Note 27: Provisions (continued)

Key Assumptions

The key assumptions and the methodology applied in the valuation of the red zone valuations are as follows:

Option choice

As at 30 June 2012, 78% of homeowners eligible for the red zone support package have chosen their preferred option. Where the option choice is unknown the valuation is based on actual experience to date that 75% of homeowners will choose option B (the Government purchases land and buildings along with the EQC claims for damage to land only) while 25% would opt for option A (the Government purchases land and buildings along with all insurance claims for damage to both the land and buildings).

Price of purchase

The price the Government has to pay to purchase properties under option A and B are the 2007 capital value rating and land value rating issued by the Christchurch City Council and Waimakariri District Council. An allowance has been made for subsequent improvements to properties since 2007.

Insurance recoveries

Insurance recoveries are based on current insurance policy settings (including coverage and excess limits). Individual policies may differ between insurers. Therefore a number of policies were reviewed to establish “typical” policy settings. Assumptions have also been made regarding the proportion of damage to red zone properties.

Discount rate

Due to the short term nature of the liabilities the impact of discounting is not generally material. Where applicable, claims and recoveries have been discounted using a risk-free rate based on New Zealand Government bonds and the payment profile of the underlying cash flows.

The provision represents the Crown's contribution of 60% for recovery costs relating to essential three waters infrastructure (waste water, storm water and fresh water) and river management systems. The provision includes recovery costs for Christchurch City Council (CCC), Waimakariri District Council, Selwyn District Council and Environment Canterbury.

The provision has been estimated based on information provided by the councils.

For the Waimakariri District Council, Selwyn District Council and Environment Canterbury the costs are based on estimates provided by these councils included within their long-term plans. These estimates have generally been established by councils following detailed evaluations of assets, a scheduled repair work programme and expenditure forecasts which align to this work plan.

In the case of CCC a full underground assessment and a long term prioritised work programme is progressing but has yet to be completed. So the best information to estimate the provision is an analysis produced for CCC by an independent consultant and verified by internationally recognised quantity surveying specialists in September 2011. The detailed asset analysis presents the likely cost of repairs based on asset and catchment data available at the time.

The key risks to the estimate are damages may be more substantial than indicated by testing completed, programming and scheduling may lead to extended repair timeframes and there may be greater inflationary pressure on material and labour. As an indication, if recovery costs were 10% higher or lower the impact on the Crown's obligation would change by $54 million.

Provision for weathertight services financial assistance package

This provision represents the Government's obligation to contribute 25% of agreed repair costs to eligible owners of leaky homes under the Weathertight services financial assistance package. Melville Jessup Weaver has prepared an independent actuarial valuation of the obligation as at 30 June 2012. The valuation of the provision takes into account claim experience which was previously not available, which is the main reason for the decrease in the provision since last year.

Description of weathertight services financial assistance package (FAP)

The FAP offers qualifying homeowners a share of the agreed actual repair cost of repairing leaky homes. The Government and the Territorial Authority (if the Territorial Authority is participating in the FAP) each pay 25% of the agreed repair cost and the homeowner pays the remaining 50%. Under the FAP the homeowner agrees not to sue contributing Territorial Authorities and the Government, although homeowners can still pursue other liable parties such as builders, developers and manufacturers of defective products.

The FAP scheme became available to homeowners from 29 July 2011 and eligible homeowners must lodge claims with the Department of Building and Housing prior to 29 July 2016. The 10 year limitation on lodging a weathertight claim means that over time the forecast eligible claims will reduce.

Key assumptions

Due to the early stage of the claims process for this support package, there is considerable uncertainty attached to this provision and what the ultimate cost of the Government's contribution will be under the FAP.

The most critical assumption in estimating the Governments obligations under the FAP is the number of eligible claims (which can be derived from estimated weathertightness failures in New Zealand), recognising the requirement that houses must have been built or altered (if the alterations leak) within 10 years of the date of lodging a claim.

As at 30 June 2012, after the first 11 months of the scheme, the actuary has estimated the number of eligible claims based on actual claim information and knowledge across the sector. This calculation projected that 14,721 (2011: 14,939) dwellings would be eligible for the scheme.

The second most critical assumption is the take-up rate for the scheme. It is assumed take up of dwellings will be 3,544 (2011: 11,040).

The third critical assumption is the assumed cost of repair per eligible homes. The 30 June 2012 estimate has been split between single dwellings $336,741, and multi-unit dwellings at $134,696.

Sensitivity analysis

The sensitivity of the provision for FAP against the three critical assumptions described above is further described below: