Sharing the risk?

In light of news that insurers are now using "risk based pricing"* which means that "high risk areas" won't be offered certain classes of business https://www.radionz.co.nz/news... I thought I'd offer some thoughts on the performance of the domestic insurance market in New Zealand since 2010 (specifically since September 2010). The reason for my musings are that since the CES events, earthquakes are a bit of a trojan horse/bogeyman. For example, if you talk to geophysicists, their assessment of the risks of "the big one" haven't changed much for Wellington over the years. The Kaikoura quake did some very localised damage to a specific class of building (non-base isolated high rises in the CBD) and EQC (for now) bear the risk of the first $20,000 of contents damage caused by earthquake, so the insurers exposure hasn't changed. So what is going on to lead to first Tower and now IAG deciding that "OMG Wellington has earthquakes!?"   

(*quite what they were doing before when their pricing wasn't apparently based on pricing the risk is another question, given that an insurer's 2 functions are pricing risk and paying claims)

I suspect that three things are driving this; the Reserve Banks signalling that insurers will need to have more capital backing, the changes to EQC legislation removing EQC cover for contents, and ROI. 

The last of these; return on investment raises the question, if insurance is about risk sharing, how much of the risk are the insurers (and their shareholders) sharing with us, the premium payers? 

(Statement of accuracy - some content in this post is about pricing, I am less than expert on the intricacies of the actuarial pricing mechanisms used to calculate premiums, so treat those bits with a pinch of salt.)

I recently renewed some of my business policies and had a fairly eye watering bump in price. This raise, and others is driven by a number of factors; 

  • external factors such as; fire levies, EQC, the price of international re-insurance, and returns on the fund of invested premiums from which claims are paid; 
  • internal factors such as; the costs of paying claims, the costs of running the business, and
  • market factors. 

But is a healthy market prices rise and fall, however premiums have gone only 1 way in New Zealand over the last 10 years; up, and this seems to be the case across most classes of business. 

In New Zealand the insurance market is small by global standards. This is true both in the scale of the market (NZD$5,727,157,999 in 2018 according to the ICNZ compared to the USD$2.7 trillion annually in the USA or the UK market which is worth USD$389 billion annually) and in terms of the number of providers; there are currently 88 insurers registered with the Reserve Bank and therefore able to carry on insurance business in New Zealand, however, in each market segment (eg: Life,Health, Fire and General, Liability) there are probably no more than around a dozen providers. In the main segments, the market pattern is for there to be 2-5 large providers and a scattering of smaller (usually niche) providers. Fire and General is a great example of this; Vero and IAG (both owned by Australian listed companies) dominate the segment with about 60% of the market between them,Tower next with about 7%, FMG with about 5% and a bunch of other smaller insurers making up the rest.

The small number of providers in any market segment means that consumer choice ( and therefore market effects on pricing) is not what it would be in Australia or the UK for instance. In specialty markets (such as the Financial and Professional Insurances market) the lack of providers is even more pronounced, and this can lead to significant pricing fluctuations as overseas providers (such as Lloyds syndicates) enter and leave the market. At one stage when I was a broker selling Solicitors PI there were a grand total of 4 PI providers in the market. 

This leads to volatility, which can be seen in the premiums charged BUT NOT, it seems, in the profits made. This has been bugging me since 2011 when IAG CEO Jacqui Johnson announced to the New Zealand Insurance Law Association Conference that the aftermath of the Canterbury Earthquakes would see the Industry rebuilding Christchurch and changing public perceptions of insurance in New Zealand. Despite this a) premiums rose b) the claims response, albeit generous to begin with became less so by late 2015, and c) IAG posted after tax profits of: 

  • Au$660 million (2011), 
  • Au$832 million (2012), 
  • Au$1.428 billion (2013), 
  • Au$1.579 billion (2014), and 
  • Au$1.1billion (2015). 

IAG paid dividends every one of those years. 

If we look at Vero's parent company SunCorp the results are similar; from the general insurance business after tax profits of: 

  • 2011 Au$392 million, 
  • 2012 Au$493 million, 
  • 2013 Au$883 million, 
  • 2014 Au$1 billion, 
  • 2015 Au$624 million, and 
  • 2016 Au$689 million.

These profits were made despite the following catastrophes (the majority of which were billion dollar plus insured losses); 

  • 2009 Victoria Bushfires 
  • 2010-2011 CES earthquakes
  • 2010-2011 Queensland floods
  • 2011 Cyclone 
  • 2014 Brisbane hailstorm
  • 2015 Cyclone Marcia
  • 2016 Kaikoura earthquake

Now to be fair, the profits aren't shared around; Tower has struggled with losses from EQ related shortfalls in 2016 and 2017, and of course AMI had to be bailed out after its re-insurance arrangements were woefully inadequate to deal with its exposures to CES claims. However, the troubles of Tower and AMI seem to be related the particular arrangements and geographical exposures of those insurers, as similar sized insurers reported no such problems. 

Now the OECD annual insurance reports show that premiums have risen steadily world wide, but the increases have been disproportionate in New Zealand. Why? 

Our domestic insurance market is dominated by two Australian Giants similar to the NZ banking industry. The New Zealand divisions of these 2 insurers are their most profitable. This duopoly is growing and in my view distorts the market. It seems that if you are a shareholder in either Suncorp or IAG you are protected from risk, but if you are a premium payer you bear the risk in the form of higher premiums.

Underwriting is (or should be), about pricing the risk of future events. Sometimes that is not an exact science; nobody in Insurance or building regulation expected the CES events, although the fact that the spire of Christchurch Cathedral has been brought down 4 times by earthquakes in 140 odd years should have been something of a clue. But it seems that the market isn't working in New Zealand, to the point where future premium pricing is being used to compensate for failure to properly price past eventuated risks. But the "increased risk" of earthquake in Wellington is being used to justify a price hike. In other words "we charged you too little before the quakes so now we'll charge you more to make up for the failure to underwrite accurately, but we can't let the shareholders miss out on their dividends now can we?". 

I don't believe the profit incentive leads to good structural outcomes in the New Zealand market, and it seems to me that the market really isn't working. When you consider the probable effect of data driven granular underwriting (which I've written about before) and the effect it will have on the healthy function of a risk pool, these issues are going to make insurance unaffordable or unobtainable for a significant number of people.

What is the answer? Firstly a bit more assertiveness from the Commerce Commission when the big two try to acquire more market share (although I suspect that boat has sailed). Legislation changes to favour mutual (customer owned) insurers, these used to be very common and well run (Farmers Mutual Group and Medical Assurance Society remain as good examples, as was AMI but for an over-exposure to Christchurch risks coupled with inadequate reinsurance) The other option (which will trigger the economic libs) is a state insurer.   

Christchurch should have taught us the value of a well insured community, lets hope the lessons stay learnt.