Policyholders with small New Zealand insurer Western Pacific – now in liquidation after collapsing under the weight of Christchurch earthquake claims – and much larger insurer AMI can broadly be placed into two categories: those hoping for a payout and those racing for the exit.

For AMI, the situation is mixed. With a government guarantee and up to $NZ500 million ($370 million) in equity to draw upon, AMI has assured policyholders that all claims will be paid in full, even if it means the New Zealand Government is forced to temporarily assume ownership.

Over at Western Pacific, policyholders may be justified in feeling short-changed. Both AMI and Western Pacific essentially suffered from a shortage in short-term capital – the difference being AMI went to the Government with tin cup in hand before collapsing. Yet only AMI and its policyholders, it seems, are worth saving.

Finance Minister Bill English says Western Pacific won’t be rescued because the company faced “different issues and is of a different scale and significance to the rebuilding of Christchurch”.

“Commercial failure will be handled in the normal commercial manner,” Mr English said.

While its true that Western Pacific’s 7000 New Zealand policyholders pales almost into insignificance alongside AMI’s 500,000 – and 85,000 in Christchurch alone – Mr English’s use of the ‘too big to fail’ moral hazard argument invites other questions. Just how big does a company need to be before its collapse would threaten the entire system?

And why has the New Zealand Government lagged so far behind Australia in devising and maintaining realistic prudential standards that would have prevented exactly this scenario?

Under a new regulatory regime that comes into effect next year, all insurance companies in New Zealand will be required to have a credit rating supported by actuarial reports on the company’s assets and potential liabilities in a worst-case scenario.

That’s better than the present situation – AM Best had AMI on A-plus until last month, and it measures only the insurer’s financial strength and claims-paying ability. It doesn’t make actuarial assessments of insurers’ assets and potential liabilities.

The Government’s long-term lack of interest in tougher prudential standards for insurers should be compared with Australia’s system, where shortfalls in reinsurance and reserves would have been picked up and acted on long before they reached this stage. The New Zealand Government may well end up paying for that inattention.

Insurance Council of New Zealand CEO Chris Ryan says that in the case of AMI, the Government had no choice but to intervene.

“The social impact would have been severe if AMI had fallen over,” he told insuranceNEWS.com.au.

Liquidators are now picking apart Western Pacific’s finances to determine how many of the 157 claimants (and counting) from New Zealand’s two earthquakes will be honoured, and how much they will be paid.

Assuming a shortfall – and without sufficient reinsurance there probably will be – the New Zealand Earthquake Commission (EQC) can provide some assistance.

“That’s what the purpose of the scheme is – to be immune to any insurer default,” EQC Commissioner Giselle McLachlan told insuranceNEWS.com.au.

“New Zealand doesn’t have any other policy protection, which is basically what we are here for – it means the money is in the bank.”

While the EQC was conceived for an event just like the Christchurch earthquake, it’s unlikely to be much use for Western Pacific’s SME policyholders.

The EQC only covers residential claims, leaving businesses at the mercy of liquidators. It also doesn’t cover a wide range of items typically claimed under a policy, including jewellery, money, cars, trailers, boats and the cost of alternative accommodation.

While policyholders hope their livelihoods can be restored, those looking to leave AMI and Western Pacific face a different problem. They’re likely to be paying a lot more for their insurance, if they can obtain it.

Both companies have for years been accused of undercutting their rivals for market share.

Vero sank the boot into AMI last week, warning that if “people [were] looking for cheap insurance, they should not in the future”.

And as reported in our Corporate section, Western Pacific was apparently playing a more risky game with unsustainably low premiums.

New Zealand brokers have told of Western Pacific offering premiums at 60% below their competitors. And the company seems to have used much the same tactic in picking up business in Australia as well.

It’s not yet known how much business Western Pacific wrote in Australia, but it’s obvious much, if not most, has been hard-to-place business at rates Australian insurers wouldn’t contemplate.

That’s what led SRS Underwriting to note a drastic rise in the past week in the number of hard-to-place liability slips requiring urgent cover circulating in the local market. The only likely reason for the sudden rise is the withdrawal of Western Pacific.

“In the past, we have lost business to Western Pacific at prices that were less than half our terms and excesses,” SRS director Paul O’Leary told insuranceNEWS.com.au.

Western Pacific has assets of about $NZ4.7 million ($3.4 million), including the $NZ500,000 ($371,450) security bond it is required to pay on registration as an insurer.

Reinsurance proceeds, a reported $NZ2.6 million ($1.7 million) of premiums held by brokers, and another $NZ1 million ($743,000) or so of fixed assets and investments are not likely to cover $NZ5.8 million ($4.3 million) in unsecured creditors and unsettled claims from its 7000 New Zealand policyholders.

All in all, it’s a mess. The New Zealand Government has decided it has to help AMI, which will presumably adopt more prudent pricing and reinsurance cover as it moves ahead.

As for Western Pacific, just how big the mess really is – and how much business was passed across the Tasman from Australia – may become clearer in the weeks ahead.