place, so we are no longer talking about insurance at all.
Insurance involves sharing risk between an underwriter and an insured. The price point reflects the risk, so policyholders pay a fair premium according to the risk of loss they bring to the pool of premiums. Masking that signal to hide an inconvenient truth puts everyone at peril.