It may seem unfair to non-homeowners that, once the EQC’s established fund runs dry, the Government will pick up the tab for future claims due to the Crown guarantee clause, but abolishing the Commission could make things much worse, says Dr Eric Crampton.
Well prior to the Christchurch earthquakes, the Earthquake Commission warned the Government it would not be up to the task of assessing damage to tens of thousands of homes following a major disaster. It lived up to its own expectations following the Christchurch earthquakes.
Thomas Coughlan last week argued for the abolition of the Earthquake Commission. Some of those who endured EQC after the Christchurch earthquakes might find abolition to be too lenient a sentence for the organisation. But Coughlan’s recommendation was not due to the Commission’s performance, but because of its financial situation.
Coughlan argued that because the Commission’s financial reserves are almost drained, any substantial future natural disaster will quickly see the agency call on the Government’s backstop. Once reinsurance funding runs out, taxpayers at large will have to cover EQC’s liabilities. Since homeowners are generally wealthier than tenants, the transfer from taxpayers to insurance claimants will be regressive. And so Coughlan wishes the end of the organisation.
While I am hardly the Commission’s biggest fan, I fear Coughlan misses the most important role the Commission serves in avoiding even larger bailouts. Which is why even though Coughlan fears the regressive nature of any taxpayer bailout of EQC, the alternative could easily be far worse.
Earthquake insurance coverage through EQC is a compulsory part of home insurance policies in New Zealand. Since insurance is necessary for those with mortgages, insurance coverage is very broad. And while there are many inequities built into the way EQC premiums are set, at least some of these are designed to help ensure insurance coverage remains broad.
While it seems incredibly callous to argue that the Government should not bail out the uninsured in an earthquake event, disaster insurance more generally unravels in the alternative.
So after the Christchurch earthquakes, there was little pressure for the Government to bail out homeowners who had not taken out insurance. The Red Zone payouts to the insured and uninsured alike were not about bailing out the uninsured but rather were compensation for something very close to takings under the Public Works Act: The Government wished to clear out entire neighbourhoods so that Council services could retreat from hard-to-serve areas.
Because insurance coverage was so broad, those who had chosen not to take out insurance were more typically seen as people who had gambled and lost rather than as victims in need of substantial Government support. The uninsured deserving of most sympathy seemed the owners of bare land; it was never particularly clear it was even possible to insure bare land. The Government did not feel compelled to make right those losses.
While it seems incredibly callous to argue that the Government should not bail out the uninsured in an earthquake event, disaster insurance more generally unravels in the alternative. If everyone expects that the Government will make right the losses of the uninsured, then those taking out insurance are mugs – they pay an annual premium every year in which there is no disaster; come the disaster, their insurance coverage is little better than those without. Few then take out insurance.
Bailouts then become a self-fulfilling prophecy. If everyone expects that the Government will bail out the uninsured and so no one takes out insurance, the pressure on the Government to bail out the uninsured would quickly become unbearable.
Coughlan worries that the Government could be on the hook for damages to homes, up to each property’s $150,000 EQC cap, when EQC’s reinsurance runs out. In the absence of the broad insurance coverage facilitated by EQC, the Government could easily be responsible for much more than that. It would be worse for taxpayers, and it would be worse for claimants.
After the Christchurch earthquakes, it was very hard to avoid concluding that EQC was shortchanging everyone to avoid drawing on the Crown’s backstop guarantee. Insurance assessments were downscoped as the magnitude of the potential liability became clearer. Owners of broken homes had to get through EQC’s scoping before being able to deal with their private insurers. Homes that EQC had scoped as repairable patch-jobs became full rebuilds once the owner was able to get the assessment over the EQC cap and talk with their own insurer.
Whatever pressure private insurers were under from international reinsurers to keep costs down seemed minor relative to EQC’s practice. It would be surprising if any government post-disaster bailout programme in the absence of EQC would be more generous.
The Government has made important changes to EQC since the Christchurch earthquakes and is weighing further changes. The EQC cap is higher now than it was in the Christchurch event, and it is likely claimants will deal with their private insurers in the first instance rather than with EQC. Treasury had recommended these kinds of changes; we built on those recommendations in our recent report drawing together the policy lessons of the Christchurch earthquakes. These changes should improve outcomes for claimants after any substantial disaster.
But the Government could go further in addressing some of the equity considerations highlighted by Coughlan.
The EQC premium scheme is rather regressive. Currently, EQC premiums stand at $0.20 per $100 of insurance cover to a maximum levy of $240. The owner of a fully insured $500,000 home pays the same EQC levy as the owner of a fully insured $2,000,000 home. But more expensive homes are more likely to require repairs reaching the EQC cap. Work by Motu’s Sally Owens and Victoria University’s Ilan Noy demonstrated the regressive effects of the premium structure.
EQC’s land coverage also has a regressive effect. More expensive homes tend to be built in places with substantial landslip risk because clifftop views are valuable. But land coverage is bundled with policies without any additional premium. That need not be the case.
Revising the premium structure to account for the more costly claims originating from more expensive properties would both be equitable and help maintain broad insurance coverage – less of the burden of rebuilding the disaster fund would then fall on poorer households, so there would be less excuse for not being insured.
Doing away with EQC risks eroding New Zealand’s current broad base of private disaster insurance coverage. In its absence, taxpayers could easily be exposed to bailout risk more substantial than the Crown’s backstop guarantee to EQC, and owners of broken homes could be in even worse shape.
As someone who was far less than impressed with his experience in dealing with EQC after the Christchurch earthquakes, I can sympathise with Coughlan’s call to abolish the agency. But it could easily do far more harm than good.
Dr Eric Crampton is Chief Economist with the New Zealand Initiative. His home in Christchurch was repaired just in time for him to move to Wellington with his family in 2014.