New Zealand May Use Cat Bonds to Recapitalize Disaster Fund

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New Zealand’s government may have to recapitalize its crucial national disaster safety fund after being hit by two major earthquakes in five months, analysts and insurers say.

The government could decide to dip into its own coffers to top up the Natural Disaster Fund to pay current claims, after its reinsurance program has dwindled to near depletion point from paying out on hefty insurance claims from the September earthquake.

The fund’s depletion could trigger the first foray for New Zealand into the fledgling catastrophe bond market as its government seeks for ways to boost its reinsurance portfolio.

Catastrophe bonds allow insurers to pass on extreme risks, like earthquakes or hurricanes, to financial market investors, and are seen as an alternative to reinsurance.

Insurers and reinsurers are still reeling from the September earthquake – 7.1 on the Richter scale – which struck Christchurch and caused an estimated NZ$4 billion [US$3 billion] in damage.

If claims from the Tuesday earthquake hit NZ$7 billion [US$5.24 billion], the fund will run out of reinsurance protection altogether, say analysts and insurers.

Before the September quake, the New Zealand Earthquake Commission (EQC), which administers the Natural Disaster Fund, said it had NZ$4.5 billion [US$3.37 billion] in its Fund as well as NZ$2.5 billion [US$1.87 billion] reinsurance.

September’s earthquake, as well as five aftershocks which generated over 185,000 claims, has already eaten through the first layer of reinsurance protection. Now the fund needs its reinsurance panel to pay out again for Tuesday’s event – which is thought to be one of the costliest global insurance events in recent times.

“There’s a distinct possibility they may have to go to the government,” one insurer said.

“They’ve gone over from their first reinsurance levels,” he said. “So they’ll be down to their last billion or so but it will be a close call. They could sell some of their assets that haven’t been classed as reserves.”

Insurance losses of between $3.5 billion and $8 billion are expected from Tuesday’s earthquake, according to catastrophe modeling firm Air Worldwide.

More than NZ$4 billion of the Fund is in the New Zealand government securities, meaning the government would have to the find cash to redeem these if the EQC was unable to pay its insurance claims, according to the EQC’s 2009/2010 Annual Report.

If this happens, the EQC said it would look at a “different balance” between the Fund and reinsurance.

In the meantime, credit rating agency S&P said the government will be able to honor its grants to the EQC, given its financial ability.

In a note to investors, S&P reaffirmed its AAA/Stable rating for the Earthquake Commission.

Based on the population of Christchurch, should the costs exceed $7 billion, the volume of claims would not require the government to pay out further multiples of millions, Michael Vine, director of Financial Services Ratings at S&P told Reuters.

New Zealand Prime Minister said the government could afford to pay out on the recent earthquake.

“We’ve preserved for this,” he told reporters, but admitted it would cause a significant dent in the resources of both EQC and a huge impact on the reinsurers.

But the New Zealand fund will need to recapitalize and restructure its reinsurance program to buy more reinsurance cover following the devastating quake on Tuesday, said one U.S. based investor.

“This puts into play the possibility of a catastrophe bond for New Zealand, as well as more reinsurance which could potentially contain some collaterized cover,” he said.

The New Zealand EQC were not available for comment.

(Additional reporting Gyles Beckford and Narayanan Somasundaram; writing by Sarah Mortimer; Editing by Toby Chopra)