Business insurance in New Zealand: the ramifications of the Kaikoura Earthquake
- Published: Friday, 09 December 2016 10:40
Wellington based insurance risk consultant, John Sloan, looks at the implications for business insurance in New Zealand following the recent Kaikoura Earthquake; concentrating, in particular, on property and business interruption risk coverage.
The Boston based firm, AIR Worldwide, has estimated that the insured damage for the recent New Zealand South Island earthquake could cost between $1.5 and $5.5 billion but did not give a breakdown of this estimate. This estimate does not include uninsured damage such as infrastructure especially the road network. At the time of writing this article (30th November 2016) neither the Earthquake Commission (EQC)(1) nor the major insurers (including the Local Authority Protection Pool for certain infrastructure) have provided their individual estimates of their liability.
Although the three 2010/11 Canterbury earthquakes clarified the extent or limitations of both EQC and commercial insurers liabilities, many problem areas will still arise in the wake of the Kaikoura earthquake which also had a significant impact on Wellington commercial properties.
After those earthquakes, EQC increased their levy but not their principal coverage or limitations which will apply to the latest earthquakes.
One issue will be the self-insured claims deductibles which insurers apply to earthquake damage. These are based on the total site insured value for buildings, contents and business interruption policies. The usual earthquake claims deductible in the Wellington region is 5 percent meaning that for, say, a site insured value of $20 million, the claimant must bear the first $1 million. It is likely these claims deductibles could rule out many claims which fall below the threshold. Site is generally not defined and can mean that the value of all insured components accumulated by multiple tenants in a single location can increase the amount.
Some claims deductibles may be 2.5 percent but for older buildings it can rise to 10 percent. For entities with multiple damaged properties the separate site deductibles could be costly and they may not be individually or regionally capped.
The Canterbury earthquakes revealed widespread under valuation and insurance of properties and this may arise again in the South Island and Wellington. After the Canterbury earthquakes, domestic insurers ceased to insure earthquake on an open-ended replacement basis and limited their ‘top up to EQC’ liability. Another restriction was that commercial insurers did not provide automatic reinstatement of sums insured following earthquake damage. Another complication which could be inevitable is that subsequent earthquakes can cause further damage to unrepaired buildings.
Although major changes are in the pipeline for EQC, the basic structure remains unaltered and claims in excess of EQC liability will still fall on private insurers, meaning that demarcation disputes may still arise.
The principal options for non-residential building insurance are either current replacement value or indemnity value, that is, the physical depreciated value. If the replacement value has been professionally established on a ‘new for old’ including inflation, the sum insured should be adequate. If the policy wording is correct a replacement value policy should also include seismic coding upgrades imposed prior to the earthquake but this may warrant confirmation from the insurers.
Indemnity value coverage can also apply a deduction for what is termed ‘betterment’ as the cover is essentially ‘old for old’ and does not normally include any provision for code upgrades. In both cases demolition and removal of debris costs are included in the sum insured but, if costly, can erode the balance left for rebuilding.
If an indemnity value building is a total loss, then the insured claimant can effectively take the money and run. With replacement insurance, there is often the provision that, if insurers agree, a different type or occupation can be rebuilt as long as the insurer’s liability is not increased. In other words, a car parking building could be replaced with an apartment block on the same or another site.
Although land underneath and within 8 metres of a residence is insured by EQC, land is not normally included in any non-residential policy but assets such as car parks or port/airport tarmacs can be specifically insured.
Buildings slated for demolition prior to the earthquake could or should be insured for demolition costs alone.
A major problem area will be for business interruption insurances which are sometimes termed as loss of profits or consequential losses. These policies are meant to insure reduction in turnover or revenue or rental income and include protection for continuing overheads (including wages and salaries) plus increased costs to maintain services. In both Canterbury and in other major non-earthquake losses under insurance often emerged.
A major component in business interruption insurance is what is termed the ‘indemnity period’ which is the time estimated to fully recover from the insured disaster. This can be up to 24 months or longer and normally commences from the date of the earthquake. However, if there are extreme delays in rebuilding the indemnity period can be consumed. It is possible to include a beneficial provision that a deferred indemnity period starts when actual repairs commence.
The earthquake claims deductible also can apply to any business interruption claim meaning that, depending on the amounts involved, the loss could be totally self-insured.
For those unable to access buildings due to adjacent closures, certain policy extensions are available but these are generally limited to 5-10 percent of what you insure your business interruption levels at. It’s now evident that some buildings are closed, not from earthquake damage, but because of the discovery of asbestos which is a total exclusion in almost all insurance contracts; so this could be a potentially widespread uninsured area of unpredicted loss.
Most government entities are not insured for loss of income but their cover is confined to what is termed as ‘additional increased costs of working’ which includes expenses such as for relocation, additional staff and extra travelling costs. However, this kind of policy does not cover continuing overheads especially wages and salaries and is specifically confined to extra costs which must be carefully accounted for. Again, the claims deductible could mean that the final total costs are not covered by the insurance.
Both in Kaikoura and Wellington the earthquake proved to be a real live test for entities’ business continuity planning and resilience.
Correctly arranged business interruption insurance should arrange an extension for claims preparation costs, especially when accountants or other specialists are required to collate and validate claims. A properly worded extension should include the costs internally absorbed by the insured claimants.
A major problem in Canterbury was that of ‘depopulation’ which meant that if people were disinclined to shop in an area perceived to be dangerous, the business interruption insurance did not apply as the premises involved were not actually damaged. Some insurers agreed that depopulation was indirectly caused by an earthquake and generously viewed claims. Whilst business interruption policies can include prevention of access and damage to utilities or civil authority closures, again it all depends on the policy wording and limitations if a valid claim exists.
The future insurability of damaged or compromised buildings will be a challenge for the owners. Following the Canterbury earthquake, earthquake premiums increased but other the past three years have been reducing. However, in the wake of the recent earthquakes and aftershocks, it is likely that premium reductions will cease.
- New Zealand’s Earthquake Commission (EQC) cover: New Zealand is unique in having a compulsory government indemnified insurance scheme. This provides natural disaster/earthquake cover for insured residencies and their contents up to $NZ100,000 and $20,000 respectively (plus GST). Private insurers can provide ‘top-up’ cover to the total sum insured. EQC charge a flat capped premium for their cover which includes land underneath and within 8 metres of insured homes plus limited cover for paths, drives and retaining walls.