Speech – Vero
Thank you for attending our lunch today and your interest in the future of insurance in New Zealand. We borrowed the title of my address – The Year of Living Dangerously – from a popular Australian novel and film. The novel was about a naive young man …Trans Tasman Business Circle
20 November 2012
The Year of Living Dangerously
Thank you for attending our lunch today and your interest in the future of insurance in New Zealand.
We borrowed the title of my address – The Year of Living Dangerously – from a popular Australian novel and film.
The novel was about a naive young man who makes a number of ill-conceived decisions in the midst of national turbulence and disaster.
I want to assure all here today that the situation in the novel does not apply to me or Vero.
I am no longer young!
Perhaps more aptly – the title was also used for a recent report by the Brookings Institute about natural disasters throughout the world.
New Zealand was the most dangerous place in the world for insurers and reinsurers following the Canterbury earthquakes during 2010 and 2011.
The danger was tragically real for the people of Canterbury who lost lives, family members and possessions.
The dangers for insurers came from the massive impacts on their balance sheets; the subsequent drain on their capital reserves; the overload of their claims management capabilities; and the subsequent reputation damage as they met a surge in customer demand.
It is a testimony to the resilience of the people of Canterbury and the quality of the earthquake response by government, business and insurers that the immediate danger has been reduced and recovery is well underway.
I would highlight that point.
There have been many obstacles along the way and many remain. It will be years before a full recovery is completed.
Yet I believe the Government, its agencies and insurers have worked well to gain control of the largest and most complex natural disaster in the world when you take the size of New Zealand into account.
The foundations have been laid for a new Christchurch as the hub for a revitalised Canterbury Region.
That is certainly the message Vero is relaying to the international investment community, reinsurers and others who previously were concerned about the ability of Canterbury and New Zealand to recover from such a massive disaster.
It is the message I am pleased to relay today.
Of course, the danger of natural disasters will always remain.
We can take steps to mitigate the impact of that danger on the New Zealand economy, businesses and communities.
The best time for reform is when the need for change is most obvious.
We are managing the recovery of the worst natural disaster in New Zealand’s history.
That’s why I believe we have a ‘once in a generation’ opportunity to significantly improve the way natural disaster insurance is funded and managed.
The recently announced review of the Earthquake Commission Act is timely and a key step forward in improving disaster insurance.
I believe it would be a lost opportunity if the Government, insurers and others simply looked upon the review as an opportunity to finesse existing legislation.
For insurers it should be the start of an ongoing reform process designed to deliver a resilient general insurance sector that underpins New Zealand’s economic competitiveness.
For Government, it should be an opportunity to consider the best way to reduce the fiscal risk to the Crown of natural disasters, while providing an acceptable level of protection for public and private property.
The underlying message of my comments today is that reform of New Zealand’s approach to earthquake insurance is not simply a matter of importance to the general insurance industry.
It is a matter that will ultimately influence the living standards of all in New Zealand.
Insurance and the New Zealand economy
The starting point is for the insurance industry to do a better job at promoting the link between efficient general insurers and a healthy economy.
It is a little recognised fact that the level of dependence of New Zealand on its general insurance sector is unique in the world today.
The latest Reserve Bank of New Zealand Financial Stability Report says expected total claims costs related to the Canterbury earthquakes may exceed $30 billion.
That would be more than 15% of the GDP of New Zealand.
Fortunately, most of those costs will be met by insurers.
If the New Zealand Government had to borrow what reinsurers and insurers are paying out for the Canterbury recovery the Government would have to find an additional $800 million a year in debt interest payments.
Company or personal income tax might provide some of the recovery cost in the absence of insurers.
However, a $30 billion recovery cost is more than the Government collects in personal tax annually and three times what it collects in company tax.
Funding earthquake damage costs from taxation would require massive increases in both commercial and personal taxes – a prospect that would have significant economic and political impacts.
Expenditure could be reduced – although at massive social and political cost.
The current insured cost of the earthquakes is about the same as the entire annual Government spend on social security and welfare in New Zealand and close to the spend on health and education combined.
These points illustrate the way insurance has protected New Zealand from current dangers resulting from the Canterbury earthquakes.
What about the future?
Is the contribution of reinsurers and local insurers to New Zealand likely to be as important in the future as it is today?
The answer is – yes.
The insurance industry will continue to have a significant impact on New Zealand’s economic strength, international competitiveness and standard of living.
The rebuilding of Canterbury is expected to add around one percentage point to annual growth in New Zealand each year from now until 2016.
To put that into perspective – growth remains moderate and is expected to be 2.8 per cent this year and 3.8 per cent for the following year.
The latest Reserve Bank Financial Stability Report notes that total insurance claim payments for the Canterbury earthquakes are nearly $11 billion.
Insurers are well over a third of the way through the completion and payment of claims.
The pace and quality of the insurer response to the earthquakes will continue to have an impact on medium term national economic growth.
There is also a longer term perspective government and insurers alike need to consider.
New Zealand’s macroeconomic framework is the way fiscal policy, monetary policy and the exchange rate are managed.
The quality of that management by government, departments and regulators influences competitiveness, productivity and New Zealand’s standard of living.
Well capitalised and competently managed insurers, banks and other financial institutions also have a key role to play.
The Reserve Bank recently noted that New Zealand’s external debt is high relative to GDP and continues to be fed by ongoing current account deficits.
Private sector debt is down; but public sector debt has risen and this poses a potential financial risk for New Zealand.
The Government is keen to restore the budget to surplus and then begin the necessary reduction of external debt.
It can only do that if the fiscal drain of the Canterbury earthquake recovery is reduced and revenue is enhanced through more efficient and globally competitive industries.
The World Economic Forum produces an annual report on the competitiveness of national economies.
It has developed 12 factors it believes have a significant impact on a nation’s competitiveness.
New Zealand does well on a number of these and is amongst the most competitive nations in the world for factors such as the quality of its institutions; goods market efficiency; and financial market development.
The key point is that the individual factors are not independent and reinforce each other. A weakness in one area will negatively impact on others and ultimately the overall level of competitiveness.
That is particularly the case for a relatively small, open economy such as New Zealand.
If the performance of key institutions such as major insurers is weakened through natural disaster policies and regulation, that ultimately impacts other areas of the economy and national competitiveness.
I believe the policies governing natural disaster insurance in New Zealand are in need of reform because they impact the productivity of the general insurance sector.
Why earthquake insurance reform is important
The Canterbury earthquakes exposed weaknesses in the current EQC and private insurer hybrid insurance approach.
There are obvious operational problems.
The model is systemically flawed when placed under the stress of a massive volume of claims and no consistency in the terms and conditions of policies being managed by both the EQC and private insurers.
Having a government insurer and private insurers responsible for claims from the same customer has made the Canterbury recovery extraordinarily complex and has reduced claims management speed and efficiency.
Conventional insurer claims management models assume an orderly, linear progression from receipt of the claims through to assessment and reinstatement or settlement.
They also assume one insurer will have control over all facets of the claims they are managing on behalf of their customers.
Another major deficiency of the current approach is that it increases costs and wastes capital for both the Government and private insurers.
Those additional costs are ultimately met by taxpayers and customers.
Since the 2008 global financial crisis – capital has become a scarce commodity for financial services companies and governments.
In the latest Financial Stability Report, the Reserve Bank notes that requiring financial institutions to hold more capital reduces the probability of another financial crisis.
While Vero and other local insurers may have a healthy debate with the Reserve Bank about the size of mandated capital ratios – we certainly agree about the need for capital prudence.
That is why we believe every effort should be made to ensure capital is not needlessly wasted by a hybrid earthquake management model that duplicates costs and escalates claims handling expenses.
That is not only an issue for insurers and reinsurers. It is also a growing concern for the Government.
The latest EQC Annual Report notes the Commission has net liabilities of $1.6 billion and the Government has guaranteed to meet that shortfall.
The EQC has another 80,000 properties with claims to manage and that will presumably mean an increase in the net liabilities that will need to be met by the Government and ultimately the New Zealand taxpayer. That is an expense that would not be incurred if the EQC did not manage earthquake claims.
The process complexity created by the current EQC and private insurer model has been a key contributor to community and customer concerns about the capabilities and motives of insurers.
The problem is that neither government nor insurers can easily reduce systemic complexity during the course of a recovery effort.
We have to persevere with the current hybrid model for the duration of the Canterbury recovery.
That does not prevent us from making the necessary changes now to ensure we are far better prepared for any future natural disaster.
What needs to change?
Looking ahead I believe New Zealand’s major insurers need to address three key issues.
The first is to progress Canterbury earthquake claims as quickly and competently as possible.
Vero is currently managing around 19,000 domestic and commercial claims and have settled nearly 50 per cent.
We have paid out $1.76 billion to commercial and domestic property owners.
We have over 1,000 domestic and commercial projects in the final stages of preconstruction.
Importantly, we were the first insurer to provide domestic customers with construction dates ranging from the next six months to 2015.
The second issue insurers need to address is the reshaping of their organisations to ensure their strategies, structures and operating processes can cope with crises as well as ‘business as usual’ environments.
The collapse of AMI was the result of a business model and capital base that could not cope with a major natural disaster.
New Zealand’s competitiveness and economic growth require local insurers resilient enough to operate under any market conditions.
Vero has begun a major strategic review and change programme to increase the competitiveness and inherent strengths of our businesses.
For an organisation with a 100 year history and trusted, proven brand in New Zealand, this is a significant initiative.
There will be obvious commercial benefits for Vero from the changes we are making.
We also believe we can argue for Government policy change much more confidently if we can demonstrate we are prepared to invest heavily in improving our own, long-term efficiency.
That brings me to the third issue for general insurers in New Zealand – the need to work constructively with the Government, Treasury and others to substantially improve the current approach to natural disaster financing, mitigation and management.
The logical starting point is the proposed review of the EQC Act.
The current Act is designed to implement the current hybrid approach to earthquake and other disaster insurance provided by both the EQC and private insurers.
Vero believes the major lesson learned from the Canterbury earthquakes is that there needs to be fundamental changes to the roles of private insurers, the New Zealand Government, and the EQC in natural disaster financing, mitigation and management.
The Crown wants to reduce fiscal risk and improve the efficiency of post disaster recovery management.
It is clear the current approach increases fiscal risk and reduces post disaster claims management efficiency.
Vero believes a key objective of any model should be to recognize the fact that earthquakes are rare – but massively damaging and costly.
You need a disaster insurance approach that segregates or decouples the rare need to manage earthquakes from the usual marketing and management of insurance designed to protect against more common property risks.
That is the fundamental flaw of the current approach.
It requires the Crown and private insurers to continually fund and resource operations designed for events that are rare.
Given the Government’s commitment to a balanced budget and debt reduction, Vero questions whether it is sensible to operate a fully resourced and funded public insurance agency with the sole mandate of managing claims after a major natural hazard disaster.
Vero has had the benefit of substantial disaster recovery management expertise within our parent Group, Suncorp, as well as the ability to call on the Group’s reinsurance purchasing scale and capital reserves.
That has enabled Vero to ensure the appropriate resources and operational process efficiency to underpin our Canterbury earthquake recovery effort.
I believe there are a number of different models that should be considered for private insurer and Government involvement in earthquake insurance.
Some of the models could result in a substantially reduced level of Crown involvement in the provision and administration of general insurance, including no involvement in claims management.
Others could have a changed level of Crown and private insurer funding.
For example, private insurers could write earthquake insurance up to a set maximum amount; and the Crown could act as a virtual reinsurer and meet the costs of claims above a set cap.
Vero plans to model the costs to insurers and the Crown of a range of options that are alternatives to the current hybrid approach. This will form part of our response to the review of the EQC Act.
The American Congressman, Daniel Patrick Moynihan once remarked that: “Everyone is entitled to his own opinion, but not to his own facts”.
There are usually more opinions than facts whenever the performance of insurers is discussed.
That is particularly the case with the Canterbury recovery.
It is an ongoing source of frustration to government and customers alike that there seems to be no clear way to measure or assess progress with the recovery.
That is partially the fault of insurers.
We are very good at assessing risk and charging for managing risks; but much less competent in accurately portraying to the public the good progress we are making.
It is also due to the fact that there is no standard pace or completion time for a natural disaster recovery.
Each disaster recovery is influenced by factors such as unique local climate and physical conditions; the experience of private and public sector organisations in managing disasters; and the processes and resources available.
That is small solace for governments and communities.
The reality is solid progress is being made and prospects are bright for investment in Canterbury.
That progress would have been faster and more substantial if not for the inefficiencies of the current earthquake insurance model.
Pleasingly, we now have an opportunity to rectify those.
The main character in The Year of Living Dangerously novel learns from his traumatic experiences and heads off into the sunset with his new female companion.
I must admit there has been little romance in my past year of dealing with seemingly intractable insurance matters.
Yet there has been important learning and I am pleased to have been able to share that with you today.