Quake may cost insurers up to $US35bn

THE earthquake that devastated parts of northern Japan caused as much as $US35 billion ($34.5bn) in insured property losses, a figure that would mark Friday's quake as the costliest ever for the insurance industry even before the effects of the tsunami are factored in, according to a disaster-modelling company.

While the actual cost of the catastrophe will take months to become clear, Boston-based AIR Worldwide said today the quake alone caused insured property losses of $US15bn to $US35bn. If claims come in at the middle of that range, the cost of the disaster would surpass all other natural catastrophes besides 2005’s Hurricane Katrina.

Loss estimates from AIR and its rivals are closely watched by the insurance industry and by Wall Street to gauge potential losses for individual insurers.

No major companies have disclosed estimates of their own losses yet, but the size of AIR’s estimate will fuel conversations in the industry — already underway — about whether the quake will force an abrupt spike in the price of insurance and reinsurance.

Such a spike would be felt by businesses and homeowners in catastrophe-prone areas around the world, including Florida and California.

AIR’s loss estimate includes “insured shake and fire-following damage to onshore residential and commercial buildings and contents, and to properties in agricultural line of business,” but doesn’t include the potential increase in the cost of building supplies and other materials that often occurs after a disaster, AIR said.

The estimate doesn’t yet include estimates for the loss caused by the tsunami, the risk-modelling agency said.
But on Saturday, AIR said it had examined prefectures most directly affected by the tsunami, and concluded that $US24bn of insured property had sat within three kilometres of the shore in those areas. Of that amount, $US5bn was within one kilometre of the coast.

The company warned against adding its loss estimates to any outside estimates of tsunami damage provided by others, “as that would result in significant double counting”. AIR noted that “many of the properties destroyed by the tsunami first sustained damage from ground shaking and fire, as witnessed by videos of tsunami waves sweeping along entire buildings ablaze”.

AIR said it plans to independently estimate the loss caused by the tsunami, as more detailed information becomes available — including satellite photos from NASA of the flood extent–and provide a combined loss estimate that avoids double-counting in the affected areas.

There have been few reports about major structural damage in the Tokyo and Chiba prefectures, except for several serious fires. However, the risk-modelling agency cautioned that the high concentration of insured properties in the area and some quake impact felt means that “even relatively small individual claims will likely add up to significant numbers”.

Munich Re and Swiss Reinsurance, the world’s largest reinsurers by gross premium income, reiterated last night it was too early to provide estimates of their potential losses.
Smaller peer Hannover Re, and Allianz, Europe’s largest primary insurer by premium income, said the same. So did American International Group and Lloyd’s of London, Britain’s 322-year-old insurance and reinsurance market.

However high the insured losses run, total economic losses are likely to be significantly more.

Japanese homeowners and businesses have been reluctant to buy insurance to cover all of their potential losses because the cost of the protection has been perceived as too high.
AIR estimated about 10 per cent to 12 per cent of commercial property exposures are insured against earthquakes outside of Tokyo.

Reform could result in ‘huge cost savings’

DAWN Stocks wanted to change her $550,000 mortgage to another lender.

But she found the big problem was not the exit fees, but the $24,000 cost of paying a new round of mortgage insurance for the loan with the new provider.

Stocks is one of the many unhappy customers who have responded to the “Compare, ditch and switch” campaign being launched by consumer advocacy group Choice.

“I’m locked into my mortgage because I can’t afford to pay a new lender for more mortgage insurance,” she wrote on the Choice website this month.

While the market digests the package of measures announced by Wayne Swan on Sunday aimed at producing a more “competitive and sustainable banking system”, Choice is arguing that consumers should be on the front foot now, shopping around and comparing bank offerings and testing the market.

Richard Lloyd, director of Choice’s Better Banking Campaign, argues that one of the more potentially powerful changes flagged in the Treasurer’s package is not the end of mortgage exit fees, which is to come into force from July next year (parliament willing), or the review of bank account portability, but the fact the government has promised to look at ways to make mortgage insurance portable from lender to lender.

The Swan package has already been criticised for being more about the wrapping than the Christmas present, but Choice does see it as “a good starting point” for change, provided that the banks get on board and consumers themselves become more proactive.

“There are potentially huge savings in costs from these reforms,” says Lloyd.

“There is huge potential here for much more movement in the home loan market, as people start to question the value of their deal following the recent rate hikes. A recent poll suggests that there are more than a million borrowers who would like to change their mortgage over the next six to 12 months if it could be made easier.”

Lloyd argues that the government could move earlier with measures to make mortgage insurance more portable which, he says, would open up the market to more competitive pressure — not just for new loans taken out from July 1 as envisaged in the announcement.

It is clear that the real potential impact of the proposed changes will fall very differently on different age groups and bank customers.

Young people looking at new home loans and who are prepared to do their homework are more likely to benefit from an array of new deals, while older people who are coming to the end of their mortgage life and are traditionally less interested in switching banks will be less affected by the changes.

More worrying, however, could be the implications for the less financially literate, who are more dependant on personal loans and credit card advances, and small business owners, who may end up bearing the brunt of higher fees and charges as the banks seek to repackage those products, such as mortgages and deposit accounts, under the political spotlight, and lay off the costs elsewhere.

As Reserve Bank governor Glenn Stevens warned the banking inquiry, there is always the danger of “unintended consequences” of proposals to change the banking system.

The Swan package was put together in the heat of a highly politicised debate and released even before the Senate Standing Committee on Economics had a chance to hold its public hearings, which are now under way.

While Swan’s package in supposedly aimed at making the big banks more competitive, the sharemarket has already signalled that it believes the measures will put more pressure on the second-tier banks that are less able to absorb changes such as the abolition of exit fees.

In theory, the abolition of mortgage exit fees should save those mortgage holders who want to switch loans midstream anywhere from $600 to $7000 a loan.

Even if they don’t, the impact of the potential to shift mortgage providers more easily should put competitive pressure on banks to think twice about how much they put up their mortgage rates.

That said, expectations are that the banks will seek to recoup the lost exit fees with higher upfront fees for mortgages or in fees and charges elsewhere.

“The government has made its decision (on mortgage exit fees) and so be it,” says Stephen Munchenberg, chief executive of the Australian Bankers Association. “But our concern is that there are real costs (in setting up a new mortgage), and so far as exit fees do represent deferred costs upfront in establishing a mortgage, the banks will have to decide what they do about those costs.”

Michael Peters, business law lecturer at the Australian School of Business, is sceptical about the impact of the removal of exit fees.

“Will the removal of an exit fee of up to $1000 for a $300,000 loan change the world?” he said yesterday. “It’s fundamentally unlikely.

“There are laws and policies in place, but the market favours the big balance sheets (and big banks) and they will always dominate the financial markets.

“There will be a lot of catharsis going on, but don’t bank on any real changes.”

Peters argues that it would be better if the banks introduced a standard statutory term for home loans with no exit or establishment fees. This, he says, would allow for the evolution of a secondary market in home loans.

He says this could generate an opportunity for the smaller banks that would be able to offload their existing home loans and continue to make new ones.

On the face of it, the Swan package will help new borrowers with the advent of mandatory “key fact sheets”, which are supposed to provide how much they will pay each month and over the life of their loan and, according to the announcement, ‘where they can shop around so they can compare lenders side by side”.

That could be useful, but it will not take the onus from would-be borrowers making sure they are comparing like with like when they shop around.

Low-income customers, particularly in remote areas where there are few banks or ATMs, could also benefit from the review of ATM fees.

Swan has called on the Reserve Bank and Treasury to set up a task force to further monitor whether more action is needs to “boost competition and transparency on ATM fees”.

The Reserve Bank has already been monitoring ATM fees, introducing a number of significant reforms that came into effect in February last year, including the abolition of interchange fees and more disclosure of fees charged.

The RBA estimates that those reforms have already resulted in a reduction in fees paid by ATM consumers of about $120 million a year in their first year of operation and have also been followed by the addition of another 1500 ATMs around the country, increasing numbers by 6 per cent.

The Reserve Bank’s submission to the Senate Economics Committee inquiry into competition in the banking sector notes that the income from fees in the domestic banking sector has grown at an average rate of 10 per cent a year since 1997.

But it notes that the growth in fees has been significantly less than the growth in balance sheet assets since 2002. This has led to a decline in the ratio of fee income to assets from a peak of 1 per cent to close to 0.6 per cent last year.

The figures, from the RBA’s annual survey of bank fees published in June, show that in recent years the banks have reduced fees on the politically sensitive areas such as exception fees on deposit and transaction accounts for both business and personal customers.

But there had been an increase in other fees charged to business, particularly the fees on undrawn loan facilities.

The survey showed that fee income received by banks from households rose from $4.5 billion in 2007 to $5bn in 2009, while fee income from businesses rose from $6.2bn in 2007 to $7.6bn in 2009.

The annual growth rate on fees from households dropped from 8 per cent in 2007 to only 3 per cent in 2009, as the banks responded to consumer pressure, while the growth rate in fee income from business rose from 7 per cent in 2007 to 13 per cent in 2009.

The RBA survey also shows a shift in the nature of fees charged to householders, with a decreasing reliance on fees from bank deposits (in the wake of consumer scrutiny) and an increasing reliance on fees from personal loans and credit cards.

In the five years to 2008, fees from housing grew by an average of 7 per cent a year and fees from deposits grew by 6 per cent a year — while fees from personal loans grew by 11 per cent a year and fees from credit cards jumped by a significant 17 per cent a year.

The more fundamental change — if it ever happens — could be the move towards bank account portability. Swan has called on former Reserve Bank governor Bernie Fraser to do a feasibility study on whether bank customers could be moved from bank to bank in much the same way that mobile phone customers can now move to different service providers, keeping their original phone number.

If this were to happen, it would potentially affect all bank customers, making it easier for them to take their business elsewhere if they have a problem with their existing bank.

But early indications are that the technological costs in standardising bank account data between banks to facilitate portability could be prohibitively expensive.

Harry Senlitonga, a senior analyst with Datamonitor, says that only 5 per cent of Australian consumers switched their bank transaction accounts over the past year. He notes that there are substantial difficulties in changing bank accounts, including having to reorganise bank debits and deposits.

He notes that the reduction in transaction fees for deposit accounts also reduce the attraction of shifting to a new banker.

But he argues that making it easier to switch bank accounts will be a trigger for some customers to change accounts as it will “open their eyes wide to other products”.

But he argues the benefit in terms of actual fees saved by moving accounts with be small.

The ABA’s Munchenberg says the fear is that the cost of developing account number portability would “far outweigh” the benefits.

“There is a whole host of reasons why it is very complex. It is not like mobile phones where there is a standard approach to numbers,” Munchenberg says.

“But there are things which can be done to make it easier to move bank accounts and we are happy to talk to Bernie Fraser on how this might be done.”

As with the abolition of mortgage exit fees, Munchenberg also notes that the technological costs involving in standardising bank accounts for portability would also weigh heavier on smaller lenders than the big banks.

Deutsche Bank analyst James Freeman says the reform package was not as onerous on the major banks as expected.

“None of the highly mutual-friendly measures that had been canvassed by the press (wholesale guarantees for mutuals, risk weighting changes, franking credit proposals, Australia Post distribution) were included,” Freeman says. “In fact, many of the funding cost proposals will aid the major banks and potentially improve sector returns.

“Lack of distribution remains the single biggest impediment for mutuals and these proposals do nothing to change this.”

Disasters in 2010 cost insurers $38bn

NATURAL catastrophes and man-made disasters this year cost the global insurance industry $US36 billion ($38bn).

But the economic loss for society was much higher at $US222bn, Swiss Re said.

Severe catastrophes claimed significantly more lives this year than in 2009. Nearly 260,000 people died in these events, compared with 15,000 last year and the highest number since 1976. The deadliest event was the Haiti earthquake in January, which claimed more than 220,000 lives. Many people also died during the northern summer floods in China and Pakistan, and the northern summer heat wave in Russia.

The humanitarian catastrophes revealed large differences in how developed insurance systems are in affected countries, and how important insurance is in coping with the financial consequences of disaster, Swiss Re said.

“While most of the costliest events caused by the earthquakes in Chile and New Zealand and the winter storm in Western Europe were covered by insurance, events like the earthquake in Haiti and floods in Asia were barely insured,” said Thomas Hess, chief economist at Swiss Re.

Due to a comparably mild US hurricane season this year, losses for the worldwide insurance industry were in line with the 20-year average in 2010, although they did increase 34 per cent from 2009, Swiss Re said.

The relatively modest losses from catastrophes this year are a mixed blessing for insurers, particularly reinsurance companies like Swiss Re. The industry has been suffering from a so-called soft market for several years already, meaning that reinsurers are unable to increase prices, in part because demand for reinsurance is moderate.

Another factor is excess capital. In the absence of costly disasters, reinsurers can preserve capital, which results in stiffer competition and thus keeps a lid on prices.

Reinsurance companies act as insurers of last resort for primary insurers, typically stepping in to cover losses from large events like earthquakes, floods or man-made disasters.

The costliest event this year was the earthquake in Chile in February, which cost the insurance industry $US8bn, while the New Zealand earthquake in September cost insurers around $US2.7bn.

Property claims from the oil spill in the Gulf of Mexico are estimated at $US1bn, but the figure is subject to substantial uncertainty due to the complexity of claims. Liability losses aren’t included in these estimates.

Rate warning cites funding cost

THE Reserve Bank of Australia has told the nation's major banks not to raise interest rates outside the cycle.

The move comes because funding costs have started to stabilise and are unlikely to rise significantly in the year ahead.

In the quarterly Statement of Monetary Policy released yesterday, the RBA said that while wholesale funding was more expensive than before the global downturn, the current costs were at the same level as a year ago.

The central bank said that if current market conditions remained in place, the banks’ funding costs would rise by just 5 basis points in the next 18 months.

The forecast effectively dispels the banks’ constant argument that funding costs could force interest rate rises outside the official policy cycle.

“If bond spreads and hedging costs were to remain around their current levels, then as maturing bonds and hedges are rolled over, the average spread on banks’ outstanding bonds is estimated to increase by around 20 to 25 basis points by the end of 2011,” the RBA said. “Together with spreads on deposit and short-term wholesale funding around current levels, this would imply a rise in banks’ overall funding costs of around 5 basis points over the next 18 months.”

The RBA said the spread on major banks’ bonds was 25-50 basis points higher than the recent low in April but well below the peak in early 2009.

The competition among the major banks to attract deposits had also started to ease, the RBA said, which would relieve pressure on that source of funding. Some banks, led by Westpac, are offering up to 6 per cent on term deposits. However, the average rate for the banks is now down 40 points from February.

“The cost of deposits relative to the cash rate has been little changed since the beginning of the year,” the RBA said.

“Given deposits account for about one-half of the major banks’ overall debt funding liabilities, the cost of this funding source is particularly important in driving movements in overall funding costs. The banks continue to offer attractive rates on deposits, particularly term deposits, to attract this source of funding. The intensity of competition in the deposit market seems to have eased somewhat over the past few months.”

It also said the banks were able to ease the price of higher funding costs by jacking up some of their business lending rates.

“These pressures on funding costs are partially offset by banks continuing to reprice their business loans as facilities are rolled over,” the Reserve said.

“Average risk margins have been gradually increasing over the past couple of years.”

Wayne Swan has constantly warned the banks not to move their interest rates above the official moves by the RBA.

Despite the RBA’s funding forecasts, NAB this week said that it expected funding costs to continue to increase as older debt matured.

RBC Capital Markets senior economist Su-Lin Ong said it was a significant move by the RBA to emphasise that it believed funding costs would be relatively contained over the next year.

“This could well be a veiled warning to the banks that out-of-cycle hikes will be difficult to justify,” Ms Ong said.

Axa’s cost cuts prove profit winner

THE move by Axa Asia Pacific (APH) to slash costs heading into the global financial crisis and rebounding financial markets have paid dividends for the takeover target as it returned to profit in the past year.

The Melbourne-based group, the target of a $14.2 billion takeover from National Australia Bank that trumped an earlier bid from AMP, recovered from a $278.7 million loss in 2008 to record a $679.2m profit for the past year.

The profit surge was mainly due to the company cutting its corporate costs by 10 per cent and interest expenses by 19 per cent, as the financial downturn unfolded.

APH also benefited from the resurgent world financial markets, which boosted its overall investment earnings from a $537.7m loss to a $185.1m profit in 2009.

However, some analysts questioned the performance of the Australian operations of APH, which experienced a 25 per cent decline in earnings that the company blamed on volatile market conditions.

The earnings for the Australian assets, which NAB is specifically targeting, dropped 25 per cent to $176m. But the value of new business rose 41 per cent to $150.6m. The group also reduced its corporate gearing from 56 per cent to 27 per cent.

APH chief executive Andrew Penn gave little away on negotiations under way between APH, its French parent company Axa SA and NAB.

The potential NAB deal is reliant on Axa SA buying the lucrative Asian assets for about $9.1bn. The two parties have been locked in negotiation for the past fortnight.

The Asian business, not including Hong Kong, grew its operational earnings by 44 per cent to $50.2m and now has $5.16bn worth of funds under management.

The Hong Kong business experienced a 20 per cent increase in funds under management to $11.47bn.

“My focus very much has been business as usual,” Mr Penn said.

“I have continued to drive the business forward and focus on maximising shareholder wealth, that’s been my 100 per cent focus.”

Mr Penn said the relationship between the French and Australian operations remained strong.

“I sit on the global executive team and we have a very good relationship with the senior team,” Mr Penn said.

“Our team continues to operate.

“I have made the important point to our team that our business must continue as usual.”

Elio D’Amato, chief executive of Australian research house and fund manager Lincoln Indicators, said the “ho hum” performance of the Australian operations meant NAB and AMP might have to work harder to convince investors that taking over APH would contribute to their bottom line.

“Both AMP and NAB are probably going to have to do a stronger job convincing shareholders that the synergy benefits they are going to acquire through an acquisition are really going to do something to bump up the recent trend in the Axa APH business, which is really just going sideways,” Mr D’Amato said.

“Some might see it as favourable for NAB or AMP because if the operations were booming they might have to put in a higher offer. The recent run of increased offers may come to an end now.”

Mr Penn said the group’s move to slash costs had contributed to APH returning to profitability.

The company declared a final dividend of 9.25c a share, taking the full year distribution to an unchanged 18.5c.

APH shares rose 3c to $6.32.

Existing mortgages cost more

RESEARCH showing that banks charge their home-loan customers a higher variable rate than the average offered to new borrowers has ignited a controversy over the cost of switching mortgages.

The research, commissioned by The Australian from independent industry analysts brandmanagement, says the average variable rate offered to new borrowers is 5.24 per cent.

However, based on a survey of 4722 borrowers, brandmanagement says the four major banks charge their existing home-loan customers an average premium of 29 to 44 basis points.

The big four banks rejected the findings, which came on the eve of today’s Reserve Bank board meeting that is likely to leave the official cash rate at 3 per cent.

Commonwealth Bank’s head of mortgages Michael Cant said an examination of the bank’s mortgage book, worth more than $220billion, showed that the difference between the average variable rates offered to new and existing customers was “1-2 basis points”.

