Risk under the microscope - a sea change in pricing property insurance
New Zealand’s largest property insurer group recently announced a move towards more risk-based underwriting for property and contents insurance in areas considered prone to natural disasters. These changes will result in premium increases – some of which will be very substantial – for customers in affected areas.
While all insurance pricing is risk-based to some extent, insurers have traditionally spread the cost of natural disaster risks evenly across the country. With an increasing focus by reinsurers on the extent to which New Zealand insurers are exposed to risks in specific areas, this is changing. Insurers are now under pressure to ensure they are not disproportionately exposed in high risk areas. Risk-based pricing helps ensure that their insurance books are appropriately weighted to areas and types of risk.
Currently this shift will affect customers of Tower Insurance and the IAG group of companies, which include the State, NZI, AMI and Lumley brands and provide insurance through ASB, BNZ, The Co-Operative Bank and Westpac. Together, these brands provide around half of all property insurance in New Zealand. Vero Insurance has indicated an intention to move to partially risk-based pricing. Other insurers are likely to follow.
There have been media reports of very substantial premium increases for customers who are viewed as at an increased risk of natural disaster loss due to the location or type of their property. In 2018, one Tower Insurance customer reported that the annual premium on a Karori home had increased from $2,200 to nearly $7,200. More recent reports include a premium increase of $15,000 for a house in Fendalton, Christchurch and increases of $12,000 and $5,000 for houses in other areas.
Tower informed its customers that property insurance in earthquake-risk areas like Wellington, Napier and Gisborne would be likely to pay the most, but increases have not been confined to those areas or older properties. For instance, an Auckland homeowner reported a premium increase from $2,089 to $3,012 for a Green Bay house built in 2014 and an Auckland investor reported an increase of 40% on another property.
Tower initially said that very substantial increases will be confined to a small number of customers. Tower’s Chief Executive, Richard Harding, told media that the majority of customers would not see a significant change, with fewer than 2.5% receiving an increase of more than $250 and only 1% increasing by more than $2,000. While this may reflect only an initial round of increases, it suggests that, in the first instance, substantial increases will be confined to specific properties or areas that are regarded as particularly high risk. Insurers are also withrawing from regional markets, which may have the effect of removing some of the highest premiums from their books.
The premium increases will not only be linked to the risk of earthquake. Tower has indicated that pricing of flood insurance will also change according to risk.
Insurers tighten criteria
In addition to premium increases, IAG has indicated that it will be taking a “conservative approach” to underwriting new business in Wellington due to higher earthquake risk. There have been reports that IAG has tightened its criteria for accepting new risks from the Wellington, Porirua, Wairarapa and Hutt Valley areas. IAG reportedly insures around half of all homeowners in the wider Wellington area so its cautious approach to this exposure may have the effect of constraining supply in this region.
What does this mean for property owners?
For some owners, insurance may become unaffordable. Owners of apartments may be hit particularly hard. The premiums at one small apartment complex in Wellington were reported to have trebled since 2016. The owners voted by a slim majority to continue buying insurance. This resulted in an increase in the annual body corporate levy to more than $12,000 per apartment.
Going without natural disaster insurance is not a realistic option for apartment owners. This would breach the Unit Titles Act, which requires that body corporates organise full cover, and also the terms of owners’ mortgages. It would also make apartments unsaleable to buyers who require mortgage finance, which is likely to reduce their value significantly.
The move to risk-based pricing is also likely to affect values of properties that become more expensive to insure, depending upon the extent of the increase. As significant as the increasing cost of insurance may be, buyers’ apprehensions that an increase in premiums now may foreshadow a reluctance by insurers to provide cover at all in future may have an even greater impact upon property values.
Buyers of property will also need a more sophisticated understanding of the specific risks attaching to a property than is presently the norm. Buyers may obtain a copy of the Land Information Memorandum report for a property and look for any risk modelling obtained by the local council for such events as landslips and flooding. They may also wish to take advice from brokers or insurers as to whether the property is likely to be insurable in future. Brokers and insurers will need to be careful to explain all of the risks to their customers, including the risk that insurance may become increasingly difficult to obtain.
If insurers move entirely to risk-based underwriting, this could result in whole areas that are earthquake or flood prone or otherwise at risk becoming uninsurable. Some properties are likely to become unsaleable as they become too expensive or impossible to insure. People may become ‘trapped’ in houses or apartments where their insurers are willing to renew their existing cover, but buyers find themselves unable to insure the property as a new risk on reasonable terms.
What regulatory considerations are relevant?
While insurers’ conduct towards their customers is under increasing scrutiny by regulators in New Zealand and Australia, this is largely focussed upon life insurance and areas in which large commissions are payable or products are mis-sold. Property insurance has not been a particular area of focus as it is not generally susceptible to these issues.
Insurers do not generally owe their customers any duties with respect to pricing or their decisions as to whether they will insure risks at all, provided their conduct does not amount to unlawful discrimination under human rights legislation. Insurers will, however, be conscious of the need to explain these changes to their customers carefully and accurately.
What has happened in other earthquake-prone countries?
According to the California Earthquake Authority website, only around 1 million of California’s more than 7 million homeowners have earthquake insurance. California is a known earthquake risk and is believed to be due for a major earthquake within decades. The low up-take of insurance presents a substantial risk for California’s economy.
The state legislature first stepped in to address this in 1985 when insurers became obliged to offer earthquake insurance to homeowner customers. Over time, however, premiums increased and eventually almost all insurers ceased offering homeowner earthquake insurance altogether.
Accordingly, in 1996, the California legislature set up the California Earthquake Authority (CEA), a non-profit, publically managed, privately funded statutory body which provides the majority of earthquake insurance in California. It offers earthquake cover through insurance companies that are CEA members. Policies have relatively high deductibles, ranging from 5% to 25%.
The CEA assesses premiums based upon a range of factors, including the following:
- The age of the building
- The age of the building
- Whether it is constructed from brick or masonry
- Whether it has more than one story
- Ground conditions
- Whether it is up to current code
The CEA appears to have enabled those who wish to have earthquake insurance to obtain it, although uptake remains low by New Zealand standards.
Will the New Zealand Government intervene?
There has been no immediate indication that the New Zealand Government intends to look into a statutory scheme like that in California or otherwise take action to prevent insurance becoming unaffordable.
The Minister of Commerce and Consumer Affairs, Kris Faafoi, said in early 2019 that he would continue to monitor the situation, but that he understood insurance companies other than IAG were still offering policies and did not intend to withdraw from the market. The Minister said that the Government was “a long way from intervention” but invited insurers to share more information with consumers so they can be better informed about availability of policies and risk-based decisions.
In time, it seems likely that premiums will continue to rise for areas that are regarded as high risk. Ultimately, some areas may become insurance ‘black spots’ where property values plummet and calls for Government intervention become increasingly loud. In the meantime, careful consideration will be required by those who choose to invest in potentially affected areas.
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