Farewelling open-ended house insurance
Australians are warming to open-ended house insurance just as Kiwis prepare to give it up. It could leave us short in a natural disaster, reports Eloise Gibson.
Say there was a fire and your house burned down.
Everyone is safe, so you can focus on rebuilding. How much would it cost?
Have a stab. Actually, don't, because getting it wrong may cost you.
New Zealanders are going to be asked to value their homes. Not the market value, sadly, because then everybody and their dog would have a view, but the bricks and mortar, garage roof, bathroom fittings and wooden decking. Oh, and the labour to build it.
Under pressure from reinsurers, the overseas companies that share the cost of major disasters, local insurers are about to tell Kiwis to surrender their open-ended policies.
Right now if a house is knocked to the ground, most people are covered whatever the rebuild cost.
Soon they will need to pick a maximum.
There are online calculators to help you do this, or you can pay professionals.
But no matter how accurately you estimate, there is danger that building costs will spike for unforeseen reasons - as they have in Christchurch.
Once insurance is capped, home owners, not insurance companies, will bear the risk.
THE LUCKY COUNTRY
New Zealand has been lucky. While many countries are dominated by "pick a sum" policies, Kiwis have been able to buy open-ended house insurance that covers the actual rebuilding costs.
Often premiums are based on a fairly crude measure - the size in square meters of the house. Finer points like the cruddiness or luxuriousness of the bathrooms is seldom factored in.
But our love of uncapped policies does not sit well with reinsurers after the Canterbury earthquakes.
"It might take five years until they've rebuilt Christchurch to find out exactly what it's going to cost them. That is essentially the problem," says Gary Young, chief executive of the Insurance Brokers Association.
Should New Zealand be unlucky enough to suffer another disaster, reinsurers want more certainty, says Tim Grafton, Insurance Council chief executive.
In the background is the annoyingly expensive truth that insurance premiums are soaring.
Grafton says the quakes amounted to: "One of world's smallest markets experiencing one of the world's most costly events ... in an area not really recognised as very earthquake prone."
Like jilted lovers, our overseas underwriters would rather not put themselves out there a second time.
So starting in July, AA Insurance will give its policy-renewing customers an estimate of what their policy should be capped at. People are strongly advised to check the number and make sure it accurately reflects their house, it says.
All other insurers are expected to follow suit.
"I doubt very much that you will be able to buy open-ended replacement cover here in future," says Young.
Grafton says the experience in Australia and other countries proves capped sums can work.
However Australians - who first had uncapped policies made availaable to them six years ago - have taken to them happily. Australian consumer advocate agency Choice calls them a "great advance in consumer protection that it wants applied to all policies".
Australians have had a rockier relationship with capped sums.
A 2005 report by ASIC, the Australian Securities and Investment Commission, investigated why so many people who lost their homes in the 2003 Canberra bush fires were unable to rebuild because of low payouts.
It laid part of the blame for rampant underinsurance on capped policies, which put the burden of estimating future rebuilding costs on ill-equipped consumers.
"This is an intrinsically difficult task, requiring technical knowledge," ASIC's report said.
"Only a small number of insurers provide consumers with access to reliable or comprehensive tools for estimating the cost of rebuilding their home."
A comprehensive online tool will be available in New Zealand. AA Insurance says it has been independently assessed by New Zealand quantity surveyors.
The quality of the calculator matters. In 2007 Choice trialled some of the online calculators on offer by Australian insurers with less than encouraging results.
Some of the less detailed calculators netted estimates ranging from $145,000 to $300,000 for the same three-bedroom Melbourne house. Many of the better estimates clustered around $209,000.
Generally, the more fluffing around a calculator requires the better, says ASIC, which recommends' Australians try at least three.
AA Insurance refers people to the free Cordell online calculator, which takes readers through a detailed questionnaire to work out the cost of rebuilding. Otherwise it suggests paying for an estimate by a quantity surveyor, valuer or builder.
Cordell looks set to become New Zealand's chosen calculator, says Young.
It asks about postcode, section slope, deck size, number of bathrooms, cladding type, pools, tennis courts and room sizes but doesn't touch on the quality of kitchens and bathrooms.
