Appendix 2: Preparations before the Canterbury earthquakes

Preparedness expectations of the Earthquake Commission

At the time of the first Canterbury earthquake on 4 September 2010, there were no specific legislative or Ministerial expectations about the scale of event the Earthquake Commission (EQC) was to be prepared for. The Government had not indicated which of the range of responses available under the Earthquake Commission Act 1993 (the Act) were preferred.

Legislation

EQC is a Crown entity. Its functions, as described in section 5 of the Act, are:

(a) to administer the insurance against natural disaster damage provided under this Act:

(b) to collect premiums payable for the insurance provided under this Act:

(c) to administer the Fund [the Natural Disaster Fund] and, so far as is reasonably practicable, protect its value, including by the investment of money held in the Fund:

(d) to obtain reinsurance in respect of the whole or part of the insurance provided under this Act:

(e) to facilitate research and education about matters relevant to natural disaster damage, methods of reducing or preventing natural disaster damage, and the insurance provided under this Act:

(f) such other functions as may be conferred on it by—

  (i) this Act or any other Act; or

  (ii) the Minister, in accordance with section 112 of the Crown Entities Act 2004.

Settling claims is a part of EQC's insurance administration function. The Act enables EQC to settle insurance claims for natural disaster damage to houses in a number of ways:

• by cash settlement;
• through replacement of a house;
• though reinstatement of a house – that is, through repairs to return a house to its state before the natural disaster; and
• by relocating and then reinstating a house.

The Act also states that EQC "shall not be bound to replace or reinstate exactly or completely, but only as circumstances permit and in a reasonably sufficient manner."

EQC considers that its first settlement option under the Act is to consider a cash payment. The advantages of cash settlement are administrative simplicity and the potential for minimising EQC's costs and liability. Cash settlement also has a number of social and economic risks, the extent of which depends on the scale of an event. The risks include:

• pushing up the cost of repairs by flooding a market with money;
• the order of repairs being determined by people's ability to pay regardless of need;
• settlement money being used for purposes other than repairing damage, and in the extreme case leading to a risk of depopulation and degradation of the housing stock; and
• EQC being perceived to be "walking away" from a difficult situation.

For example, after the 2007 Gisborne earthquake, there was some concern that:

… claims settlements in cash were being spent other than on repairing the damage they were compensating for, leaving some homes in an unsafe condition or prone to further damage (or a repeat claim for the same damage after the next earthquake).

Overall, EQC has the discretion to decide which settlement method it uses in a given situation.

Internal policy

EQC has determined a claims settlement policy that gives it the flexibility to adopt any settlement method specified in the Act. The policy, adopted by EQC's Board in 2004, states:

EQC would prefer to settle claims by paying the amount of the damage. This may be by way of settlement being made direct to repairers at the discretion of the claimant.

EQC will elect to settle claims by repair, replacement or reinstatement, or by relocation, if good reason exists to do so. The claimant's wishes will be taken into account.

An election to repair, etc, must be recorded on the file along with reasons and any steps taken to limit EQC's liability, for example, the agreement of the "top up" insurer to bear costs that exceed EQC's maximum sums insured or the wording of a building contract for which EQC is the principal.

Ministerial and government expectations

Respective Governments have treated EQC as a Crown Financial Institution (CFI). This is because EQC administers a large fund (the National Disaster Fund, which was $5.9 billion on 1 July 2010) that is used to pay the costs of settling claims resulting from natural disasters (as defined in the Act). The guidance and expectations given to EQC before the Canterbury earthquakes were consistent with those provided to other CFIs. These included:

• being a responsible investor (2007 Ministerial letter of expectation);
• engaging in investment activity that adds value to the Crown (2011 Ministerial letter of expectation); and
• providing responsible Ministers with high-quality information and analysis about EQC's performance against its plan (2012 enduring Ministerial letter of expectations).

In February 2011, the Minister responsible for EQC, also the Minister of Finance, included a paragraph about the first Canterbury earthquake in his Annual Letter of Expectation to EQC. This stated:

Clearly, the EQC's response to the Canterbury earthquake will continue to be your top priority for some time to come, and particularly the new functions and roles that the EQC has taken on in dealing with the earthquake. While bearing in mind the importance of responding to the Canterbury earthquake, the Government seeks reassurance and confidence that the EQC has the capability to respond to any future disasters.

