Apocalypse Wellington – ground zero for earthquake reinsurance

by Alastair Thompson
It’s as if an earthquake has hit Wellington. Only no one will talk about it publicly, and nobody is willing to speak its name. It was the same earthquake that hit Christchurch. In Wellington, it rended asunder a market fault-line. As I understand it the facts are roughly this.

Before the earthquake in Christchurch, the Government had a $1billion excess $5billion reinsurance contract for earthquake damage – which automatically reset following a major event. We claimed $10billion on this policy.

We now have a $1billion excess $1.5billion EQC reinsurance contract in place – for the nation. I think that the rough figures for premiums were $500million a year for the $5billion + facility and $250million for what we have now.

For earthquake damage, NZ Inc. is – by necessity – self-insuring. Like the Japanese.

And we need to remember this happened last time we had a massively damaging quake – in Napier in 1931. EQC 1.0 died on February 22 2011. EQC 2.0 is yet to be created.

So how does this work out for Wellington?

Sources tell me that insurance chiefs from the biggest reinsurers in the world are now pricing Wellington as “ground Zero for earthquake reinsurance risk” in the world. Not the Asia-Pacific. Not the ring of fire. The world.

And as a result, practically speaking, earthquake reinsurance cover is not practically available for commercial property in Wellington.

Yes some policies are being written on some buildings (usually ones which are up to code and have blue chip tenants) for 400% to 600% premium increases.

And there are also policies being written for “functional” replacement – i.e. a specific less costly remedy.

But for most of the city, the insurance premium increases are unaffordable and irrational. In some cases they more than double the costs of building ownership. For unit title flat holders the prospect of monthly insurance bills in the order of $400 a month is normal, on a property which is no longer saleable and possibly in a negative equity.

For the purposes of illustration I provide a single example. Relatively new suburban building, outside of the CBD with retail, apartments and carparks. Unimpaired value $2.8 million, replacement insurance quote is for $5.8 million rebuild cost and quoted premiums are way up.

What will happen to the value of this business? To the businesses and apartment holders in it?

In the Wellington commercial property market, full insurance is a condition of all the mortgage business. Full replacement earthquake insurance is a standard term and condition.

In NZ most companies which carry business interruption insurance also need to have earthquake interruption cover to satisfy the conditions of the bank credit facilities. These often include warrantees around the quality of the building that business is being conducted out of – including the existence of earthquake insurance cover.

So what does this mean?

It means that the Wellington CBD property market is frozen. The only purchasers are ones which are buying with cash. There are hundreds, possibly thousands, of distressed mortgaged unit title and company share owners in the city.

It means rentals are falling and landlords are getting creative.

But above all else it means an enormous impairment -i.e. write down – of:
1) property assets (estimated in the $10+ Billion effective immediately across Wellington); and
2) the mortgages which are collateralised against those assets.

Knowing all the above, but being frustrated that literally nobody is willing to go on the record about this stuff – I recently ran into a finance guy and we had a chat.

I asked him what the story was inside the banks (he was in a position to know).

He confirmed the thesis that there are massive unrealised property losses in the Wellington and Auckland commercial property markets. And he also confirmed that everybody knew this was the case.

He said the current response of everybody was “head in the sand”, adding, “don’t get me wrong, not head in the sand don’t know, head in the sand deliberately.”

But what about IFRS accounting standards? I asked.

At which point he shrugged.

So it’s just a matter of time?

Yes.

So what needs to be done?

This problem is not going to go away by itself. At present the banks are being accommodating with their commercial property debtors because the alternative is mutually assured destruction. There is nothing to be gained from banks taking ownership of all the property in Wellington.

But every mortgage document for every commercial property in Wellington needs to be amended. And probably many business loan agreements also. For this to happen new insurance arrangements – acceptable to creditors and debtors alike – need to be put in place for owners of property and businesses. It is likely that these will need to exclude earthquake cover for equity but include cover for loans lent against assets.

One suggestion being discussed is that central Government – through the EQC and possibly the Reserve Bank – could provide a “loan protection insurance scheme” which enables banks and debtors to at least insure the loans made against Wellington properties. Enabling them to at least roll-over all existing mortgages when they come to term.

But for this to happen central and local government, and banks need to get together and move very very fast.

At the moment nobody is even publicly acknowledging there is a problem.

Alastair Thompson is editor and co-founder of Scoop.

 

5 comments:

  1. KB, 13. March 2013, 11:28

    “For unit title flat holders the prospect of monthly insurance bills in the order of $1000 a month is normal.”

    Can you elaborate on this? It seems completely untrue, based on what my apartment building’s body corporate recently got an insurance contract for, and new apartment buildings being sold off plan have nowhere near this amount either.

     
  2. Rooster, 13. March 2013, 17:29

    Insurance costs have risen, in many cases by 3-4 times, because the lower cost insurers have dropped out of the market. But the Body Corp bills may not have risen as high, as they cover more than just insurance (ie cleaning, power, maintenance. etc). The net result for us in our building is that the monthly BC bill has gone up by about 150%, rather than the 300-400% implied above. As the value of the bill is related to the Unit Title entitlement, there will be some of the larger apartments which are attracting a $1000/month bill.

    This is definitely one occasion when Small is Beautiful….

     
  3. alastair, 13. March 2013, 22:01

    KB,

    I have had a look at the figure again and it does overstate the problem a bit. I expect with expensive apartments it could be real though as Rooster says. I have changed the figure in the article to $400 which fits the context of the remark much better.

     
  4. KB, 14. March 2013, 9:45

    Thanks for clarifying – that seems closer to where I would expect for the average apartment.

    Still your point stands that it is rather expensive compared to the value of the insured property.

     
  5. PGC, 14. March 2013, 15:55

    It just goes to show that perceptions matter as much as the science. Wellington hasn’t had a major earthquake for 150 years or so, and several major Pacific Rim cities have had one. But that doesn’t mean that Wellington is somehow due for one. If historically there has been a major earthquake every, say, 150 years, what that means is, in any given year there is a 1/ 150 chance of an earthquake. It doesn’t mean an earthquake occurs at 150 year intervals. But some insurers seem to be treating it as if that is the case. You could have two in successive years, or nothing for 300 years. Are Wellington building owners being penalised by risk-averse insurers?

     

Write a comment: