Miguel Sanchez :I just realised that we haven’t even touched on the worst aspect of this moral hazard. Bailing out AMI – but not Western Pacific – tells insurers to go for growth at all costs, until they’re big enough to be “too big to fail”. Never mind that that rapid growth will probably sow the seeds of their own demise. It worked for South Canterbury Finance – ten years ago they wouldn’t have been large enough to warrant a bailout.

I totally agree with this and it is something that seems to have been missed in the media.
There is a lot behind this decision, nor did it surprise me that it was made, I know that not all government members were supportive of this bailout for the very reasons mentioned here, but senior members made the decision.
NZ Prudential Regulation is currently weak and the Reserve Bank was in the process of increasing the controls, more will come out of this in the next 6 months and insurance companies will not squeal too much when it is accelerated, knowing that potential Government support is at stake.

In relation to this situation perhaps it should only be insurers with significantly diversified global resources to draw on that should be able to insurer these sorts of risks. That would provide a natural barrier for mutuals getting too large, given that if people want the fully comprehensive cover that includes natural disaster they would have to get at least some of their policy from a more diversified insurer.

MrV :
However given that Western civilisation has only lived on these islands for say 200 years, we really don’t know what geological time has in store for us.

Not quite true. I have a couple of geologist friends who explained how the geological record can provide evidence of major seismic events stretching back megazillions of years. Whether we a) researched, b) interpreted ans c) applied the geological record correctly is another matter.

Greg :After some pondering, I’m back where I started. The knowledge that their claims will always be paid will lead customers of insurance companies, house buyers, to be imprudent. If an insurer knows that she can’t make money from a bailout, i.e. that she has to face the true risks, she will not fall prey to moral hazard.

No, that’s a false distinction, and funnily enough in this case it’s easy to demonstrate why. AMI is a mutual; the customers ARE the owners.

The moral hazard lies definitely with the householder and only possibly with the insurer; it is the householder who has taken on excessive risk and is now being bailed out.

I guess we’ll see. If insurance premiums do not rise differentially for property in liquefaction-prone areas, now that the risk has been made plain, then that would be prima facie evidence of moral hazard in insurers.

Matt Nolan :
@Greg
The moral hazard issue I’m talking about … insurance firms are … willing to take on more risk, as they know that when an event that causes a large claim comes in they have a society that will pay for them …

Again, that applies if AMI’s owners don’t bear their losses in full. If they do bear the losses in full (i.e.without benefit of bankruptcy, etc), we avoid moral hazard. But perhaps you are operating in the real world … 😉