Part 7: Managing leaky building liabilities

Local government: Results of the 2011/12 audits.

In this Part, we:

Overview of leaky building liabilities

Providing for leaky building liabilities continues to be a major matter for many local authorities. Auckland Council, Christchurch City Council, Tauranga City Council, and Wellington City Council ("the four local authorities") are the four most significantly affected local authorities.

This matter is as significant as it was when we last reported. The challenge of leaky buildings is, if anything, greater. Local authorities completed their long-term plans and through this process, set out the liabilities expected during 2012-22. However, the Supreme Court ruling in October 2012 that local authorities' duty of care extends to all buildings, whether residential or commercial, effectively expanded the potential for liability.

As at 7 January 2013, the Ministry of Business, Innovation and Employment (MBIE) recorded that 6928 claims had been lodged for 9833 properties and that assessments had been completed for 12,500 properties.27 There were 1568 active claims, affecting a total of 4653 properties. The four local authorities were responsible for 95% of the properties with active claims, and 86% of the active claims. Although the overall number of claims and properties continues to increase, the number of active claims is 15% less than one year ago. This might reflect the effect of the FAP, but is difficult to assess conclusively now.

Provision for leaky building liabilities for the four local authorities decreased from $514 million in 2010/11 to $482 million in 2011/12, a decrease of $32 million or 6.2%. The movement in provisions appears to reflect further refinement of the local authorities' ability to estimate their leaky building liabilities. This refinement reflects work that local authorities completed during 2012 for their long-term plans and more understanding of how claimants have responded to the FAP. None of the four local authorities recorded any unquantified contingent liabilities related to leaky buildings, although the assumptions related to the provisions make clear that the final costs of leaky buildings remain highly uncertain.

2012-22 long-term plans

The Act required local authorities to explicitly disclose their financial strategy in their 2012-22 long-term plans.28 We noted that those local authorities most significantly affected by leaky buildings included specific mention of their approach to funding their liability within their financial strategy.29

Wellington City Council has provided for $53.2 million to settle leaky buildings claims. The liability is expected to be realised during the next eight years and will be funded at first through borrowing, with rates increasing by 0.75% a year until the liability has been settled and the debt has been repaid.30 Auckland Council noted that its leaky home liability would be funded through borrowing spread over 30 years and repaid through rates during this time.31 In all instances, ratepayers must fund the local authority's share of this liability.

The Supreme Court's decision

On 11 October 2012, the Supreme Court released a decision on the case between Body Corporate No. 207624 and Alan Millar Parker and others and the (former) North Shore City Council  - the Spencer on Byron case. The plaintiffs in the claim successfully argued that North Shore City Council had breached the duty it owed to the owners to take care when inspecting and certifying the building as complying with the building code. Until the Supreme Court's decision, it was recognised that local authorities owed a duty for residential properties. This duty was not commonly thought to extend to commercial properties.

Provisions included in local authorities' 2011/12 annual reports and 2012-22 long-term plans provide for liability to homeowners. Now, local authorities need to consider the effect of their duty of care for all buildings, residential and commercial, and adjust their reporting provisions accordingly. Few claims for commercial buildings have been lodged to date and no such claims have been settled.

Calculating the effect of the Supreme Court's decision will present a challenge for local authorities in the coming year. This challenge has been faced by Auckland Council when preparing its six-month accounts released at the end of February 2013. Auckland Council reported that, at this stage, it does not have historical claims experience on which to reliably calculate the Council's liability so it has not recorded a provision or a quantified contingent liability for unreported claims. These accounts provide a lead for other local authorities on how to approach 30 June 2013 reporting responsibilities, but as claims are dealt with the possibility of recording a provision will increase.

The Government's Weathertight Financial Assistance Package

The FAP became available to homeowners from 29 July 2011, to help them repair their homes faster. Although local authorities tried to factor the FAP's effect into their leaky building liability calculations as at 30 June 2011, this was refined based on the uptake of the FAP in 2011/12.

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 taking part in the FAP scheme) each pay 25% of the agreed repair cost and the homeowner pays the remaining 50%. Under the FAP, the homeowner agrees not to sue the contributing territorial authorities and the Government or any other contributing parties. Homeowners can still pursue other liable non-contributing parties, such as builders, developers, and manufacturers of defective products.

Eligible homeowners must lodge claims with MBIE before 29 July 2016. The 10-year limit to lodge a weathertightness claim means that the forecast eligible claims will gradually reduce.

The Crown has provided $189 million for the FAP as at 30 June 2012.32 This represents the Government's obligation to contribute 25% of agreed repair costs to eligible owners of leaky buildings. This is a significant decrease on the amount provided in 2011 and reflects a significant modification to the estimated take-up rate of homeowners entering the scheme. This is based on take-up rates during the first year and analysing prospective take-up rates further. There is still considerable uncertainty about the assumptions used to measure the provision because of limited experience with claims.

Thirty-eight local authorities have chosen to take part in the FAP; 29 territorial authorities have chosen not to.

The kinds of claims that local authorities face

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

  • Category one – claims that have been investigated and reviewed, where the total claim amount and the local authority's share have been confirmed;
  • Category two – 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 three – 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 matters that might not yet have been identified by property owners.

Categories two and three continue to be of most concern to local authorities because of the associated high uncertainty. However, for residential properties, local authorities now have more historical information from recent claims and are able to more reliably estimate their liabilities. Liabilities for commercial buildings will be more difficult to estimate reliably until there is a history of claims.

Accounting for leaky building liabilities

The accounting standard that applies to leaky building 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 building liabilities is assessing whether a liability that needs to be estimated can be calculated reliably enough to meet the definition of a provision.

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

  • Category one – a provision for the confirmed amount should be recorded in the financial statements;
  • Category two – a provision for the estimated amount should be recorded in the financial statements; and
  • Category three – a provision should be recorded in the financial statements if there is a reliable actuarial assessment; otherwise it should be disclosed as a contingent liability.

Our monitoring 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 2007. 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.

We found that, in many instances, estimates used to assess liabilities for category 2 and 3 claims, whether 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 building. This has improved considerably as more historical data on claims is available. We note that the four local authorities have made estimates reliable enough to be accounted for as provisions as at 30 June 2012 and no longer have any quantified contingent liabilities for residential properties.

Our review of how the four local authorities accounted for leaky building liabilities

Overall, the provision for leaky home liabilities for the four local authorities decreased by $32 million between 2010/11 and 2011/12. The decrease is primarily attributed to a decrease of $39 million in Auckland Council's provision. Local authorities generally carried out significant reviews of their provisions during the year, mainly for the purposes of the estimates included in the 2012-22 long-term plans. The Financial Statements of the Government reflected the Government's decreased share of this liability, decreased in 2012 because of more reliable estimates of the uptake of the FAP.

Because of uncertainty about the number of properties with earthquake-related claims or potential future claims that will be repaired or demolished and rebuilt by insurers or will be abandoned, Christchurch City Council did not do an actuarial assessment of leaky home liabilities as at 30 June 2012. Christchurch City Council calculated its provision based on the estimated cost of known claims outstanding and based on the average actual settlement costs. The provision for leaky home liabilities was $4.3 million -   $713,000 more than in June 2011.

Auckland Council's total provision for 2011/12 was $417 million. Of this amount, $123 million related to claims 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 $294 million reflected claims that have been reported to Auckland Council or the Weathertight Homes Resolution Service (WHRS), and claims that are expected to be notified. Auckland Council completed an actuarial valuation on leaky building liabilities and included extensive disclosure of the assumptions applied in calculating its provision amount.

Wellington City Council's provision increased by $5.2 million compared to last year. In 2011, Wellington City Council began treating unreported claims as a provision instead of an unquantifiable contingent liability ($24 million), but this year's movement is simply a refinement of the provision estimate. The refinement reflects greater claims history and a better understanding of the FAP uptake.

Tauranga City Council included a provision for claims under the WHRS of $1.2 million and a provision for claims under the FAP scheme of $3.5 million. The $3.5 million provision reflected higher risk claims eligible under the FAP scheme because of the uncertainty surrounding this provision. The provision was based on an actuarial calculation.

Tauranga City Council was the only one of the four local authorities to record a quantified contingent liability of $1.1 million for less certain claims in 2011. However, in 2012, Tauranga City Council removed contingent liability, noting that it considered its provision was enough (the WHRS provision was increased by $730,000 during 2012) and that it considered most future claims would be under the FAP.

All of the four local authorities made reasonable disclosures for 2012.33 We continue to encourage local authorities to ensure that they clearly present information about the calculation and assumptions about leaky building liabilities, including the effect on calculations of changes to the assumptions.

27 See the Ministry of Business, Innovation and Employment's website for building and housing information, The figures presented reflect total applications and accepted claims since the start of the Weathertight Homes Resolution service.

28 For further details on the financial strategy requirements, see Matters arising from the 2012-22 long-term plans (2012), Part 2.

29 Christchurch City Council did not complete a long-term plan during 2012 as the Canterbury Earthquake (Local Government Act 2002) Order (No 2) 2011, clause 7(3) allowed for completion to be delayed by one year.

30 See page 128 of Wellington City Council's long-term plan and page 131 of its Annual Report 2011/12.

31 See Auckland Council's long-term plan, Volume 3, page 92.

32 See Financial Statements of the Government of New Zealand for the year ended 30 June 2012, page 88.

33 Auckland Council Annual Report 2011/12, Volume 3, pages 93 to 95 and 119; Christchurch City Council Annual Report 2011/12, pages 211 and 212; Tauranga City Council Annual Report 2011/12, pages 203 to 205 and 208; and Wellington City Council Annual Report 2011/12, pages 128 to 131 and 153.

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