The seismic scenario
The seismic scenario is based on a main earthquake of magnitude 8.7 rupturing the central and adjacent sections of the Hikurangi Subduction Zone.
The main earthquake immediately causes a tsunami followed by a major aftershock of magnitude 7.7 one month later and smaller seismic shocks for a further 12 months. The New Zealand economy experiences an initial sharp fall in GDP and loss of productive capacity. This is followed by a demand surge from the rebuild of affected property and a government relief package. The Reserve Bank raises the official cash rate to rein in inflation.
The scenario was expected to generate losses greater than our solvency standards for seismic risk.
Seismic scenario results and insights
- Participants, who accounted for around 70% of the general insurance market, modelled $62 billion of losses. This was the insured value of damaged properties. This could represent up to $100 billion for the total market. Despite the severity of the scenario, all policyholder claims could be met.
- Approximately half of the losses were covered by the government-guaranteed Natural Hazards Commission, 39% were covered by reinsurance arrangements, 8% retained by policyholders and the remainder covered by the insurers.
- The high proportion of claims paid out by reinsurers and the NHC suggest that policy changes since the 2010/11 Christchurch earthquakes have added to the resilience of the system. This includes the introduction our 1-in-1,000-year loss solvency standard, and the increase in the monetary cap on NHC payments to $300,000 plus GST per dwelling.
- As intended, given the severity of the selected scenario, locally incorporated insurers modelled a significant fall in their capital. The aggregate solvency ratio fell from 168% at the start of the stress test to 11% (compared to the minimum requirement of 100% for licenced insurers) at the end of year 1.
- Participants identified a range of actions to rebuild their capital levels including capital injections, repricing (especially in risk-affected areas), adjustments to reinsurance cover and cost cutting. The results highlighted the importance of the Reserve Bank working with the industry to ensure insurers could return to required solvency positions. The exercise has provided valuable input into the Reserve Bank’s recovery planning and the next stage of our review of Solvency Standards.
- A seismic event of the magnitude modelled in this scenario would have far-reaching impacts for New Zealand. Experience with the Canterbury and Kaikoura earthquakes suggests the Crown could be exposed to over 50% of the total economic costs, through its indemnity of NHC, coverage of uninsured public assets and funding of recovery support programmes. Ensuring sufficient fiscal buffers to manage such shocks is critical and has been identified as a key consideration of the Treasury’s current consultation on fiscal policy.
The cyber risk scenario
The cyber risk stress test included a major data security breach, an outage of an important cloud service provider, and a ransomware attack. These three scenarios were developed in collaboration with Lloyd’s of London, Bank of England Prudential Regulatory Authority and CERT NZ.
Cyber scenario results and insights
The reported losses were much smaller than the seismic scenario. However, given the size of the exposure the relative effect on profitability was significant, reducing annual aggregate profit by one-third in the cloud-down scenario. Reinsurance covered a large portion of cyber claims on insurers.
Insurers used the exercise to improve data collection, develop modelling, and inform risk appetite. The test highlighted exposure of particular industries to cyber risks and the need for greater clarity in policy wording regarding coverage.
Participation
We thank the following insurers for their participation and contribution: AA Insurance, AIG Insurance New Zealand, IAG New Zealand, Tower Insurance, Vero Insurance, Chubb Insurance New Zealand, QBE Insurance (New Zealand).
We would also like to thank Moody’s Risk Management Solutions (RMS), Verisk Extreme Event Solutions (Verisk) and GNS Science for their assistance in developing the seismic scenario, as well as CERT NZ for their input into the cyber-related risk scenarios.