In praise of liability

Christchurch City Council helped ensure that a dozen people died last February. Ann Brower, who lectures at Lincoln, narrowly missed being one of them; she was the only survivor when an old dangerous building fell on top of the bus she was in. She catalogues the failures that led to her very close brush with death.

Regulatory failure at its most murderous made Colombo St run red that day. Responsibility falls at the feet of the building owners, Parliament, and most of all the Christchurch City Council.

In the Building Act 2004, Parliament encouraged and enabled, but failed to require, councils to enforce a minimum safety standard for known "earthquake prone" buildings.

Christchurch City Council chose a "passive" policy, of no strengthening requirements. Parliament failed to require, the council failed to enforce, and the owners failed to reinforce - in 1982, in 1991, in 2005, after September 2010, and after December 2010. For 30 years, the owners and the council did nothing.

On Day 1 of the hearing, the building owners blamed the council, for delaying demolition with the consent process. Council solicitors blamed the Resource Management Act, for requiring consents, and said they had no discretion in the matter.

Council's hands were tied, they said.

Yet, on September 14, 2010, a unanimous Parliament untied council's hands when it passed the Canterbury Earthquake Response and Recovery Act 2010. It gave the Crown power to amend or repeal any law, in the interest of public safety and earthquake recovery. Then they issued an order in council that expanded the situations in which council could demolish without consent. City council had the power.

...

The evidence, five centimetres thick, makes it searingly obvious that everyone knew what would happen. It was predicted but not prevented. It's not a case of trying, but failing, to protect public safety. Everyone failed to try, likely because neither council nor the owner bore the risk of deaths and injuries.

ACC bore the risks. I bear the scars. And 12 died. Under ACC, the government absorbs all liability, no matter who is at fault. So to the owners, safeguarding the building was all cost and no benefit. Since council failed to enforce building standards, why repair? Absorbing all liability creates a moral hazard. That's economist-speak for unwittingly encouraging risk by cheaply insuring against it. This rewards irresponsible behaviour by failing to penalise it.

The regulatory framework in place on February 22 forced taxpayers to subsidise risks that should have been borne by building owners and their insurers. Subsidies render unaffordably risky activities affordable, like repeatedly failing to reinforce an unreinforced brick building less than 200 kilometres from the Alpine Fault.

Without the taxpayers' subsidy of the risk through the no-fault ACC Act, many of the unreinforced masonry buildings would have been too expensive to insure, and the 12 who travel with me might still be alive. If there are to be subsidies, it is better to subsidise safety with public funding for earthquake strengthening than to subsidise risk.

I wonder to what extent other nested bits of regulations caused problems. I've often heard rumours about that some of Christchurch's charming deferred maintenance on older buildings stemmed from that getting consents to do any upgrading triggered requirements to bring older buildings up to newer code. And then this will interact with regulations on heritage buildings making any particular level of structural engineering upgrade far more expensive and time consuming. Small marginal upgrades that could have made small bits of difference for some buildings, if that's correct, then required owners to take on reasonably large upgrading costs. In worse cases, heritage regulations effectively barred earthquake strengthening altogether, although 603-13 Colombo was not on the Heritage Register. [Update below]

What's a way forward?

1. Require building owners to carry liability insurance for risks their buildings pose.
2. Establish Council funds, to which people would be invited to provide supplementary voluntary contributions, that would pay owners of buildings with heritage amenity value an annual subsidy for the positive contribution they make to the City. The burden of heritage preservation ought to fall on those enjoying the external benefits; that's best captured through payments by Council and voluntary contributions from high-demanders.
3. Abolish existing heritage protection legislation and fix the RMA - make it extremely easy for building owners to demolish or make safe their buildings. While CERA can stomp on RMA in Christchurch for the time being, I wonder how tough it is for an owner of an older Wellington building to get the permissions to fix it.

New Zealand building insurance markets seem relatively seized up; it could take a few years before private insurers are willing to start writing contracts on these risks. But that's no reason not to start the ball rolling. Announce this year that liability insurance will be required as of say 2018 and that the regs easing up on demolitions and building strengthening will be in place for 2015. That gives Councils a couple of years to start figuring out which buildings really merit subsidy and for owners to figure out whether their buildings are viable in a world in which they bear the risks of failure.

If the choice were between ACC and America's broken tort system, I pick ACC. But I'm not sure that we can't make improvements at the margin.

Full disclosure: Ann is a coauthor of Canterbury's Phil Meguire and, back before the earthquakes, sometimes joined us for drinks at Canterbury's Staff Club. I hope to be able to buy her a drink when the staff club is repaired and when she's again up for the trip out to Ilam.

Update: Ann emails:

Also it was a category 4 heritage building, meaning it was municipally (not regionally, nationally, internationally) significant and it was desirable (not important, very important, or essential) to keep it.  So under the city's own plan, they had the discretion to demolish without consent, even without resorting to the special powers granted by parliament.

Council staffers were far more rigid than the legislation required. Rigid structures collapse in earthquakes. We can't afford non-ductile Councils in earthquakeland. See also this excellent post from TheAntiplanner.

Dog days of summer... this time with data

Two nice bits of data came of the last round of dog panic.

Here's ACC:

There were 3,435 dog attacks reported to 72 New Zealand councils in 2001/2. From 1989 to 2001, there were 3119 hospitalizations and one fatality due to dog bites. In the year ending 2003, ACC received 8,677 claims for dog bites requiring medical attention. [1]

A recent New Zealand study of adults who made claims to ACC for dog bites found that 26 per cent of the bites occurred in a public place and 21 per cent occurred at home, with the remainder divided between other types of private property. [2] In this study, only 11.6 per cent of dogs were loose and unsupervised in a public place, although other studies have found higher levels than this. Territory defence was the most common reason for a dog to bite, followed by accidental bites due to pain or fear. Pure-bred dogs were responsible for 40 per cent of bites, mixed breeds for 27 per cent and the remainder unknown. The top fi ve pure-bred categories were German Shepherds (8%), Pit Bull Terriers (7%), Rottweillers (6%), Jack Russell Terriers (4%) and Labrador Retrievers (3%).

Here's the underlying survey data, though note that this is just on adult survey respondents; folks seem most outraged about attacks on kids.

As pit bull terriers are pretty uncommon and labs are very common, the conditional risk presented by pit bulls is pretty high, although that could easily be due to that scary people who like to abuse dogs and to intimidate people choose that breed; if that breed were banned, scary people would likely converge on another breed pretty quickly. Note also that a reasonable proportion of mixed breed attacks will likely involve Staffie-crosses.

If less than 12% of dog attacks involved dogs running loose, where ownership would be most difficult to pin down under a liability regime, that increases the likely feasibility of a strict liability plus insurance regime over alternatives.

More data: the Department of Internal Affairs's Dog Safety and Control Report:

Looking at dogs by breed and considering only those with more than 500 in the NDD, the highest rate of dangerous dog classifications are for the pure-bred American Pitbull Terrier with 1.9% of 3,469 classified as dangerous. Next are the cross-bred American Pitbull Terrier (1.4% of 3,258) and the Dogue de Bordeaux (1.2% of 599 dogs). All the remaining 126 breeds with 500 or more dogs in the NDD have a dangerous rate less than 1%.

In terms of actual numbers, the American Pit Bull Terrier pure-bred has the largest number (67) of dangerous dogs in the NDD, followed by the Staffordshire Bull Terrier (48), the American Pit Bull Terrier cross (46), the Labrador Retriever (43) and the German Shepherd (42). Some 352 breeds did not have any dogs classified as dangerous.

This all makes me more confident in my current heuristic: upweight the chances that a dog and its owner are dangerous if the dog is a Pit Bull. That gives no argument for banning Pit Bulls, as scary owners would shift into other dogs - a determined psycho could turn a German Shepherd into a scary attack dog fairly easily.

And in response to a couple of comments on a prior post: the point of a strict liability regime isn't to ensure compensation to those bitten. It's to ensure that an actuarily fair premium is assessed on owners who are compelled to buy liability insurance as part of dog ownership so that owners who pose too great a risk are priced out of the market. But as liability insurance isn't even mandatory for car ownership, I'm less than optimistic about the chances for it in dog ownership.

HT on all of this: Wayne Heerdegen, who spent a bit of time at Treasury working on dog policy.

Insurance problems

Christchurch is going to have to face higher insurance costs for a while. Earthquake risk here is now revealed to be higher than we had previously expected. We're now less likely to get major quakes than we were a year and a half ago, but we're probably more likely to get them than we had expected we were as of a year and a half ago. And so the risk payment goes up not because the actual risk has increased but because we have better expectations of the real risk.

John Pagani argues for the nationalisation of AMI, the big Canterbury insurer that had to be bailed out when it was revealed to have insufficient re-insurance for the series of major Christchurch earthquakes. And he makes some reasonable arguments: if the government's going to be liable for bad outcomes, it ought to have some hand in making sure it doesn't happen again. And, he's right that there are moral hazard problems with the big private insurers perhaps banking on the potential for bailout; I know that I didn't worry about checking into AMI's asset and risk structure because they had so substantial a Canterbury presence that, even if they tanked in an earthquake, there was no way the government would fail to bail them out.

But I'm not sure what problem nationalization solves. You can make a good case for that companies with exposure to concentrated correlated risks buy more reinsurance than those having a diversified customer base, and that regulations could be tighter around that. But whether AMI is private or public, it will still have to buy reinsurance on the global reinsurance market. And if that market has seized up, I'm not sure how changes in AMI's public or private status affects things.

I remain a bit perplexed about why people can't get new policies. You can't insure against a certain risk, but if the risk of another February hitting Christchurch is around 5%, you'd think reinsurers would be happy enough to issue cover at a fairly high premium. Some potential explanations:

• Reinsurers fear being saddled with the costs of prior quakes in any new event if a full assessment of a property's prior damage hasn't been completed
• But then, why is there difficulty in getting coverage for new builds?
• Uncertainty over what portion of future claims will be covered by EQC if the EQC fund is exhausted,
• But then, wouldn't we expect solution through better insurance contracts? 
• Reputational costs of actuarially fair pricing would swamp potential returns
• But reputation accrues mostly to the local agent, not the big reinsurer; for those, reputation is determined, I would have thought, by track record in paying out.

I think we need a fair bit better understanding of what's going on before we start nationalizing insurance companies. 

Killing downtown

Regulatory uncertainty, delays in building approval, the central city cordon, lack of information about future building codes, and insurance delays really aren't helping prospects for a downtown recovery in Christchurch. Recall that somewhere around 60% of downtown buildings are being torn down and nobody in Christchurch gets any access to downtown while the demolitions continue; the cordon's not expected to come down entirely for rather a while. In yesterday's Press:

On Friday, the 14-storey Westpac building on Cashel St was approved for demolition, the last of Miles Middleton's four central Christchurch high-rises to be be pulled down because of quake damage. Middleton said he wanted to rebuild in central Christchurch, but without changes to the seven-storey height restrictions in the draft central city plan, he would be forced to take his insurance money to Auckland or even Brisbane.

"A lot of people that were keen to rebuild here have gone cold," he said. "I would love to rebuild here but at the end of the day I don't want to go broke."
...
Christchurch developer Ernest Duval, who fronts the CBD property group Core, said insurance money was already draining out of the central city, with owners who had been without tenants since the September 4 quake the first to look elsewhere to invest. "The simple solution for many property owners is to take their money elsewhere to restore their income stream," he said.

Most central Christchurch property owners were not developers and would rather buy a building in Auckland than grapple with a consents hearing, tougher building standards and the ongoing shadow of possible Government intervention in Christchurch, he said. Others simply could not afford to wait until the central city reopened in April next year, Duval said.

I don't entirely buy that delays of a up to a year wind up being the critical issue; if Christchurch's downtown is likely to be viable, I would have thought that developers could have thrown insurance money into bonds or term deposits while waiting to rebuild. But more plausible is that the set of restrictions and uncertainty just makes Christchurch a less attractive investment option; the added delays then help tip folks to take their investment elsewhere.

One bit of slightly good news:

Christchurch City Council has moved to douse concerns about the draft plan. At a meeting with property owners this month, council strategy and planning general manager Mike Theelen said owners of multi-storey building would retain the rights to rebuild to the same height. Theelen was unavailable for comment at time of print.

Two problems with this though.

First, if the grandfathered right is restricted to the location of the former building, we have the somewhat perverse result that you can only build really tall buildings in the places where really tall buildings did really poorly during the earthquake. Sure, we can fix some of that with better site compaction and stronger and deeper foundations. But if tall buildings are a bad thing due to earthquake risk, requiring that they be built in the place where old ones fell over seems a bit odd.

Second, if the right stays with the owner but isn't site-specific, why oughtn't we just let anybody who wants to risk his own money building a tall building that meets code go ahead and do it? I can get that we want to compensate those from whom Council has confiscated wealth through regulations barring that they replace a building with one of like quality, but if we're doing that by letting folks rebuild rather than giving them cash, it kinda suggests that there isn't any great reason for the six story building limit (or seven if you're green enough!).

Meanwhile, Labour's proposed an earthquake recovery policy [unconstrained by any prospect of forming government] that includes this bit:

"Under Labour's plan to acquire 1500 sections, the cost of buying and readying the land for rebuilding will be recovered when it is on-sold to Red Zone residents who have been paid out from the Canterbury Recovery Fund.

"We will do this at cost to keep the price low so as many residents as possible can make a fresh start without suffering extreme financial hardship.

"It is expected our plan will act as a signal to the market and help keep property prices reasonable in other areas.

"We will not rule out using the Canterbury Earthquake Recovery Act to purchase land in the face of any evidence of price gouging by developers if that is needed to ensure a fair price is sought and paid."

Ok. The main constraint keeping land prices up is the supply constraint stopping people on the edge of town from subdividing. There's plenty of land within reasonable driving distance of downtown that could be opened up for Red Zone residents if only the land were zoned for denser residential use. Wouldn't it make more sense to get rid of a regulatory barrier to building than to have government purchases help to bid up the price of inelastically supplied sections? And I can't see how it's helpful to threaten losses on developers working to build new houses for folks in the Red Zone by promising to intervene in property markets if prices don't meet Labour's standard of fairness.

Labour also promises that the insurance standoff would be resolved: insurers won't take on new policies in Christchurch, partially because, as I understand things, the reinsurers won't touch new policies until the aftershocks ease off. I really wish I knew more about what's breaking insurance markets currently. I can believe that an actuarily fair premium right now would be very high for the next few months and that some reinsurers would sooner delay than be viewed as profiteers. I'd expected that some uncertainty had been resolved by the recent court decision finding that EQC takes the first $100k of all earthquake claims on a property rather than of the cumulative total damage to the property. But that's not yet seemed to open up the insurance markets.

An odd kind of insurance

Sometimes, it's hard to tell the difference between insurance and lotto.

Recall that the general point of insurance is to equalize utility across world-states. So you forgo some utility in the good state of the world by spending money on insurance so that you get some bonus utility in a bad state of the world. Yeah, yeah, this requires that the marginal utility of money not get out of whack across the two world-states; if you don't get many jollies from money in the bad state of the world, this doesn't work. But let's hold that constant for this case.

A Manitoba pool and hot-tub company took out a weather insurance policy such that if temperatures hit more than 34.5 degrees Celsius on 18 July, they'd get a big payout. They then told customers that if the temperature hit 34.5 degrees, they'd get a full refund on any pool, hot tub, or water heater they bought between 1 March and 4 July this year.

In March, the owners of North West Wholesale -- a pool and hot-tub company -- took an insurance policy on the weather. This means, if temperatures reach more than 34.5 C at the Richardson International Airport today, people who bought either a pool, hot tub or water heater from the company between March 1 and July 4 will be eligible for a full rebate.


People may have scoffed at the store owners back in March on the gamble they took, but some 80 customers may be laughing their way to the bank, as Environment Canada is predicting a 35 C high for this afternoon.
...

But chances may have been better for Tuesday's weather, as Environment Canada predicts temperatures could be much higher in Winnipeg and southern Manitoba.

The projected high is 37 C, which will most likely prompt the weather agency to issue a humidex advisory, said Environment Canada meteorologist Eric Dykes. 

(HT: Mom)

Today's temperature at the airport reached 33 degrees (link valid 18 July but probably just gives current day's temperatures thereafter), so the insurance event wasn't triggered.

But if I were sinking a pile of money in a pool, I'd want the refund if the weather turned out too cold to use the darn thing rather than in the state of the world in which I'm very happy with my purchase. And so it seems more like lotto than insurance for the customers.

Seriously... daytime highs of -20 in winter (night-time lows of -40); +33 in summer. Winnipeg's only really liveable for five weeks around May-June and another five weeks mid-September through mid-October. The other 42, unliveable. And then there are the mosquitoes. On the upside, I don't think they've ever had an earthquake. Floods, often. Tornadoes, rarely. But never an earthquake.

Christchurch insurance

American readers may be surprised that we in NZ have been able to insure against earthquake damage. But all insurance comes with fine print.

When we decided to buy a house back in 2005, insurance was one of the first things on our minds; we wanted a place near the beach and tsunami risks were salient. After a lengthy phone call with our home contents insurer, AMI, we found that while full replacement cover would cover the rebuilding of our house in case of disaster, it wouldn't cover us were the land itself to disappear. The buildings are insured, but the land itself is not. AMI would build us a house of similar size and quality were the Brighton and SouthShore spit to disappear, but we'd have to buy the land on which to build it.

