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Reinsurance cover for quake claims

29 Nov 2016

Report by ARTEMIS 

Reinsurance capital looks set to pay for some of the damage caused by this weeks earthquakes in New Zealand, with local insurers having low deductibles and the EQC likely to call on its program as well, but questions of how many events have occurred could complicate matters, as could supply chain interruption.

The industry loss is likely to be less, given the epicenter was in an area of much lower population, but the industry should expect it to be of a size where some reinsurance claims are to be expected.

Infrastructure damage from the first earthquake raises issues related to business interruption and supply chain risk, as ports are unable to operate, roads and rail tracks blocked due to landslides and local authorities saying it could be many weeks before things are back to normal.

That could exacerbate the extent of any loss for insurers, ultimately increasing the risk of reinsurance capital paying a larger share as well.

The region has been rocked by hundreds of large aftershocks, which have been severe enough in some cases to exacerbate the damage seen. A second major earthquake occurred on Monday as well, initially put as a magnitude 6.8 event, but later downgraded. Two other major quakes of magnitude 6+ have also occurred in the vicinity since the first earthquake, according to the USGS.

Questions are already arising as to whether those can be deemed aftershocks or whether at least one could be deemed a separate event by the insurance and reinsurance industry.

Risk modelling firm AIR Worldwide calls the events aftershocks, but we’ve heard contacts in the market questioning whether at least one of the stronger aftershocks (the one highlighted by most of the mainstream media) could be a separate event.

If it were a separate event it could make insurers and the Earthquake Commission (EQC) retain more of the losses associated with the quakes, lessening the amount reinsurance would pay for. The EQC has a retention of around US$1 billion we understand, before its NZ$4.7 billion of reinsurance protection kicks in.

Were the larger aftershock deemed a separate quake by reinsurers it could cause the EQC to pay a second retention. Under such circumstances the same could be applicable to primary insurers reinsurance programs.

At this stage we’re hearing some market chatter that the second earthquake is being investigated by some reinsurers to see how it should be treated. But it seems that risk modelling firms and others, including the wider press, are already stating that this is an aftershock and so a single event, which would suggest a single event and a single claim.

If that’s the case it’s entirely possible that the EQC could blow through its deductible and call on some reinsurance capital to help it to finance the payment of claims associated with this earthquake.

The collateralised reinsurance and ILS fund market generally participates in the upper layer of the EQC’s reinsurance program, so these could be safe from impacts to the EQC program. It’s perhaps more likely that ILS funds may find themselves exposed through either primary insurers with low reinsurance program deductibles, or through world-wide aggregate retrocession type contracts, given the greater level of loss events seen in 2016 so far.

Primary insurers underwriting earthquake risk in New Zealand tend to have low deductibles on their reinsurance program, making claims more likely.

New Zealand insurer Tower Group explained; “Tower’s reinsurance programme provides over $700m of cover for events such as this. Tower advises its reinsurance programme provides cover once the excess of NZ$10 million has been surpassed. Therefore the maximum possible impact is NZ$7.2 million after tax.”

Judging by the level of damage seen from the quakes, it is hard to imagine that Tower won’t blow through that retention level and call on its reinsurers for support.

Other insurers operating in New Zealand likely have similarly low retained deductibles on their reinsurance arrangements, which could mean a larger proportion of the eventual loss from this weeks earthquake falls to reinsurance capital.

However the events are treated (single or separate) and whatever insurers reinsurance arrangements are, the fact is that losses suffered by the re/insurance industry are expected to be much lower than were seen from the Canterbury quake event.

Complications due to supply chain risks and the potential for business interruption, due to infrastructure damage and key supply routes being out of action for some weeks could exacerbate claims, but still the overall impact is expected to be much lower.

The Canterbury quake experience and the long period of time taken for claims to be settled will concern some reinsurers, as that event has seen the industry loss continuing to rise five years after the event and caused some insurers to increase their reinsurance protection.

Reinsurers do not want to be held on losses for years, particularly for risks typically classed as shorter-tail like earthquakes. Hence the ILS fund market commuted its exposures to the Canterbury events earlier on, which right now looks like a very smart move.

The event will further highlight the important role of reinsurance capital and the benefits of softer pricing. The EQC and regional insurers have all benefited from the softening of the reinsurance market, enabling them to buy increased coverage and reduce their deductibles in recent years.

New Zealand property insurance rates have risen somewhat since the Canterbury event, as have some layers of pricing on reinsurance programs, but still these remain more affordable and protection broader than it was pre-the 2011 event.

It will be interesting to see whether reinsurance rates remain low, or whether the global market looks to push through rate increases in New Zealand after this latest earthquake.

 

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