The Herald’s Jenée Tibshraeny reports that Treasury is considering increasing the Natural Hazards Commission’s cap from $345,000 to $460,000 while increasing the levy by up to $400 per year to make up the difference.
I hope another change could be in the mix.
The Natural Hazards Commission covers what amounts to a giant excess on behalf of homeowners, with private insurers taking the cost above the cap.
Private insurance policies can charge higher premiums for properties that are riskier. The Commission does not. A million-dollar property sitting on top of an eroding Auckland hillside, or on the edge of a Wellington fault, will pay the same Commission premium as a million-dollar property in Southland with much lower earthquake risk.
So if the Commission covers a greater proportion of the cost after a disaster, the private insurer covers less of that cost. The more of the cost that the Commission covers, the smaller the premium that a risky property has to pay for insurance as compared to a safe place.
That much should be obvious. If the Commission covered 100% of the cost of damages caused by natural hazards, there would be no price difference between the riskiest and safest places. If the Commission covered none of it, and if private insurance were still available, the riskiest places would pay much higher premiums than the safest places.
So Tibshraeny points to a trade-off. The government might want to increase the Commission’s covered cap. But increasing the cap means a larger subsidy for living in riskier places. The flat premiums that the Commission charges means that safe places subsidise risky places.
Subsidies encourage people to do more of the subsidised thing than they otherwise might. Taxes do the opposite. A government insurance scheme that acts as a tax on living in safe places and a subsidy to living in risky places encourages people to build on risky sites and live in risky places.
You might think that that subsidy could be justifiable on equity grounds. Suppose that poorer people tended to live in riskier places, and richer people could afford to buy houses in the safest places. If that were true, then you might want to maintain the subsidy on grounds that it helps poorer people.
Unfortunately, there are two big problems with that argument.
First, if we care about poorer people and want to use subsidies to help them, giving them cash makes more sense than giving everyone a subsidy for choosing to live in riskier places. It is not only better targeted, it also avoids the big problem inherent in subsidising people to live in riskier places: that it encourages people to choose to live in risky places.
That concern is not just theoretical. A substantial academic literature has examined the effects of flood insurance schemes subsidised by the American government. For example, work by Peralta and Scott, published last year in the Journal of the Association of Environmental and Resource Economists, showed that America’s National Flood Insurance Programme caused increases in the population of flood-prone areas that became eligible for insurance. And the effect was larger in more flood-prone places.
Land use planning restrictions then have to try to undo the effects of subsidies provided through government-backed insurance schemes. It’s less than ideal.
So giving people cash, rather than subsidies for living in risky places that encourage people to live in riskier places, might make more sense.
Second, most people’s intuitions about the redistributive effects of New Zealand’s hazards insurance are backward. When Motu’s Sally Owens and Victoria University’s Ilan Noy looked at the figures in 2017, it turned out that the then-EQC’s premiums were regressive rather than progressive.
Why? Because EQC winds up having to cover a lot of cost when expensive mansions on cliff-tops fall over. Any given claim from an expensive house is more likely to hit the top of EQC’s coverage because expensive houses take more expensive repairs. And the clifftops with the best views are pricey to begin with.
The hope has always been that, because private insurance covers the majority of the cost when an expensive home is written off in a disaster, higher premiums in riskier places will still help to encourage living in safer places.
But while private insurance premiums in riskier places have started increasing, insurance companies would be taking a risk of their own if insurance premiums in the country’s riskiest places really reflected that risk. Premiums in the riskiest parts of Wellington could go up substantially.
How much?
There is about a 120-year return cycle on giant earthquakes in Wellington. Or about 0.83 percent chance per year. If you own a house insured for up to a million dollars of damage in an earthquake, and you’re sitting in one of the places where it would take that full million to fix things when that that quake hits, your insurance premium just for damage in a giant earthquake would be $8,300 per year. And your homeowners’ insurance covers a lot more than just city-ending earthquakes.
Insurers have been moving toward premiums that more accurately reflect risk. But fully pricing that risk could be politically risky.
Insurers will have seen the current government’s shouting at banks that do not want to lend money to petrol stations that banks see as too risky for loans.
Insurers, like banks, are highly regulated. Parliament ultimately controls the regulations governing both banks and insurers. Small changes in regulation can have big consequences. Avoiding Parliament’s ire can matter more than losses from cross-subsidies.
If insurers here expect a populist backlash against high but fair premiums in risky places, they will find it politically safer to withdraw insurance in those places instead – like they did in California.
And so we come to the change that I hope could also be in the mix.
Let the Natural Hazards Commission charge higher premiums in riskier places. The change could be phased in over time, with expected levies over the next decade published in advance.
