‘Plunder’ How the quake bill was passed on
Political meddling and creative accounting left Canterbury billions of dollars short after the earthquakes, slowing a painful rebuild and passing the bill on to future taxpayers. This is how it happened. Charlie Mitchell and Michael Hayward report.
They hadn’t expected it to happen – not when, or where, it did. Just after 4.30am on a Saturday September 4, 2010, in a paddock somewhere near Darfield, a forceful 30-second jolt rippled across the Canterbury Plains towards Christchurch, where windows rattled and chimneys fell. People stumbled out of their homes and didn’t go back inside, even when the dawn sunlight cast brilliant shadows across a damaged city.
In Wellington, the news made its way to the agency in charge of handling residential damage claims, which at the time employed 22 people. It took a few days for the financial implications to become clear.
After a week, the damage was estimated at $2 billion, comprising around 100,000 damage claims, 20 times the size of the largest event the EQC had handled in its recent history.
By the beginning of 2011, the estimate had risen to between $5b and $8b. EQC was yet to visit about 60,000 claimants, though its staff had now risen to more than 1000.
Then on February 22, at 12:51pm, a shallow earthquake centred in the Port Hills screamed beneath the damaged city, leading to 185 deaths, felling the central business district and shattering the iconic Christ Church Cathedral. The clock was reset entirely.
As the city was slowly rebuilt, it emerged that settling the claims for property and land damage would cost more than what had been set aside.
Several experts say the shortfall was a consequence of political decisions made by successive governments, which have likely slowed the rebuild, prolonged earthquake settlement claims, and deferred much of the cost of New Zealand’s most expensive disaster to future generations. It has raised questions about how future disasters should be paid for, and to what extent it’s worth rebuilding the fund dedicated to paying for them, which will cost many homeowners thousands of dollars over the coming decade. Before the September earthquake, the Natural Disaster Fund (NDF) totalled around $6b, the result of the longest quiet period for earthquakes in New Zealand since human settlement.
Until then, the biggest disaster it had been tapped for was the 1968 Inangahua earthquake – 10,500 claims at a cost of around $25m. The Gisborne earthquake of 2007 resulted in around 6000 claims worth around $55m.
There had long been debate about how much EQC would need to respond to ‘the big one’. Figures had ranged between $5b and $15b.
A report from 2009 examined EQC’s ability to respond to a ‘‘worst-case scenario’’ earthquake, which – if it happened in Wellington, as expected – was estimated to result in 150,000 residential damage claims.
On top of the $6b, EQC also had access to several billion in reinsurance. It allowed EQC to respond to a more costly disaster than any in recent history, but still wasn’t enough.
In the months after the September quake, around 150,000 claims were lodged with EQC, equal to the so-called ‘‘worst-case scenario’’. The first wave of claims was expected to cost $3b to settle. The second earthquake produced another 150,000 claims. Since September 2010, nearly half a million claims have been lodged in relation to 14 separate earthquake events in Canterbury, effectively three ‘‘worst-case scenarios’’ in quick succession.
On February 23, the day after the second major quake, Bill English – then Minister of Finance and Minister for EQC – said EQC likely had enough money reserves and reinsurance to cover the cost. As claims continued to flood in, that turned out not to be the case. When the number of claims more than doubled, the estimated cost rose to $7b, then $12b. By the end of June, 2011, EQC’s accounts showed its liabilities exceeded its assets by around $1.1b, meaning it was insolvent
Like many in Christchurch, Cam Preston had to navigate the bureaucratic behemoth EQC had become in his quest to repair his damaged house. An accountant, he kept a close eye on the finances backing EQC and its NDF. In the months after the September quake, he had done contract work for EQC, and seen the organisation up close. He became a strident critic of the rebuild, as he struggled to resolve claims with both private insurance and EQC, both of which took several years.
(Preston was one of several claimants government-owned insurer Southern Response hired a private investigator to monitor.)
To understand how the rebuild went wrong, you need to start by looking at the NDF, Preston says. The moment when EQC reported it was insolvent was pivotal.
