The resilience of New Zealand’s insurance and financial market sectors has been described as “relatively stable” by the Reserve Bank’s November Financial Stability Report (FSR), with governor Adrian Orr highlighting that profitability remains robust, and ongoing regulatory changes will contribute to long-term, positive outcomes for the sector.
The Reserve Bank’s November FSR, released this week, said that New Zealand’s financial system is ‘reassuringly resilient’ despite the ongoing Delta outbreak and the challenges faced by the global economy. Orr noted that New Zealand managed to get its activity back to pre-pandemic levels before the current outbreak, though the subsequent lockdown has created a lot of stress - particularly in the Auckland region.
However, he said that longer term challenges will still remain for insurance and financial services - particularly in the claims and regulatory spaces, as insurers will need to make high initial investments to meet new regulatory requirements. He added that insurers will also start to see the effects of climate change impacting their portfolios.
Nonetheless, Orr said the insurance space has remained resilient throughout this latest period of uncertainty, and has undoubtedly been helped by the experience it gained throughout 2020.
“Insurers have remained open for business, and have transitioned well into remote and virtual working practices during lockdown,” Orr said.
“Even though the worst case economic scenarios envisaged earlier in the pandemic in early 2020 have not materialised in New Zealand, it has been our expectation that insurers have appropriate contingencies in place at all times to mitigate significant stresses on their businesses, and protect the interests of policyholders.”
“Insurers play a vital role in the financial system as they allow businesses and households to manage their risks,” Orr explained. “Insurers’ profitability has been relatively stable, while their capital buffers have been supported by lower dividend payments.”
When it comes to areas of exposure, Orr highlighted the rising costs of weather events and higher-risk regions as a key issue for insurers, and said that they are expected to increasingly reflect this risk in their pricing over the coming years.
Auckland experienced its most costly tornado in 2021, and the flood season this year has also been particularly strong - both of which have brought weather costs for insurers to almost record levels. Orr noted that reinsurance costs are likely to increase as a result, and insurers are likely to pass those costs on through higher premiums as part of a risk-based pricing approach.
“In recent years, the cost of weather-related catastrophes in New Zealand has been rising,” Orr said.
“Climate change will impact future weather events to varying degrees, and it is expected to affect future insurance premiums. In some locations where adverse weather events become more frequent or intense, insurance cover might become more expensive or unavailable, as it would no longer be commercially viable.
“This has material implications not only for insurers, but also households and businesses, banks, and governments. We anticipate that insurers will respond to climate change with risk-based pricing models, which will in part be driven by the cost of obtaining reinsurance for these risks. These changes in pricing and coverage will come on top of changes already being introduced for updated assessments of earthquake risks.”
The Reserve Bank expanded its regulatory stress test programme in 2021 to include insurers for the first time, and the results showed that insurers bear a “large share” of the claims costs for severe weather events.
Ken Nicholls, adviser for stress testing financial stability, said that it is therefore vital for insurers to stay resilient to weather-related losses - though for the moment, it seems that they are well protected with reinsurance arrangements and lower dividend payments.
“Reinsurance arrangements and reductions to dividends prevented significant falls in the insurers’ capital under the severe weather events scenario,” Nicholls said. “Insurers benefited significantly from their catastrophe reinsurance arrangements, which are put in place to mitigate much larger impacts expected from a severe earthquake.”
Orr added: “The stress test is not a pass or fail exercise, but rather is intended to develop our and the industry‘s capabilities, engage with insurers on their approaches to stress testing, including consideration of mitigating actions, and to improve understanding of potential vulnerabilities to four adverse scenarios.
“The recent history in New Zealand of natural disasters, severe weather events, and pandemics helps to inform stress test design, thereby ensuring that insurers are better prepared to withstand any future shocks.”
