Note 30: Canterbury Earthquakes

These consolidated financial statements report both revenue and expenses in relation to the earthquakes and aftershocks that have occurred in the Canterbury region over the last two years. These fiscal impacts have been estimated based on the information available at the time these financial statements were produced. The largest and most complex valuations have been carried out by independent professional actuaries and represent a best estimate of the costs to date. However, the final costs of the Canterbury earthquakes will not be ascertained for some time and the actual, ultimate costs may differ from these estimates. As a result, information on key assumptions (along with the sensitivity of those assumptions) has been included in the relevant notes to these financial statements (eg, insurance liabilities).

Amounts recognised in the statement of financial performance in respect of the earthquakes are:

In addition to these net earthquake costs, the Government's assets have suffered damage and approximately $200 million (2011: $175 million) has been impaired against the asset revaluation reserve.

These results do not represent the total expense to the Government of the earthquakes as some expenditure is yet to be incurred, or will not be determined until significant policy decisions have been made, such as how best to reinstate health and education assets in the region. These decisions are likely to result in fiscal costs being incurred at a future time.

The costs outlined in this note do not include the impact on tax or other revenues as a result of the earthquakes.

Note a - Earthquake Commission (EQC) Insurance Claims

EQC covers damage to residential property caused by earthquake, landslip, tsunami, volcanic eruption, hydrothermal activity, storm or flood (land only), and fire following any of these events.

Residential property cover generally consists of dwellings (up to $100,000 + GST), contents (up to $20,000 + GST), the land under and immediately around the dwelling, main access-ways, and retaining walls (within certain limits).

EQC's obligation (and reinsurance recoveries) in relation to the earthquakes has been valued by an independent actuary (Melville Jessup Weaver). The key sources of uncertainty in estimating the obligation are:

• the impact of multiple events on the allocation of damage, EQC coverage and EQC's reinsurance coverage
• severe land damage and a very complex land claims environment from both engineering and legal perspectives, and
• the potential for construction cost inflation (“demand surge inflation”) to differ from expectations.

Consequently there is a degree of unavoidable uncertainty regarding the future claims costs at this stage. Over time, as further assessments are completed and claims are settled, the reasonableness of the valuation and its assumptions can be tested against the emerging claims experience and the level of uncertainty will reduce.

The key areas of estimation risk relate to claims that have been incurred but not reported or claims where the estimates are considered insufficient. The volatility of these claims is partially mitigated by the maximum settlement amounts for dwellings and contents. However, claims in relation to residential land are not subject to a monetary limit and are therefore subject to greater volatility.

These financial statements include EQC insurance costs (net of recoveries) of $662 million for the year ended 30 June 2012 (2011: $7,471 million). This figure represents the increase in EQC's expected cost of settling its outstanding Canterbury earthquake claims. The increase was driven by claims arising from the 23 December 2011 earthquake, as well as the revaluation of outstanding claims relating to the previous year.

Up to 30 June 2012, EQC had made cash payments of approximately $4.0 billion in total (2012: $2.8 billion, 2011: $1.2 billion) for settling approved claims, leaving an outstanding insurance liability estimate of $8.9 billion, some of which is expected to be offset by reinsurance proceeds.

Details of the calculation of EQC's claims obligation (including discussion on the sensitivity of assumptions) are provided in note 25 of these financial statements.

Note b - Share of Local Authority Expenses

Under the current government policy settings, as outlined in the National Civil Defence Emergency Management Plan (‘the Plan') and Guide to the National Civil Defence Emergency Management Plan (‘the Guide'), the Government is committed to a standard financial support package for the four local authorities in Canterbury (Christchurch City Council, Waimakariri District Council, Selwyn District Council and Environment Canterbury) that were adversely affected by the earthquakes. This support package covers certain types of response and recovery costs incurred as a result of the earthquakes.

Response Costs

The Government has recorded an expense of $89 million (2011: $133 million) in the current financial year for its share of response costs under the Guide. The majority of the costs in 2012 related to temporary repairs to essential infrastructure, carried out by the Christchurch City Council.

Recovery Costs

The Government's standard financial support under the Plan and Guide is to reimburse local authorities 60% of recovery repairs to essential infrastructure (waste water, storm water and fresh water) and river management systems. Recovery repairs are permanent repairs to restore the essential infrastructure to pre-emergency condition.

An initial estimate of $554 million for the Government's share of these recovery costs has been included, for the first time, in these financial statements. The majority of the recovery estimate provided relates to Christchurch City Council's essential infrastructure. While best available information has been used to provide this estimate, significant uncertainties remain with regard to:

1. the amount of damage to infrastructure under the ground, and
2. the basis for restoring the infrastructure, whether it is like-for-like, or some other method.

