If you can't insure something, are you still responsible for the risk of owning it? And how sorry for you should we feel if that risk turns bad?

Back in 2011, I wrote this post about the Government’s offer to purchase the residential properties of Christchurch’s “Red Zone” inhabitants. In it I noted that behind the Government’s “offer” lay the power to compulsorily acquire property under the Canterbury Earthquake Recovery Act 2011, meaning that:

[H]ere’s the position those in the Red Zone face. They can accept one of the Government’s two offers of compensation at 2007-values. Or, in nine months time, they can face the high probability that the Government will force them to sell at the present value of a quake-ravaged piece of land on which no-one may build in the midst of a sea of demolished houses.

Turns out the timeframes weren’t quite that tight, as the Government has allowed them to stretch out a bit. But the essential prediction has been bourne out—residential property owners in the Red Zone have until March 31 to decide whether or not to take the Government’s money, or else:

While no decisions have been made on the ultimate future of the land in the residential red zones, CERA does have powers under the Canterbury Earthquake Recovery Act 2011 to require you to sell your property to CERA for its market value at that time. If a decision is made in the future to use these powers to acquire your property, the market value could be substantially lower than the amount that you would receive under the Crown’s offer.

What I hadn’t picked up in my earlier post, however, was that the Government’s offer to purchase residential properties at “full” price (insofar as the 2007-value reflected this) only applied to those who had purchased insurance for their property as of the February 22, 2011 earthquake. Property owners who didn’t have such insurance policies in place instead have been given a Government offer to buy their properties at just 50% of their 2007-value.

Why this difference in treatment? What does it matter to the Government whether or not an individual property owner bothered to take out insurance for it? Well, there’s a couple of reasons for the different treatment.

First, under the Government’s offer, the purchase of a Red Zone property transfers to the Government the benefit of any insurance claims that the previous owner has in respect of that property. So, if an owner agrees to sell just the land, the Government can recover money for the damage to that land from the EQC; while an owner who sells both the land and buildings gives the Government the right to claim money from both the EQC and the owner’s insurance company.

This fact then means that the Government can expect to recoup some, and maybe even all, of the 2007-value it pays out for the property from the previous owner’s insurance policies. But if there is no insurance policy for it to claim against, the Government is left completely out of pocket.

Second, there is the issue of “moral hazard”. If people have chosen, the theory goes, not to take out an insurance policy, then they are in effect “self insuring” by retaining the premiums they otherwise would have to pay and running the risk of future uncompensated property loss. Were the Government to come in and rescue these individuals from the consequences of their choice, then that would have three negative consequences.

It would fail to respect the autonomy of each person. After all, we don't make home insurance compulsory—we let people decide for themselves if they think they need it. And if they decide they don't, then surely that's their call to make for themselves? Doesn't the State infantalise individuals if it acts to undo every choice that (with hindsight) turns out to be not such a good one to make?

Furthermore, if the Government were to come in and pick up the pieces for uninsured homeowners, then that would encourage others to favour self-insurance over purchasing pooled-risk policies. After all, why pay a policy premium to some insurance company if you think that the State will do the job of compensating you for loss in any case? And there's a good to having people take out private, pooled-risk insurance policies in that it spreads the potential cost of property damage to a far wider set of pockets than exist in New Zealand.

Finally, there's the equity problem. If someone has (say) skimped on insurance premiums for a decade, they've not only had the use of that money for other (probably far more enjoyable) purposes. They've also failed to pay into the communal EQC fund that is now being drawn down to help pay for the costs of the Christchurch disaster. And what is more, if they are paid out in full by the Government in circumstances where the Government can't recoup any of that loss, they will be drawing on the taxes that you, I and everyone else pays to the State (thus depriving us of the other, far more enjoyable, uses that we could put them too).

Now, even as knee-jerk lefty and collectively-minded as I may be, I find these arguments pretty compelling. In fact, I think it's pretty damn generous of the Government to be paying out anything at all to uninsured homeowners in Christchurch—certainly it's a far more generous position than other nations have taken in respect of recent natural disasters. The only argument that an uninsured property owner would seem to have is that "my neighbour's getting full-value for his/her house from the Gummint, why can't I?" To which the response would be, "if you can get full-value from the Gummint for your earthquake destroyed dwelling, then why can't I when I leave a towel too close to the heater and burn it to the ground?"

That said, there's one class of uninsured property owner who may have more of a cause for complaint. Owners of bare land within the Red Zone also are getting only the 50% of 2007-values offer (with the backstop threat of compulsory acquisition at peppercorn value looming large). Explaining why they may feel a little more hard done by requires a bit of explanation (surprisingly enough!)

In New Zealand, residential land is insured by the EQC by way of a levy that is built into your house insurance premiums. So if you have house insurance, you automatically pay for (and get) EQC coverage for your land—you can't opt out of having it. But, by the same token, unless you have house insurance you don't pay for (or get) EQC coverage—meaning that if there is no house on a residential section, there is no way that you can get it covered by the EQC. 

I don't think many people are aware of this fact. Certainly I wasn't, when my wife and I had a bare section sitting for near-on three years before we finally got around to building our casa bella on it. And because people don't really think about insuring their land seperately from their home, while all those who do insure their home already are covered by the EQC, there's no real market for "bare land insurance" in New Zealand. I've looked as best I could via the internet, and I haven't been able to find anyone offering policies on residential sections.

So what that means is that there's a bunch of people in Christchurch who effectively couldn't insure the bare land they owned (not wouldn't, but couldn't), and post-Earthquake have found that it falls within the Government-mandated Red Zone. The consequence of which is that it cannot be used for building purposes, rendering it virtually worthless.

Now, given that background, is the Government's decision to offer owners of bare land only 50% of its 2007-value (as opposed to the 100% it is offering to those who have EQC coverage because they have an insured home on it) fair?

On the one hand, the lack of any insurance cover means that any money that the Government pays over for a section is a pure loss for it—there's no-one that it can recoup the fall in land value from. But on the other, the reason that the land is now near worthless is because the Government has declared it to be out-of-bounds for building. Sure, that declaration may have been the result of the Earthquake ... but it's still put the land's owner in their current pickle. So isn't this really a sort of "taking" by the Government, one for which it ought to pay out the full value of the property right it is expropriating?

Well, we might say, the owners of bare land chose to bear the risk of purchasing and holding an asset without insurance for any resultant loss. They may not have expected that asset to be so comprehensively ruined, but then again, that's kind of the point of "risk": if the only things that happened were things that we expect to happen, then we'd all know what was coming next and so wouldn't have to be concerned about the future. So why should the Government have to pay up just because a black swan chose to make Christchurch its home?

Against this, how much human fellow-feeling can we have for such land owners? After all, anyone who builds a new home is faced with having to run the same sort of risk—and building new homes is something that we as a society are quite keen to see more of. And if there isn't any practical way to guard against that risk, are we really creating a moral hazard if the Government steps in and treats bare land owners as if they were insured home owners?

While I still tend toward the "let the chips lie where the Earthquake threw them" line of thinking here, it seems to me that the bare land owner's claim is a bit of a trickier one to deal with. In any case, it will be interesting to see what a court does with it when this case gets in front of it.

Comments (7)

by Simon Connell on February 19, 2013
Simon Connell

If people are allowed to go without insurance, I agree that the arguments are fairly compelling that they should bear at least some of the ill consequences of that choice. However, perhaps one lefty collectivist response to this situation is to say that people shouldn't be able to go without insurance for their house. Foregoing insurance is the kind of decision that governments do step in and override individual autonomy for - we have ACC, Obamacare is intended to decrease the number of uninsured in the USA, there are various compulsory motor vehicle insurance schemes, etc.
I'm not sure if there is a principled distinction between natural disasters and towel-related house fires, but it could be possible to make just EQCover compulsory by introducing a mechanism for the currently un-insured to contribute. For example, via rates - which also might work as a way of collecting levies for bare land.

by Marcelo Rodriguez Ferrere on February 19, 2013
Marcelo Rodriguez Ferrere

Thoughtful piece, Andrew. Having recently toured the streets you're talking about though, I find it harder to apply your unique brand of cold-hearted law and economics analysis to the issue. For shame.

Seriously however, I think Simon's point on compulsory insurance is a good one. Surely we can (and already do through the very existence of EQC) make a principled distinction between towel and deity-caused house destruction, such that making natural disaster insurance compulsory wouldn't be that great a leap. It's certainly not a novel concept (and there are various funding options available; see the ACC), and would prevent the prima facie inequity that you identify in Christchurch and will doubtless occur again in these shaky isles. What say you and your Chicago school, Andrew?

One further point: another strain of inequity has arisen with the TC3 designated homes, who, without the benefit government compensation in the red zone, must make do with unmarketable - but also increasingly uninsurable homes - based on very rough and not-necessarily-geotechnically-based surveying. Do the same issues that affect the undeveloped or partially developed land-owners apply here? Or not so much since there is no risk of actual compulsory acquisition?

by Scott Chris on February 19, 2013
Scott Chris

So what that means is that there's a bunch of people in Christchurch who effectively couldn't insure the bare land they owned (not wouldn't, but couldn't), and post-Earthquake have found that it falls within the Government-mandated Red Zone.

I'd have thought a 75% redemtion of the 2007 land value would have been fairer for these unfortunate people for no better reason than its being the arbitrary midpoint between bad risk management and dumb bad luck. (within the context of the compensation allocation formula for other red zoners)

With regard to home owners within the red zone as a whole, I suspect there'd be a strong correlation between those with low disposable income and those of uninsured status.

