The move to “sum insured” cover for New Zealand home insurance policies over the past five years may have resulted in up to 85% of the country’s homes being underinsured by an average of 28%, according to the NZ Treasury.

A paper by senior Treasury analyst James Sergeant warns this would place the underinsurance gap in New Zealand at $NZ184 billion ($172 billion).

However, an accompanying assessment of a major quake hitting Wellington reveals that 95% of owners in the city would not experience any shortfall in funding to replace or repair their homes.

Most residential insurers in New Zealand moved home insurance policies from full-replacement cover to a capped sum-insured value following the Canterbury earthquakes.

Homeowners who take out sum-insured cover must specify an insurance value that is sufficient to cover the cost of a complete rebuild. This model effectively represents a cap on the total amount the insurer has to spend when repairing or replacing a home. 

“The new arrangements transfer responsibility for assessing rebuild costs to homeowners, and the evidence shows that many homeowners are not willing or able to calculate an accurate rebuild cost for their home,” Mr Sergeant says.

“This can be a difficult calculation as, in the worst cases, the costs may involve total demolition, removal of the rubble and rebuilding a new home that is compliant with the current building code.

“Therefore rebuilding costs often exceed the market value of the existing dwelling.”

Using data from insurers, brokers and valuation consultants, Treasury measured the extent of underinsurance in New Zealand as a result of sum-insured coverage. It concluded that underinsurance is a “real issue”.

Treasury initially estimated that up to 85% of New Zealand homes are underinsured by an average of 28%. In dollar terms, that translates to an underinsurance gap of $NZ184 billion ($172.2 billion).

However, Treasury decided this overstates the risk, noting that even a major earthquake would be limited to one location, and most houses in that area would not suffer so much damage as to reach the limits of their cover.  

To investigate the effect of a “realistic major event”, Treasury used modelling from the Earthquake Commission to calculate what the underinsurance shortfall might be after a 7.5-magnitude event on the main Wellington fault, using underinsurance assumptions.

This produced a shortfall of around $NZ135 million ($126 million). It found 95% of homeowners would not experience any shortfall, but the impact on the remaining 5% would be severe, with several thousand households facing an average shortfall of around $NZ40,000 ($37,000).

“On the basis of that modelling, our assessment was that, although underinsurance could cause difficulties for some householders after a major event, the total shortfall would represent only a very small proportion of the overall costs of the event,” Mr Sergeant says.

He believes insurers and brokers want to avoid widespread underinsurance and want to encourage customers to assess their rebuild values carefully.

“The insurance industry needs to continue its effort to support well-informed homeowner decisions on their sum-insured values. Banks also have an interest in mortgage-holders having sufficient cover in place, in order to protect the value of their collateral,” Mr Sergeant says.