Details of the calculation of the estimate (including discussion on the sensitivity of assumptions) are provided in note 27 of these financial statements.

This obligation was disclosed as a contingent liability in the previous year, as the amount could not be estimated with sufficient reliability to record it in the statement of financial position at that time.

Note c - Red Zone Support Package

On the 23 June 2011 the Government announced zones of land damage in Christchurch and parts of the Waimakariri district. This land was mapped into four zones, with “Red Zone” land identified as being unlikely to be suitable for continued residential occupation for a prolonged period of time. For this reason, the Government instigated a process for purchasing insured residential land in the Red Zone on a voluntary basis.

Following the initial zoning announcement on 23 June 2011, further zoning announcements were made during the year to 30 June 2012. Taking these additional announcements into account, along with the experience of the last 12 months, Melville Jessup Weaver (a firm of consulting actuaries) revalued the Crown's obligation and associated insurance recoveries as at 30 June 2012. The actuarial valuation resulted in an expense (net of insurance proceeds) for 2011/12 of $258 million being recorded. Details of the calculation of the estimate are provided in note 27 of these financial statements.

The provision for outstanding property settlements excludes any costs associated with the demolition and removal of red zone houses, salvage income, and any future sale or use of land that will be purchased. The impact of these exclusions will depend on future decisions regarding the use of any land acquired.

Also, these results do not include the impact of recent announcements regarding the Christchurch Central Recovery Plan, the Port Hills and zoning reviews as no obligation existed at 30 June 2012. As a result, the fiscal impact of these and any future offers to residents will be recorded in future periods. Refer to the Subsequent Events note for more information.

Note d - Southern Response Earthquake Services (Formerly AMI) Support Package

On 7 April 2011 the Government provided a financial support package for AMI to give policyholders certainty and to ensure an orderly rebuild of Christchurch. The financial support to AMI was provided via a Crown Support Deed (CSD) under which the Crown subscribed for $500 million of convertible preference shares which were called but unpaid. On 5 April 2012 IAG purchased the on-going insurance business of AMI. Immediately after completion of the sale, the Crown paid $100 million of the unpaid balance on the preference shares and took ownership of AMI's residual earthquake business. The earthquake business was renamed Southern Response Earthquake Services Limited (Southern Response).

As reported last year, upon acquisition of AMI on 7 April 2011, an initial cost of $335 million was recorded. With a further loss relating to the outstanding claims liability of $20 million being recognised at the end of that year, the total cost of the Crown's support to 30 June 2011 was estimated at $355 million. During the 2012 financial year further net costs of $401 million were recognised by the Crown, primarily relating to increases in the liability for earthquake-related claims. These losses were partly offset by a gain realised on the sale of the ongoing business of AMI of $245 million, resulting in a net cost of $156 million being recorded for the financial year.

While the potential cost of the Crown's support has been estimated at $511 million in total, which includes a risk margin, the ultimate cost is dependent on the financial performance of the company and the underlying emerging experience from the earthquake series such as further late notified claims in relation to the liability (and resulting reinsurance recoveries) arising from the Canterbury earthquakes. The liability in relation to the earthquakes has been valued by an independent actuary (Finity Consulting Pty Limited). Key assumptions around the valuation of the liability include the number of properties damaged, the mix and cost of rebuilds versus repairs versus cash settlements, where damage will exceed the EQC limits, future claims inflation, and the timing of claims payments.

The uncertainties regarding Southern Response's outstanding claims liability are similar to those of EQC (with the exception of risks associated with land claims). The details of the insurance liability at 30 June 2012 (including discussion on the sensitivity of assumptions) are outlined in note 25.

Note e - Other Earthquake Costs

Other costs (net of insurance proceeds) represent various other initiatives raised in support of Canterbury, including the operating costs of the Canterbury Earthquake Recovery Authority (CERA). The largest component relates to the ongoing repair of local roadways, at an expense of $86 million (2011: $62 million).

Other earthquake costs do not include costs associated with the future repair of local roadways. This exclusion reflects that the first call for funding these future expenses will be from dedicated ring-fenced revenue in the form of road user charges, fuel excise duties, and registration fees paid to the New Zealand Land Transport Fund. The Government has agreed that $50 million a year will be made available from the Fund. Should the Government's share of the costs associated with the future repair of local roadways exceed the amount available from that ring-fenced revenue, the Government has a number of options to allocate future revenue to this expense. The Crown's share of the costs for local roadways remains uncertain, as is the range of funding options available to the Government.