One of the key features of EQC is its Crown guarantee: An agreement that if EQC is unable to cover its liabilities, the Crown will step in and pay. The guarantee is why EQC, as a concept, works. The fund as a whole is backed by the creditworthiness of the state.
The guarantee has only been triggered once in EQC’s nearly 75-year history; late in 2018. But it almost happened in 2011.
A few months after the February quake , officials at EQC had been talking to their Treasury counterparts about triggering it. EQC’s logic was that because its liabilities were higher than its assets, it was insolvent – a standard accounting view.
Treasury’s view was that EQC could only call on the guarantee when it literally had no money left:
When this ‘‘difference of opinion’’ was raised with English, Treasury’s view won out.
The incident highlighted a longsimmering issue between EQC and Treasury about who actually controlled the disaster fund.
‘‘It was total nonsense,’’ Preston said. ‘‘You’d never get away with that in the private sector. They [Treasury] said don’t worry about the fact you haven’t got any money, just keep costs down. That’s what happened and the whole thing turned to custard.
‘‘It’s an example of EQC knowing they didn’t have enough money, going to their master, and them turning around and saying no.’’
WARFARE
The feud had started much earlier, during the tail-end of the fourth Labour government. EQC was part of Treasury, which closely controlled its spending.
The NDF has always been under the control of the government, to some extent. In the late 1980s, it could only be put into one highly-specific type of investment: nontradeable government stock.
Levies from insured
homeowners would go into the NDF, then straight into the government coffers, in exchange for government stock. The government would agree to buy back the stock at the market rate when EQC needed it – effectively an IOU.
This meant the NDF didn’t really exist at all. The money supposedly set aside for disasters would be spent by the government on whatever it felt was important: roads, hospitals, Crown cars, under the agreement it would be paid back.
While there are advantages to this system it also has obvious flaws. Firstly, it means anyone covered by EQC effectively pays twice: Once through their levies, and once through the taxation or government debt used when the Government needs to pay back its loan.
Secondly, it means the fund is held entirely in the country affected by the disaster.
Officials at EQC fought to change this practice and diversify the fund, which took many years.
But it was another issue during that time which frustrated EQC, and still has repercussions today. To some experts, it undermined the entire NDF.
It was a period accounting expert Sue Newberry, a professor at the University of Sydney, describes as ‘‘plunder’’. Successive governments realised they could use the NDF as a source of extra revenue without raising taxes.
It started with a law change in 1988, which turned EQC into a statutory corporate entity. It made the NDF theoretically independent of the government accounts – a corporation owned by, but separate from, the Minister of Finance.
The change was sold as giving greater independence to EQC. In retrospect there appeared to be another motivating factor.
‘‘It was a budget repair job,’’ said Newberry. ‘‘There was a couple of billion dollars in EQC, so it was very tempting.’’
The corporatisation of EQC had allowed the Government to charge it various fees, while still controlling its finances.
It did so through a ministerial directive from then Finance Minister Roger Douglas. The contradictory directive noted EQC was now an independent corporation ‘‘controlling its own finances,’’ but also told EQC it must continue investing the entire NDF – valued then at $1.8b – in government stock until it could come up with an investment strategy that would ‘‘meet with my [Douglas’] requirements’’.
It then moved on to the fees. There were three in total, each substantial – In the first year, they totalled $239m, nearly all EQC’s annual surplus, the money supposed to go into the NDF.
‘‘They made up all these terms, like payments in lieu of taxes, then there’s good old dividends, then they said because it’s no longer a loan or a grant, it’s just a grant, we’re going to take a big guarantee fee,’’ Cam Preston said. ‘‘It was just a way of making it look rational, in some way, that they were stripping the fund.’’
The mandatory annual fees continued for seven years, capturing the bulk of EQC’s annual surpluses, intended to be added to the disaster fund.
In total, $1.5b was taken out of the NDF, the vast majority of its $2b in surpluses over that period.
Newberry said the strategy appeared to be about ‘‘fixing up the Government budget, rather than really trying to achieve much for people’s protection in the case of earthquakes’’.
