A detailed study of the ten years since the Canterbury earthquake sequence that devasted New Zealand a decade ago has revealed insurers struggle to accurately estimate claim costs and to quantify uncertainty.

A newly published “Funding and reserving Canterbury earthquake insurance claims” research paper by Robert Cole, senior adviser at the Reserve Bank of New Zealand (RBNZ), says existing reinsurance funded 72% of best estimate claim costs in Canterbury.

Insurers’ best estimate claim costs have doubled since 2011, with most of that increase occurring by December 2016.

“The size and persistency of increases in estimates for almost all insurers indicates they have, with hindsight, struggled to accurately estimate claim costs,” Mr Cole says in the paper, which reviews the funding and reserving of claim costs by 20 property insurers after the earthquakes.

Increases in best estimate paid plus outstanding claim costs have been large relative to both estimates and reserves for uncertainty for almost all insurers, which Mr Cole says “indicates insurers have also, with hindsight, struggled to quantify uncertainty.”

The 2010-11 Canterbury earthquakes are the most costly insurance event in New Zealand’s history with estimated property insurance claims costs of around $NZ38 billion ($36 billion).

Insurers in New Zealand are required to reserve for the best estimate cost (an unbiased mean) plus a risk margin for uncertainty, which increases the probability that total reserves are sufficient to meet the actual costs.

After 2011, claim costs exceeded the limit of existing reinsurance for eight insurers, who were not subject to solvency requirements at the time of the Canterbury earthquakes. Ten insurers required post-event funding – half for at least 30% of their claim costs – which was provided via “after the event” reinsurance and additional capital.

“After-the-event reinsurance,” purchased retrospectively to meet claim costs in excess of existing reinsurance, is typically expensive and may have restrictive terms. It is purchased to mitigate the risk of material increases in estimated claim costs for a disaster that has already occurred.

In the Canterbury case, some insurers failed to recover expected amounts from after-the-event reinsurance, and one insurer – Western Pacific – entered liquidation in April 2011 with 42% of claim costs unfunded.

In the case of Southern Response (formerly AMI), the government provided additional capital, and without this there would have been a very substantial level of policyholder shortfall and unfunded claim costs.

Today, the RBNZ requires insurers to have reinsurance and capital to cover the claim cost of a 1-in-1000 year earthquake and this means “there is greater assurance for funding of future disasters,” Mr Cole says.

“Estimates of expected claims costs and the uncertainty in costs could be significantly understated for long periods of time,” he says. “Consideration by insurers and the Reserve Bank of the funding and reserving experiences of the 2010-11 Canterbury earthquakes may assist dealing with any future catastrophic events.”

After the Canterbury earthquakes, residential property insurers changed the limit of their cover from replacement to sum-insured. For half the 20 insurers, existing capital and reinsurance were insufficient to meet the full claim costs.

Six insurers purchased after-the-event reinsurance for the Canterbury earthquakes. For some, the after-the-event reinsurance was provided by their parent as an alternative to capital injection.

“The success of after-the-event reinsurance has been mixed. One insurer failed to make a recovery due to not meeting the terms, despite claims exceeding both the excess and limit of their after the event reinsurance cover. Another insurer had a partial recovery due to a dispute with their reinsurer,” Mr Cole says.

In aggregate, 4% of claim costs were funded by after the event reinsurance and 14% by additional capital across six insurers, which was more than the funding by existing capital and more than a quarter of the total for three insurers.

One insurer funded a small portion of best estimate claim costs from profits while policyholder loss occurred for two insurers.

“With hindsight, reserves were not adequate and the quantified uncertainty was understated,” Mr Cole says.