 

by Andrew Geddis on February 20, 2013
Andrew Geddis

Simon/Marcelo,

Sure - we could change EQC coverage from "voluntary" (in the sense that you only get it if you choose to insure a building on the land) to "mandatory" (in that evey land owner must pay for it, perhaps through a rates surcharge or similar). The Government is considering this issue as part of a wider review of the EQC funding model. So we may yet move to a more-socialised system of disaster insurance.

But given that we had a model of insurance in place prior to February 2011, is it fair to say that people who (knowingly or unknowingly) chose to sit outside that model should be treated the same as someone who conscientiously sought to mitigate against future risk? That seems to me the critical point here.

As for the TC3 buildings ... without knowing much about the technical details, isn't the problem with them that people just don't want to buy (or insure) them because of perceived future problems? As opposed to Red Zone land, where the Government has said "you cannot build - full stop"? So the latter has more of a "takings" feel to it than the former?

Scott,

You may well be right in your suspicion about the income poor/lack of insurance link. If it is correct, then what it means is that there are some (lots?) of folk who were asset rich (in that they owned a home mortgage free - or else they would have been required to have insurance by their bank) but income poor, who then were unable to (or, rather, found it financially very difficult to) protect their chief asset against future harms. How, then, ought we to respond to that - with sympathy ("I can see you wouldn't have wanted to leave the home you couldn't really afford to keep - so we'll bail you out"), or with a shrug ("you chose to run the risk of something bad happening to your home - so don't come crying to me when it did"). I can see either response as being, in some way, valid.

 

by Simon Connell on February 20, 2013
Simon Connell

Good responses Andrew. The article you linked suggests there should be a public consultation document coming out next month, that would probably the place for us to follow up any suggestions of a more socialised system.

But given that we had a model of insurance in place prior to February 2011, is it fair to say that people who (knowingly or unknowingly) chose to sit outside that model should be treated the same as someone who conscientiously sought to mitigate against future risk? That seems to me the critical point here.

Scott's comment, and your "knowingly or unknowingly" raise the question of whether we should treat everyone without insurance the same. We might have:

  • people who had the income to afford insurance but knowingly chose not to be insured;
  • people who had the income to afford insurance but unknowingly chose not to be insured. That is, they somehow never made a conscious decision not to purchase insurance. Not having ever purchased a house, I don't know how realistic this is, I imagine banks etc. encourage insurance, so it's probably hard to avoid the question of insurance coming up at some point. Some of this group might have, at one point, intended to get insurance but forgotten about doing it - that's less sympathetic but still falls short of a conscious risk-taking decision;
  • people who didn't have the income to afford insurance, and unknowingly chose not to be insured; and
  • people who didn't have the income to afford insurance, and knowingly chose not to be insured.

One reason for treating all the uninsured the same is that it's probably very difficult to tell who belongs in which bucket. If there's more lenient treatment for the unknowing uninsured, or those who couldn't afford insurance, then there's an incentive for people to claim to belong to those groups.

Trying on a lefty collectivist hat again, we might have more sympathy for the unknowing  uninsured. Perhaps the state has some responsibility to make people aware of the importance of insurance, and to encourage them to get it? Maybe the system should be opt-out, like Kiwisaver, to ensure that people only go uninsured as a matter of conscious choice. And perhaps, if the state hasn't done enough here, it's not ok just to let the chips lie where the earthquake threw them.

by Andrew Geddis on February 20, 2013
Andrew Geddis

Simon,

I tend to think the set of home owners who are "unknowingly uninsured" is close to null ... perhaps there's the odd person who thought they'd posted off their policy renewal check but actually had left it under a pile of newspapers. Otherwise I struggle to see how someone could own a house and not have turned their mind at some point to the question "should I have insurance for this?" If only because of the omnipresence of insurance company ads urging you to do just that!

With respect to damage to land, but, I suspect there was a lot of general ignorance pre-February 2011 about the insurance position (and there may well still be in areas outside of Canterbury). Most people don't think of land as being "damagable" - we expect it to always be there. And if anyone did think about what happens if it was damaged, they'd likely just think the EQC pays up without thinking about how the EQC gets paid for (thus failing to see the house-insurance/EQC coverage link).

So I guess I'm arguing myself into a position that supports mandatory landowner EQC payments ... if this isn't an area of conscious decision-making, maybe the State should step in and make the "right" choice for people?

by mudfish on February 21, 2013
mudfish

Two more situations that might need some thinking through re mandatory land insurance:

Coastal erosion. No realistic opportunity to reinstate what was once there.

Farms. What risks are you insuring against? How different is that from the suburban section and the commercial plot?

 

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