Part 8: Managing leaky home liabilities

Local government: Results of the 2010/11 audits.

8.1
In this Part, we:

provide an overview of leaky home liabilities;
discuss the Government's Financial Assistance Package (FAP) for homeowners;
describe the types of claims that local authorities face;
discuss how leaky home liabilities need to be accounted for; and
set out the findings of our review of four local authorities' leaky home liabilities.

Overview of leaky home liabilities

8.2
Providing for leaky home liabilities continues to be a major matter for local authorities. Auckland Council, Christchurch City Council, Tauranga City Council, and Wellington City Council are the four local authorities that are most significantly affected.

8.3
We note that, in the recently published Auckland Council Long-term Plan for the period 2012 to 2022, which is out for public consultation, Auckland Council has provided for $526 million to meet the estimated costs of leaky home claims during the next 10 years. These costs are to be funded by borrowing, with the repayments spread over 30 years. The repayments of this debt are spread so that the funding requirement does not fall on ratepayers in the year of settlement and so that current ratepayers do not bear the full cost of the settlements.

8.4
As at 30 November 2011, the Department of Building and Housing (DBH) had received 6677 claims lodged for 9262 properties and had completed assessments for 10,128 properties.³³ There were 1837 active claims, affecting a total of 4567 properties. The four local authorities were responsible for 96% of the properties with active claims and 87% of active claims.

8.5
Provision for leaky home liabilities for the four local authorities increased from $477 million³⁴ in 2009/10 to $510 million in 2010/11, an increase of $37 million or 7.8%. The movement in provisions reflected that the four local authorities are able to estimate their leaky home liabilities more reliably because they have more historical information on which to base their assumptions. As a result, the amount disclosed as contingent liabilities was less compared to 2009/10.

8.6
In 2011, the Government introduced the FAP to help homeowners repair their homes faster. The four local authorities take part in the FAP. They have tried to factor the FAP's effect into their leaky home liability calculations, even though the scheme was not effective before 30 June 2011.

The Government's Financial Assistance Package

8.7
From 29 July 2011, the FAP became available to homeowners to help to repair homes faster.

8.8
The FAP offers qualifying homeowners a share of the agreed actual cost of repairing leaky homes. The Government and the territorial authority (if the territorial authority is participating in the FAP scheme) each pay 25% of the agreed repair cost and the homeowner pays the remaining half. Under the FAP scheme, the homeowner agrees not to sue the contributing territorial authorities or the Government or any other contributing parties, although homeowners can still pursue other liable non-contributing parties such as builders, developers, and manufacturers of defective products.³⁵

8.9
Eligible homeowners must lodge claims with DBH before 29 July 2016. The 10-year limit on lodging a weathertightness claim means that, over time, the number of forecast eligible claims will reduce.

8.10
The Crown has provided $567 million for the FAP. This represents the Government's obligation to contribute 25% of agreed repair costs to eligible owners of leaky homes.³⁶

8.11
By late March 2012, 38 territorial authorities had chosen to take part in the FAP; 29 territorial authorities had chosen not to participate.³⁷

The kinds of claims that local authorities face

8.12
We identified three categories of claims that local authorities must consider when assessing their current and future exposure to liability for leaky home claims:

category 1 – claims that have been investigated and reviewed, where the total claim amount and the local authority's share have been confirmed;
category 2 – claims still being investigated and confirmed, with work to assess whether other available parties will share the liability and work to assess the costs; and
category 3 – claims that might be made against local authorities between now and the end of the statutory limitation period but that have not been lodged, including issues that homeowners might not yet have identified.

8.13
Categories 2 and 3 continue to be of most concern to local authorities because of the associated uncertainty. However, local authorities now have more historical information from recent claims and are able to more reliably estimate their liabilities from future claims.

Accounting for leaky home liabilities

8.14
The accounting standard that applies to leaky home liabilities is New Zealand Equivalent to International Accounting Standard 37: Provisions, Contingent Liabilities and Contingent Assets (NZ IAS 37). This standard provides the definitions and criteria to identify whether a liability should be accounted for as a provision or disclosed as a contingency. The most relevant element of the criteria for leaky home liabilities is assessing whether a liability that needs to be estimated can be calculated reliably enough to meet the definition of a provision.

