Aftermath of an earthquake: why AMI was forced to demutualise

This article by Andrew Bibby, in a slightly different form, was first published by ICMIF (International Cooperative & Mutual Insurance Federation) in Voice magazine, 2012

The Christchurch earthquake of 22 February last year claimed over 180 lives and destroyed large parts of New Zealand 's second largest city, including the historic Anglican cathedral. It has also had another consequence: the forced demutualisation of one of ICMIF's best-known member organisation. John Balmforth, ICMIF Chair who retired as CEO of AMI following the demutualisation, shares his experiences with Voice.

John Balmforth was at work at AMI's head office in Christchurch when the February 2011 earthquake struck. It was a Tuesday, just around lunchtime, and an ordinary working day in what was known in New Zealand as the Garden City. The quake, when it came at 12.51pm, was relatively modest in magnitude: just 6.3 on the Richter scale but close to the surface, significantly less powerful than the earthquake which had affected Christchurch the previous September. But the damage was great.

AMI's modern head office building, for example, was so badly affected that it has had to be demolished. In total, perhaps as many as 1200 buildings in Christchurch 's Central Business District were lost. The city which has been AMI's home since the insurer's formation in 1926 had lost much of its heart. And inevitably a large number of AMI's policyholders were directly affected, needing help and needing their claims met.

It would be fair to say that, from the moment the February 22 quake struck, John Balmforth's working life has been anything but ordinary. The last year has clearly been a time when his experience and leadership has been tested in ways which very few other CEOs will ever have to face, and it is to his credit that he has not only led AMI through this traumatic period but is also willing to talk honestly about the issues and problems with others in ICMIF. Whilst he would not wish what he calls his 'black swan' event on anyone else, he knows that what he has gone through is of enormous interest and value for other mutual and cooperative insurers.

Any account of recent history should perhaps begin at the start of September 2010, just before the first big earthquake to hit Christchurch on 4 September. “Prior to 4th September 2010, AMI would have been regarded as the best performing insurance company in New Zealand ,” John says. “As a direct personal lines insurer we had great customer care, good profitability and a good return on equity.” It also had a strong balance sheet: although at that time New Zealand did not have mandatory capital requirements in place, AMI met the draft regulatory capital requirements t four or five times over. It was also covered by reinsurance, designed to meet a once-in-a-thousand-year event.

AMI, because of its historic links, has had a strong customer base in Christchurch . About one in three insured residential properties in the city were covered through the company, but John points out that AMI's exposure there, although significant, was nevertheless only about 18% of its national exposure. The company's risks, in other words, were not rashly focused simply on one geographical location. Although the September event was expensive, leading to claims on AMI of around NZD 690m (USD 530m), the company had the ability to meet all the claims, helped by the NZD 600m reinsurance cover it had arranged. As would be expected, in the light of the earthquake AMI's senior management also reviewed its operations, its risk profile, and its reinsurance requirements. Helpfully, AMI had a short time earlier invested in technology which enabled it to map in detail the location of every insured property. “We were able to plot everyone of our insured risks in Christchurch within three days of the September quake. This was a capability we had only had since the previous July. Previously we wouldn't have the capability to so precisely indentify our risks so quickly..”

In other words, by early last year, AMI was successfully coping with the aftermath of a major catastrophe. Indeed, if the exceptional claims from the earthquake were taken out of the picture, AMI was operating more profitably than ever before.

And then came the earthquake of February 22 nd . This was the quake which nobody was expecting: although New Zealand is highly at risk from seismic activity, most New Zealanders had thought that the capital city of Wellington , not Christchurch , was the city which was most at risk from a major event. The fault lines which caused the Christchurch earthquakes had not previously been identified.

In the immediate aftermath, John Balmforth and his colleagues had to cope with a company which had lost its head office and several branch offices, and which now had to prepare for a rush of claims from its policyholders. There was also the need to try to look after AMI's own staff, many of whom had themselves suffered in the earthquake and were facing home difficulties as well as work pressures. But as an urgent priority John Balmforth also had to assess whether his company could meet the new claims – or whether it had, in fact, been pushed by the earthquake into insolvency.

In fact, the assessment was that the estimated claims from the string of earthquakes could be met. John Balmforth takes pride in the fact that no policyholders have suffered from the situation AMI found itself in. But nevertheless there was a significant problem.

“The irony is that we had the cash to meet the claims – but that this would absorb the capital we needed to meet the ongoing capital requirements,” John explains. And the situation was made more difficult by the fact that prudent management, supported by the actuarial assessment, of the total claims reserves, required an allowance of NZD 290m be provided as a contingency but in the process worsening the capital requirement shortfall. Other insurers in New Zealand , subsidiaries of proprietary insurers, were able to call on their parent companies for reinforcement, but AMI as a mutual was not in this position. John Balmforth and his Board took the decision in early March to approach the New Zealand government for a capital support facility of NZD 500m, and this was negotiated and publicly announced in early April.