But he agreed that the actual premium paid by existing customers would be higher because brandmanagement excluded those on honeymoon rates and introductory offers. Distortions were also possible because some were unaware of the discounted rate they paid as part of a professional package.

A spokesman for Westpac said the bank was “puzzled” by the findings. So too were ANZ and National Australia Bank.

Banking analyst Brian Johnson, of stockbrokers CLSA, backed the survey results.

He said banks offered discounts of up to 75 basis points on their standard variable rates to new customers in their professional packages, but overall profitability was maintained through existing customers.

The gap was maintained by penalty fees and switching costs that were particularly punishing in the case of non-bank lenders.

Along with general customer apathy, the fees discouraged borrowers from seeking better deals.

The survey’s findings will intensify pressure on the federal government to address competition issues in the mortgage industry, where the big four have become unassailable. Melbourne Business School academic Joshua Gans, who petitioned the government in July for another financial system inquiry, said the survey confirmed there was healthy competition for new mortgage customers but not for those already tied to a bank.

“I think there is far more the government could be doing about this, and I’m sceptical of the banks’ claims that it’s all too hard,” Professor Gans said.

“There was an inquiry by the Australian Securities & Investments Commission into mortgage exit fees in April last year, and then the global financial crisis got in the way. The GFC is now over for Australia, and it’s time to start paying attention to competition in that sector.”

Financial Services Minister Chris Bowen said the government had taken steps to ensure greater competition in the banking sector.

But Nicole Rich, director of policy and campaigns at the Consumer Action Law Centre, said the government had failed to address the problem of mortgage exit fees.

Storm won’t cost houses: ANZ

ANZ Bank has publicly pledged that none of its customers will lose their homes as a result of the bank’s entanglement with Storm Financial.

The bank’s deputy chief executive Graham Hodges made the commitment at a hearing in Melbourne of the joint committee on corporations and financial services.

“Our intent is to ensure that no one loses their home over this,” Mr Hodges said.

ANZ last week followed the lead of Commonwealth Bank, admitting that its lending practices to Storm customers could have contributed to investor losses, which some estimates say could exceed $3 billion.

A two-month review by the bank reportedly revealed about 160 clients could have borrowed from ANZ to invest through Storm, of which 15 loans were identified as not complying with the relevant lending practices. The ANZ loans, each in a range of $100,000-$200,000, were made by two former bank employees at a Sunshine Coast branch.

A bank spokesman said the review found the lending was mainly by way of loans secured against property, as well as a small number of personal and business loans.

“Of these loans, we have determined that, in some cases, the lending decisions did not comply with ANZ’s current credit policies,” the spokesman said last week.

Meanwhile, the Australian Bankers’ Association, appearing yesterday before the Senate economics committee, said the banking industry would not have enough time to review and, where necessary, amend standard-form consumer contracts ahead of January’s start of the proposed unfair contracts regime.

Chief executive David Bell said the association wanted to postpone the starting date of the legislation until January 2011, so there was enough time to be fully compliant. The industry, he said, needed the extra time to undertake a proper transition, and the definition of unfair was also causing concern.

“It should be made clear in the existing definition that a term will be unfair only if causes material detriment to consumers, in accordance with the Productivity Commission’s recommended approach,” Mr Bell said.

“The definition of this term and others in the legislation is vague and needs to be clarified before the regime is introduced.”

To prepare for the law, banks have to review all their standard-form consumer contracts, which Mr Bell described as a “massive undertaking”.

He said this could not be achieved by the proposed starting date of January, which would leave banks and other businesses seriously exposed to the risk of litigation, as well as intervention by the regulator.

Banks were also facing changes to consumer credit and reform of personal property securities laws in the coming year.

This would require a complete review and amendments, where necessary, of credit contracts and security documentation.

Mr Bell said the banking industry could avoid substantial costs if changes required for compliance with unfair contracts legislation could be made in conjunction with changes for the new consumer credit regime.