8.15
Our guidance to auditors on the appropriate accounting treatment of claims was:

category 1 – a provision for the confirmed amount should be recorded in the financial statements;
category 2 – a provision for the estimated amount should be recorded in the financial statements; and
category 3 – a provision should be recorded in the financial statements if an actuarial assessment has been obtained and is reliable; otherwise it should be disclosed as a contingent liability.

8.16
Our monitoring of the sector up to 2009/10 found that identifying category 2 and category 3 claims was more difficult for local authorities than we had anticipated when we wrote our guidance. In our guidance, we assumed that an actuarial assessment, particularly if carried out by professional actuaries, would be enough to meet the requirements of NZ IAS 37 and allow accounting for the liability in the financial statements.

8.17
We found that, in many instances, the estimation processes used to assess liabilities for category 2 and 3 claims, whether done in-house or by a professional actuary, were not reliable enough to allow the resulting estimation to be accounted for as a provision in the financial statements. The argument to support this approach has been that the estimation processes were not reliable enough, because too many variables apply to each leaky home.

Our review of how four local authorities accounted for leaky home liabilities

8.18
The four local authorities collectively increased their provision by $37 million between 2009/10 and 2010/11. This was largely because Wellington City Council included $24.4 million for future claims for weathertightness issues that had not yet been identified or reported in its provision calculation. These claims were previously recognised as an unquantified contingent liability. Historical data on previous claims, homes that may experience weathertightness problems, and the percentage of homeowners likely to make a successful claim have allowed Wellington City Council to make a more accurate actuarial calculation of its leaky home liabilities.

8.19
Because of uncertainty about earthquakes, Christchurch City Council did not do an actuarial assessment of its leaky home liabilities at 30 June 2011. The Council calculated its provision based on the estimated cost of known claims outstanding and based on the average actual settlement costs. Its provision for leaky home liabilities increased by only $292,000 compared to the previous year to reach $3.5 million.

8.20
Auckland Council's total provision for 2010/11 was $456 million. Of this amount, $145 million related to claims that were being managed through a resolution process. (These were category 1 claims – that is, claims that are nearing resolution and whose claim amount is more certain.) The remaining $311 million reflected claims that have been reported to the Council or the Weathertight Homes Resolution Service (WHRS) and claims that are expected to be notified in the future. Auckland Council completed an actuarial valuation on its leaky home liabilities and included extensive disclosure of the assumptions applied in calculating its provision amount.

8.21
As outlined in paragraph 8.18, Wellington City Council changed its treatment of unreported claims from an unquantifiable contingent liability ($24 million) to a provision. Wellington City Council's total provision of $50 million reflected the potential net settlement of all known claims, including those Claims the council is managing and claims that have been lodged with the WHRS but are not yet being managed.

8.22
Tauranga City Council has a provision for claims under the WHRS of $0.5 million and a provision for claims under the FAP of $3.5 million. The $3.5 million provision reflected only higher-risk claims eligible under the FAP scheme due to the uncertainty surrounding this provision. The provision was based on an actuarial calculation.

8.23
Tauranga City Council was the only significantly affected local authority to record a quantified contingent liability of $1.1 million for less certain claims. Christchurch City Council and Wellington City Council disclosed unquantifiable contingent liabilities for unknown potential claims, as they could not be reliably estimated. In its contingent liability disclosures, Auckland Council did not include any disclosure on leaky home liabilities.

8.24
In terms of disclosure, Auckland Council³⁸ and Wellington City Council³⁹ were more extensive in their disclosures about the calculation of the leaky homes provision than Tauranga City Council. However, Tauranga City Council's disclosures did improve compared to 2009/10.⁴⁰ We continue to encourage local authorities to improve the way they disclose information about the calculation and assumptions surrounding leaky home liabilities, including the effect on calculations of changes to the assumptions such as the information that was reflected in Auckland Council's and Christchurch City Council's 2010/11 annual reports.

33: See www.dbh.govt.nz/ws-claims.

34: Of this, $454 million related to four of the former Auckland councils: Auckland City Council, North Shore City Council, Rodney District Council, and Waitakere City Council. The provision for all the former councils was $469 million as at 31 October 2010. See our June 2011 report, Final audits of Auckland's dissolved councils, and managing leaky home liabilities, page 15.

35: Department of Building and Housing, Annual Report 2010/11, page 84.

36: Financial Statements of the Government of New Zealand for the year ended 30 June 2011, page 121.