The government capital facility was not, in fact, drawn down and was a commercial transaction on which AMI paid arrangement fees of NZD 15m. But it was this need for government capital back-up which led directly to AMI's demutualisation. The business was sold in April this year to the Insurance Australia Group for NZD 380m, with the earthquake claims excluded from the sale and transferred to a run-off business which the New Zealand government owns and controls.. John stepped down as CEO following the sale.

The demutualisation of AMI is the result of an exceptional circumstance considered as a once-in-2500-year event, but it nevertheless is a blow not just for John, his Board, staff and policyholders but for the wider mutual and cooperative sector. One question which naturally arises is whether mutuals and cooperatives can take steps to improve their access to capital facilities, were the AMI experience to be repeated in the future elsewhere.

John Balmforth says that the problem he faced was the shortage of time available for finding a solution. An IPO for equity capital would have taken too long to organise, for example. AMI is a general insurer not based on an affinity group, so it did not necessarily have the scope of approaching members for capital which other, affinity-based, mutuals might enjoy. In any event as with an IPO time was against such an approach..

Behind the scenes, ICMIF helped AMI in trying to identify whether there might be others in the sector prepared to step in. That this did not prove viable is testimony not to any lack of solidarity but rather to the economic realities of the moment: with Solvency II looming, many mutuals and cooperatives are having to give their priority to strengthening their own balance sheets. And John Balmforth knows too that the relative geographical isolation of New Zealand and small population size does not make it a natural strategic fit for European or American based operators.

AMI's demutualisation comes, however, just at a time when the broader issue of capital for cooperative and mutual business is on the agenda, in the run-up to the International Year of Co-operatives summit in Quebec in October. Attention has recently been focused on work undertaken by the Canadian cooperative academic Tom Webb, whose paper Co-operative Capital: What it is and why our world needs it (co-written with two colleagues) has called on the cooperative movement to develop new capital funding mechanisms, and to look again at whether the assets held globally by cooperative financial institutions can be invested more readily in cooperative business.

John Balmforth is not necessarily convinced that a major capital support facility for mutuals and cooperatives – even if it proved possible to create this - would work particularly effectively, and he is concerned that it could end up simply as a rescue fund called in to fire-fight when companies were in difficulties. But he suggests that, , one thing that mutual insurers might consider is to have a worked-out strategy for raising capital quickly from members, to be kept “in the back pocket” but available in case of need.

He points out that, for mutuals, reinsurance provides a way of accessing additional capital in situations of need. His own view of the importance of reinsurance has been strengthened by the Christchurch events. “You've got to take an ultra-conservative approach to the level of reinsurance. I always advocate that you should buy reinsurance to a requirement, not to a budget,” he says. AMI had in fact purchased it reinsurance to a modelled 1in 1,000 year event then an additional $100 million cover and increased its reinsurance dramatically after the February 2011 earthquake, to protect it should a third ‘black swan' ever land in New Zealand.

He recommends going beyond technical catastrophe modelling in assessing reinsurance needs. “Look at your highest concentration and lowest level of risk, and work back from that,” he says. “One thing ICMIF members can learn is: don't look at the obvious risks, look at the obscure risks. Ensure you understand the nature of your business, and particularly your exposure.”

He also advises a structured approach to claim handling. In AMI's case, the company ensured that the highest priority claims – those for example from old people or from those with special needs - had first attention. “If you have a priority system in place, and if you stick to it, you can defend yourself against criticism,” John says. Nevertheless, his experience was that there was still opportunity for misunderstandings with policyholders over their claims. He says that many customers were underinsured on their contents cover. Some policyholders who had lost their homes also had an unrealistic idea of the sort of cover for temporary accommodation they had taken out. Where possible, AMI tried to sort things out.

He also has some observations on operational areas. AMI had wisely restructured its IT operation about five years earlier, so that processing, back-ups and operating staff were spread across New Zealand and not located just in one place. It meant that the IT and telephone systems were robust enough to be able to survive the Christchurch earthquakes. But, as with reinsurance, John's advice on business continuity planning is to look not just at likely risks but at the least expected events.

Insurance is all about risk, and in AMI's case the cards fell out particularly unkindly. There are many ironies associated with its loss to the mutual and cooperative insurance movement, not least that AMI had deliberately adopted a conservative approach to risk management to protect its mutual and new Zealand ownership. Of course it had also positively used its mutuality to build a strong reputation for customer care, strengthening the brand which its new owners the Insurance Australia Group see as a significant benefit..

John Balmforth can take the credit for staying with his company right through to its sale, coping with all the demands which came his way in the year after the February 22 earthquake. ICMIF membersare particularly grateful that he has gone out of his way to share his experiences, in the accounts he has given at the Manchester conference last year and the MORO reinsurance event in Paris this May.

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