‘‘It was a period of what I can only describe as plunder.’’
THE MONSTER
While this was happening, officials at EQC were furious. On paper, they controlled billions of dollars. In practice, they had become a lending body for successive governments to fluff up their budgets.
The EQC chairman for much of this period was Ian McLean, an economist and former National MP. He had become increasingly frustrated with the Government and Treasury, much of this expressed through EQC’s unusually frank annual reports.
While the Government’s crippling annual fees were a concern, McLean centred his fight on another problem.
Due to EQC’s inability to control its own balance sheet, he felt the public was being giving a misleading impression of the commission’s finances. In 1994, his annual report noted the financial statements did ‘‘not accurately describe the economic situation of the commission’’.
It was because the major cost facing the commission – a severe earthquake – was not accounted for anywhere in EQC’s finances.
The reason for EQC’s existence was to respond to a major disaster, but by not listing that disaster as a liability, there was no need to have the necessary assets to pay for it.
In a typically outspoken comment in the 1993 annual report, McLean described this missing liability as ‘‘a monster lurking in the shadows, waiting to pounce when catastrophe strikes’’.
However Sir Michael Cullen, the former Labour Finance Minister who became EQC chair in November, says it does not make sense to list EQC’s possible liability on the balance sheet. The range of possible liabilities resulting from an earthquake were enormous, and listing them on a balance sheet would amount to a shot in the dark.
In the 1990s, however, EQC was clearly short of money, which the board at the time felt was a consequence of the unlisted liability.
The main opponents to fixing the problem were Treasury officials, McLean said recently.
‘‘We had quite some difficulty in persuading Treasury and the Government that in fact we weren’t making a profit – that any dividend or tax was unreasonable, because we weren’t making a profit if you took into account the risk we were facing,’’ he said.
The board gained a partial victory in its standoff with Treasury.
It commissioned a complex corporate model to calculate earthquake risk, which estimated the amount EQC would need to be considered solvent was around $5b, more than double what was in the fund at the time. It found EQC’s probability of ruin over a 100-year period was close to 100 per cent.
The government took some of EQC’s criticisms on board. The annual fees were ultimately largely removed, allowing the NDF to grow again.
‘‘Looking back, I think we could have handled it better,’’ McLean said. ‘‘We were frustrated. I don’t think we handled it as well, politically, as we should have done.’’
It wasn’t until 2001 that EQC was allowed to invest up to 30 per cent of the NDF overseas, to lessen the risk of having the entire fund invested in government stock.
The amount taken out of the fund during the 90s has had farreaching effects. Cam Preston traced it back, and found if the money had stayed in the NDF, it would have totalled an extra $4b when the Canterbury quakes struck. Instead of $6b, it would have been $10b, enough to cover the city’s earthquake settlements, with money left over.
The shortfall explains a lot, Preston said. The decision to undertake a repair programme rather than the long-preferred method of cash payouts, allowing money to be drip-fed rather than paid all at once, was largely driven by cost; the agonising delays in settling claims, because EQC was scraping together money from its sole benefactor, the government, which was borrowing money to pay its costs.
‘‘The operational stuff came because the money wasn’t there, and they were being told to keep the costs down, because every dollar they could save was a dollar the government didn’t have to go and borrow.’’
In its 2012 annual report, EQC estimated its shortfall at $1.6b; In 2014, an official wrote in an email that EQC was nearly broke: ‘‘Looking at the cashflow this will definitely happen next fiscal year,’’ noting an expected shortfall of around $650m. And yet, it didn’t happen.
The mandatory levies, tripled in 2012 from 5c to 15c per $100 of insurance, were bringing in a steady stream of cash. The fund’s freefall slowed, and EQC clung to life. It wasn’t until late 2018 – seven years after EQC first warned it was insolvent – that its funds fell below $200m, and the Crown guarantee was triggered for the first time in 75 years.
The Government pitched in $50m in November to kickstart the fund, as part of the initial bailout, with another $30m to come in March. It is not know how much more might be needed after that.