We consequently consulted with a geologist about the best spot to buy conditional on wanting to be near the beach; she warned us against being too close to the Estuary as a substantial tsunami risk came from the backwash after the initial wave. She circled the general neighbourhood that seemed least risky. So we bought our place on about a meter and a half rise from the road and protected from the Estuary by a park and school on the other side of the road; we comforted ourselves with that if anything serious enough to wash away the sand spit on which we live ever happened, the government wouldn't be able to constrain itself against bailing out folks who lost their land.

And now the worst's happened, but not for us. We're in the green zone where houses are damaged but the ground is fine. I have no clue how long it will take for the Earthquake Commission (who cover the first $100k damage to the house) and AMI (who will cover damage to the fences, pool, sidewalk and drive) to assess the damage and provide a quote, but eventually the house ought to be made right.

The government is, as expected, bailing out folks whose land can't be salvaged by providing two options. The government will either buy out the property at its 2007 assessed value (the last property tax assessment), or will buy out the land and let the owner deal with the insurance company for the house. Honestly, if somebody offered me the 2007 value of our house right now, I'd be tempted even though I hate moving and love our house; property values have dropped since then. There are more than a few folks who have wound up in a bit of a bad spot though: while the government has declared their land as non-remediable, their insurers say the house is repairable and so will only pay enough to cover repair rather than rebuilding costs. They could take Option 1, but that may not be sufficient to rebuild or buy elsewhere; if assessed section value is low relative to capital improvements, Option 2 can be a problem.

We'd always figured that, worst come to worst, we'd suffer uninsured losses on the section.

In other insurance news, the national government has become the insurer for quake-affected city councils; insurers aren't keen on providing coverage where the risks are as high as here. I wonder whether some kind of conditional bond issue could work. The government could put out a bond issue that would see the principal value of the bond cut in response to specified events, then auction off the bonds on the international market. It wouldn't be a cheap way of insuring, but it would be interesting to see how the markets would price those risks. How much would you pay for a New Zealand bond promising $100 in three years if no further earthquakes of magnitude 6.0 or up in Christchurch, but whose face value would drop $5 for each tenth of a point on the Richter Scale above 6 for any further events?

Minimising liabilities

What's an earthquake event, for insurance purposes?

New Zealand's Earthquake Commission, EQC, is funded by a check-off on property insurance and covers the first $100k of property damage subsequent to an event. September, Boxing Day, February, and this past week's earthquakes all counted as separate events for EQC purposes, each with its own three month deadline for filing claims.

But what happens if EQC's assessor is slow in checking up on your property so the assessor can't tell how much damage was due to each of the events? EQC argues that the assessment then becomes the event: the first $100k of property damage on an assessment falls on EQC, with the rest going to the private insurer. EQC and the insurance companies are seeking a declaratory judgment.

And there is some sense to this. Our place was inspected post-September but we never received a quote from EQC on their estimate of the damage cost, and so we were never able to book in with a builder to get things fixed. Once EQC's assessors get around to us, hopefully before this coming September, there's no way they'll be able to tell how much damage is due separately to Boxing Day, February, or this weekend's major earthquake (for folks abroad: the city just keeps rocking). But there have been 12 separate events. If private insurers argued that damage were spread evenly across all twelve events, EQC would be on the hook for all damages - $1.2 million per home, well in excess of the "bowl it over and build new" cost for the vast majority.

On the other side, if EQC can minimise its liabilities by lumping a whole pile of separately damaging earthquakes into one event, EQC's foot-dragging in getting assessments out makes more sense. Again, using our place as example: damages from September's quake were pretty minor as we're over on the east side of town; Boxing Day provided no new damage; February was far worse for us. Our housesitter (who was also our housesitter for the Boxing Day quake) informs me that the house is currently a mess of broken glass and that the cracks in the internal wall plaster are rather worse than they've been since February. EQC footdragging then lets them count all the earthquakes against the same $100k cap, with any excess costs then falling on AMI.

Meanwhile, nothing gets rebuilt. In some cases, that's efficient; fixing cosmetic damage like plaster cracking probably doesn't make sense if the next damned earthquake will just undo everything. But each bit of structural damage that doesn't get fixed because of foot-dragging makes the next quake's damage worse. Will be interesting to see what's waiting for us on our return.