It would not only undo some of the unnecessarily regressive effects of the current premium structures but also make it politically safer for private insurers to follow suit.
Dr Eric Crampton is Chief Economist at the New Zealand Initiative. This article was first published HERE
Private insurance policies can charge higher premiums for properties that are riskier. The Commission does not. A million-dollar property sitting on top of an eroding Auckland hillside, or on the edge of a Wellington fault, will pay the same Commission premium as a million-dollar property in Southland with much lower earthquake risk.
So if the Commission covers a greater proportion of the cost after a disaster, the private insurer covers less of that cost. The more of the cost that the Commission covers, the smaller the premium that a risky property has to pay for insurance as compared to a safe place.
That much should be obvious. If the Commission covered 100% of the cost of damages caused by natural hazards, there would be no price difference between the riskiest and safest places. If the Commission covered none of it, and if private insurance were still available, the riskiest places would pay much higher premiums than the safest places.
So Tibshraeny points to a trade-off. The government might want to increase the Commission’s covered cap. But increasing the cap means a larger subsidy for living in riskier places. The flat premiums that the Commission charges means that safe places subsidise risky places.
Subsidies encourage people to do more of the subsidised thing than they otherwise might. Taxes do the opposite. A government insurance scheme that acts as a tax on living in safe places and a subsidy to living in risky places encourages people to build on risky sites and live in risky places.
You might think that that subsidy could be justifiable on equity grounds. Suppose that poorer people tended to live in riskier places, and richer people could afford to buy houses in the safest places. If that were true, then you might want to maintain the subsidy on grounds that it helps poorer people.
Unfortunately, there are two big problems with that argument.
First, if we care about poorer people and want to use subsidies to help them, giving them cash makes more sense than giving everyone a subsidy for choosing to live in riskier places. It is not only better targeted, it also avoids the big problem inherent in subsidising people to live in riskier places: that it encourages people to choose to live in risky places.
That concern is not just theoretical. A substantial academic literature has examined the effects of flood insurance schemes subsidised by the American government. For example, work by Peralta and Scott, published last year in the Journal of the Association of Environmental and Resource Economists, showed that America’s National Flood Insurance Programme caused increases in the population of flood-prone areas that became eligible for insurance. And the effect was larger in more flood-prone places.
Land use planning restrictions then have to try to undo the effects of subsidies provided through government-backed insurance schemes. It’s less than ideal.
So giving people cash, rather than subsidies for living in risky places that encourage people to live in riskier places, might make more sense.
Second, most people’s intuitions about the redistributive effects of New Zealand’s hazards insurance are backward. When Motu’s Sally Owens and Victoria University’s Ilan Noy looked at the figures in 2017, it turned out that the then-EQC’s premiums were regressive rather than progressive.
Why? Because EQC winds up having to cover a lot of cost when expensive mansions on cliff-tops fall over. Any given claim from an expensive house is more likely to hit the top of EQC’s coverage because expensive houses take more expensive repairs. And the clifftops with the best views are pricey to begin with.
The hope has always been that, because private insurance covers the majority of the cost when an expensive home is written off in a disaster, higher premiums in riskier places will still help to encourage living in safer places.
But while private insurance premiums in riskier places have started increasing, insurance companies would be taking a risk of their own if insurance premiums in the country’s riskiest places really reflected that risk. Premiums in the riskiest parts of Wellington could go up substantially.
How much?
There is about a 120-year return cycle on giant earthquakes in Wellington. Or about 0.83 percent chance per year. If you own a house insured for up to a million dollars of damage in an earthquake, and you’re sitting in one of the places where it would take that full million to fix things when that that quake hits, your insurance premium just for damage in a giant earthquake would be $8,300 per year. And your homeowners’ insurance covers a lot more than just city-ending earthquakes.
Insurers have been moving toward premiums that more accurately reflect risk. But fully pricing that risk could be politically risky.
Insurers will have seen the current government’s shouting at banks that do not want to lend money to petrol stations that banks see as too risky for loans.
Insurers, like banks, are highly regulated. Parliament ultimately controls the regulations governing both banks and insurers. Small changes in regulation can have big consequences. Avoiding Parliament’s ire can matter more than losses from cross-subsidies.
If insurers here expect a populist backlash against high but fair premiums in risky places, they will find it politically safer to withdraw insurance in those places instead – like they did in California.
And so we come to the change that I hope could also be in the mix.
Let the Natural Hazards Commission charge higher premiums in riskier places. The change could be phased in over time, with expected levies over the next decade published in advance.
It would not only undo some of the unnecessarily regressive effects of the current premium structures but also make it politically safer for private insurers to follow suit.
Dr Eric Crampton is Chief Economist at the New Zealand Initiative. This article was first published HERE
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