Planning for a large-scale natural disaster

EQC's planning for a large-scale natural disaster was based on the probabilities of such a disaster happening. For example, in 1999, EQC identified that its greatest earthquake risks were in the Wellington region and in Christchurch, and estimated that there was:

• a 20-25% probability of a large earthquake occurring on a fault in the Wellington region in the next 50 years;²² and
• a 50-75% probability of the same shaking intensity occurring in Christchurch as a result of an earthquake.

EQC anticipated that a large-scale natural disaster, such as an earthquake in Wellington, could result in about 150,000 claims and claims settlements of at least $6.8 billion.

EQC's plan for responding to such an event was to outsource the services it would require if it was settling claims in cash. It had a service-level agreement with an Australian-based claims administration company. The agreement covered the provision of claims administration, including back-office support, to approve and settle claims.

The outsourcing agreement assumed the capability for handling 60,000 claims for each year, operating in normal business hours, and using the provider's own staff. Additional staff and extended working hours would be used to handle a claims load exceeding 60,000 for each year.

Catastrophe Response Programme

EQC's plan for responding to a "large-scale" natural disaster is known as the Catastrophe Response Programme.

The objective of the Catastrophe Response Programme is to achieve a successful response to a major natural disaster. EQC's indicators of success for the Programme are:

1. All claimants are able to lodge claims with EQC within the statutory 30-day period or such extended period approved by the Minister.

2. Claims are settled within a time frame that gains broad public acceptance.

3. Claims are settled to standards of individual and overall fairness perceived as acceptable by the public.

4. Essential office services are maintained at a level commensurate with a standard of operational efficiency acceptable to the Board.

5. The health and welfare of staff is maintained over long work hours, particularly in the avoidance of stress.

The Catastrophe Response Programme was reviewed by an external panel in 2009. It had been activated for relatively small events and EQC's Board was interested in EQC's capability to handle the number of claims anticipated from a large Wellington earthquake.

The EQC Chairperson wrote to the Minister of Finance in August 2009 about the findings of the review. The letter noted:

The two most significant findings and recommendations are;

• the need to ensure that EQC's assumptions and planning for a major event, and the capacity and systems which are then based on those plans, are aligned with the Government's expectations of EQC (and its emergency management and response agencies) in a major natural disaster; and
• the need to have extraordinary measures planned for the largest natural disasters EQC could face. Our working assumption to this date has been, broadly, to maintain a single process for claims management which could be increased in scale to respond to disasters generating high numbers of claims.

… In responding to both the major findings referred to above, EQC is initially identifying each of the earthquake scenarios that will provide the stiffest challenges to current preparations. The resources needed to handle each scenario will then be calculated using quantitative methods to identify potential "choke points". Plans to address these will be developed. Once these have been completed, and timescales calculated for the settlement of most claims, we will engage with other Government agencies as the first step to ensure alignment of both planning and expectations.

By October 2009, EQC had held various internal meetings about its response to the review and an action list had been compiled. The actions included preparing a "structure" for discussions with the Government about its post-disaster expectations of EQC.

The current Chief Executive of EQC joined the organisation in February 2010. On 9 June 2010, he wrote to the EQC Chairperson noting that, as a result of the review, EQC's Claims Team was "looking for ways to increase our capacity to process claims in the aftermath of a significant event". He sought the Chairperson's permission to commission a "short review by an external organisation with experience of high volume claims processing in the insurance industry". The Chairperson agreed to that request.

During mid-2010, the EQC Claims Team continued work modelling the effect of large-scale events on EQC. This included using a "system dynamics model" for events generating more than 30,000 claims.

An external organisation was commissioned in mid-2010 to carry out a quality assurance review of EQC's claims management process, because that process was being modified to address the recommendations of the Catastrophe Response Programme review. The quality assurance review included a workshop with EQC staff in late June 2010.

Towards the end of 2011, EQC commissioned an external review of its response to the Canterbury earthquakes and record the lessons learned.

22: Although the Wellington fault is only one of the significant fault risks to Wellington, recent research has indicated a lower chance of a large earthquake happening on the Wellington fault than was previously known. It is estimated that there is about a 10% chance of rupture in the next 100 years. Further information is available on the Institute of Geological and Nuclear Sciences' website (www.gns.cri.nz/Home/IOF/It-s-Our-Fault/Likelihood-Phase).