Government borrowing is one of the cornerstones of EQC’s plan if a huge disaster were to happen – although Cullen admits doing so would be unpleasant for the Government.
EQC has three layers of response to a natural disaster, depending on the scale of the event. The first is the NDF, which needs to be built up to about $1.75b to be effective. The second is reinsurance cover, of which it currently has about $5b, bought for an annual premium of $179m. To access this, EQC would need to pay
‘‘It was just a way of making it look rational, in some way, that they were stripping the fund.’’ Cam Preston Accountant
$1.75b as an excess. Cullen said this coverage was enough to meet EQC’s liabilities for quite a large event. If it was to face a huge event, the third layer would kick in; the Crown guarantee.
Cullen said borrowing a multibillion sum would ‘‘not feel comfortable’’ for the Government, but in the context of New Zealand’s overall debt, it would not see our credit rating plunge.
‘‘It causes a gulp, no doubt it might cause the Minister of Finance to bang their head on the table because it probably means something else gets deferred for a while.
‘‘Would it cause them to go upstairs and say to the Prime Minister ‘I just can’t cope with this, find somebody else to do the job?’ No.’’
The alternative would be large costs imposed on the average homeowner if the Government decided to rapidly rebuild the fund.
It would mean significantly multiplying the current EQC levies, which have already gone up more than once since the quakes.
Cullen said rebuilding the fund was not as complicated as it sounded; EQC levies just have to be high enough to bring in more than EQC’s reinsurance and administration costs.
Levies most recently increased from 15c to 20c per $100 of insurance cover, meaning they are now four times higher than prior to the Canterbury earthquakes. With an annual cap of $276 annually, it meant an increase of $69 per year for many homeowners; But it also dropped the time to rebuild the NDF to $1.75b from more than 30 years to about a decade. Cullen saw little point in rushing to rebuild the NDF past that mark, because of the substantial levy increases needed to make it happen.
But there is an argument that if the fund had not been stripped by successive governments, it may not have needed rebuilding at all.
While the NDF has been hailed as a unique piece of public policy – it is increasingly seen as a potential model for responding to climate change – its critics say it is effectively an illusion. The common perception that it functions as a rainy day fund, set aside for a disaster, was wrong, Sue Newberry said. Because so much of it is invested in government stock, it falls on the government of the day to pay for much of the fund, affecting its own economic agenda.
Within a year of the 2011 earthquake, EQC had already spent much of the 30 per cent of the fund not held in government stock. From that point, the body funding the NDF was effectively the government itself, paying back money its predecessors had already spent. This money did not come all at once. As EQC noted in its 2013 annual report, ‘‘sales of government stock have been (and will continue to be) spread out over many months’’.
It is likely that this burden on the government to pay EQC led to cutbacks in other areas, Newberry said.
After the initial earthquakes, there were frequent references in the media to a ‘‘rainy day fund’’. ‘‘The idea is a good one, I think,’’ Newberry said. ‘‘The international bodies that New Zealand would tend to listen to, there’s recommendations from those that a disaster fund is a great idea.’’
It was the execution that was flawed – the pot proved too tempting for politicians.
‘‘I think a lot of people have grown up with some sort of understanding that this fund’s here and it would help. It has needed change for a long time, and in the interests of making it effective, it would need change.
‘‘Maybe it’s nice – if people feel there’s some sort of support there they’re able to draw on, they’ll perhaps feel more assured. Perhaps, at the time [of the earthquakes], it made people feel less stressed.’’
Much of the debt incurred to pay for the Canterbury earthquakes has yet to be paid back; and for many homeowners, it will cost thousands of dollars over a decade to rebuild the fund which, when it was needed, had already been spent.
‘‘There was all this money set aside by generations of Kiwis, that people thought was ready for them when the earthquake struck, but it wasn’t,’’ Preston said. ‘‘The problem now is that because it wasn’t, a lot of money was borrowed, and it’s still borrowed – it hasn’t been paid back. Who’s going to be repaying that debt?
‘‘It’s people paying their taxes now, and that’s not even looking at the next disaster, when that happens.’’