Another problem ASIC found was people forgetting to update their policies after renovating, or failing to keep up with rising building costs.
A year after its 2006 report, insurer AAMI began offering uncapped cover. A spokesman said there were no plans to stop.
Another Aussie insurer, Comminsure, also offers uncapped cover.
Others offer a buffer of 25 to 30 per cent on top of the sum insured, either free or for an additional premium, in case building costs spike.
HAVING THE CHOICE
Uta Mihm, a Choice senior content producer, wrote about the advent of uncapped policies in Australia in 2007.
She noted localised building costs had spiked 50 per cent after the Canberra bush fires and 50 per cent after Cyclone Larry.
Closer to home, the cost of building homes in Canterbury has risen nearly 10 per cent in a year, partly due to the need for stronger foundations. More increases are believed to be in the pipeline for labour and material.
Choice found uncapped policies were priced competitively with capped ones.
"ASIC says total (uncapped) replacement policies are safer for the consumer and we recommend that as well," says Mihm.
"Or you can go for an extended cover policy which provides for up to 30 per cent on top of the sum."
Both options are lower risk than going for "sum insured", she says.
AA Insurance points out that big events like earthquakes are a "large exception to the rule" and that an individual house fire is a more likely scenario.
In fact, Mihn says any claim at all is unlikely.
"Only a very small percentage of claims are for total replacement when a house is completely destroyed.
"[But] that's why you take out insurance ... so you are covered in case the worst happens."
She is pleased Australians now have a choice.
"We make it clear to consumers that there is a risk of under insurance and that the risk is higher if they have a sum insured."
Insured sums will be adjusted to keep up with inflation and general rises in building costs each year. If you renovate, it's up to you to add some to the policy.
Insurer IAG has said it will allow some tolerance for people to get the sum wrong, noting that overseas the tolerance tends to be 5 to 10 per cent.
However, ASIC notes that "top ups" are not the same as total replacement and the additional insurance can fall short of fully funding rebuilding.
The insurance industry acknowledges that costs may spike after a widespread disaster, as demand drives up cost.
AA Insurance says that in a disaster situation it would work with construction companies and rebuild firms to help people manage the costs of labour and materials. That should help deliver some savings from bulk bargaining.
"This helps us negate or lesson any cost increases that may occur."
It says customers will benefit from knowing the limits of their cover.
For example, if it hadn't had to wait for detailed cost scoping by experts, many people in Canterbury could have had their claims paid in weeks, rather than months, it says.
Grafton, meanwhile, suggest the change may help cool premiums.
"Where there is greater certainty there's less risk in doing the underwriting and that brings downward pressure on what premiums might otherwise have been."
FINDING A FIGURE
Young does not expect most people's premiums to change much.
But getting more detailed information about properties will spread the cost of insurance more fairly.
Floor area-based premiums are hard on people with big but simple and cheaply made homes, and soft on owners of small, high-spec houses. And there was always a danger of being underpaid if you got the floor area wrong, he says.
"Once of the problems with square metres has always been that it didn't take into account the quality of the build."
Some people will choose to deliberately underinsure, just as they do now.
"You could just say as along as I get $100,000 for my house I'll be happy and I'll just walk away and buy something smaller," Young says.
"You don't have to have replacement value."
People do it all the time with clapped out cars, however here the stakes are higher. Young fears people will cut corners "to save $100".
Mihm says even the best estimates can date quickly.
"Building costs can increase substantially. For example there might be environmental requirements by the council that would increase building costs. And if the whole street or whole town burns down, building costs go up."
Young says brokers may advise people who can afford it to build in their own buffers in case they are caught out by a wide area event.
How much will be enough is anyone's guess. But home owners will have to take a stab at it.
THREE BREEDS OF INSURANCE
~ Open-ended replacement cover: Will replace your house irrespective of the cost. This is what most New Zealanders have.
~ Sum-insured replacement cover: Will replace your house up to a specific dollar amount, as stipulated in the policy. This is what New Zealanders will have soon.
~ Indemnity (or market value) cover: A third option that will provide cover up to the current sale value of your house. Generally it is cheaper but pays out less than the cost of rebuilding if the house is destroyed, so it may mean selling the section and buying elsewhere.