Chapter 5
Responses from insurers and regulators
5.1
The main responses in submissions by insurers and regulators were:
- privatised last resort insurance has delivered consumer
protection at an economical, and still declining cost;
- complaints that the market is not competitive, and insurance is
too hard to get, may have had substance in 2001-02, after the collapse of HIH,
but this is no longer the case;
- financial assessment by insurers imposes a worthwhile discipline
on builders and has improved builders' capital adequacy, to the benefit of
consumers.
The value of the insurance to consumers
5.2
A number of consumer submissions made complaints against insurers
- mainly for denying claims, or (in the submitter's belief) offering
insufficient payment or drawing out legal proceedings in a tactical way. Where
these complaints named Vero, the committee invited Vero's reply and Vero
responded in detail. For example, in one case, according to Vero:
Most of the delays were caused by the fact that Ms xxxxxxx’s claim
appeared to be substantially higher than could be justified by the facts of the
case and her failure, despite being represented, to comply with orders and
directions made by the CTTT.... Neither she nor the other homeowners would have
been better off under an alternative scheme. In an optional scheme it is likely
they would have recovered nothing. In the first resort scheme the same outcome
would have occurred. There would still be the potential for disagreement and
the need for resolution of issues of quantum.[1]
5.3
On the claim, occasionally made, that insurers use court
proceedings to wear applicants down, Vero commented:
Less than 10% of claims Vero handle involve a tribunal or court.
Sometimes that is the only way to resolve the detailed technical issues that
arise. But to suggest that Vero adopts this as a deliberate strategy to wear
claimants down (irrespective of the merits or complexity of the claim) is
preposterous and denies the indisputable fact that valid claims settled early
and effectively always cost an insurer less than claims involving lawyers and
courts.[2]
Committee comment
5.4
Some submissions seemed to imply that complaints of this sort
arise from the toughness of the profit-motivated private insurer, and would not
arise in a government scheme. This is not necessarily so. The possibility of
disagreement about whether work is defective, or about the cost of
rectification, exists in either case. A government insurer also has a duty not
to pay more than is fair on claims.
The cost of home warranty insurance
5.5
The builder buys the insurance and passes on the cost to the
consumer; so if price was a cause of complaint it would be for the consumer to
complain. In fact the price of the insurance was not a significant issue in
consumer complaints. Price comparisons between NSW/Victoria and Queensland were
argued by those who support or oppose the two systems primarily for other
reasons, each trying to use arguments about price as another string to their
bow.
5.6
The Housing Industry Association provided this comparison of
premiums, showing that for a median value new house in NSW and Victoria
premiums are around $3 per thousand dollars of project; in Queensland, $7.57:
|
Home Owners Warranty
Insurance as percentage of new home price
|
|
|
|
2002
|
2003
|
2004
|
2005
|
2006
|
2007
|
|
Sydney
|
median new house construction
price1
|
$179,067
|
$192,167
|
$240,423
|
$240,125
|
$246,041
|
$265,433
|
|
|
HOWI premium inc. govt
charges2
|
$1,136
|
$1,496
|
$1,491
|
$1,385
|
$953
|
$796
|
|
|
HOWI % of new house price
|
0.634
|
0.778
|
0.620
|
0.577
|
0.387
|
0.3
|
|
|
HOWI % increase over the
period
|
|
24.06
|
-0.34
|
-7.65
|
-45.33
|
-19.72
|
|
Melbourne
|
median new house construction
price1
|
$165,969
|
$184,070
|
$200,987
|
$203,431
|
$219,671
|
$232,649
|
|
|
HOWI premium inc. govt
charges2
|
$837
|
$894
|
$973
|
$918
|
$779
|
$661
|
|
|
HOWI % of new house price
|
0.504
|
0.486
|
0.484
|
0.451
|
0.355
|
0.284
|
|
|
HOWI % increase over the
period
|
|
6
|
8
|
-6
|
-18
|
-18
|
|
Brisbane
|
median new house construction
price1
|
$146,340
|
$168,435
|
$199,255
|
$209,931
|
$222,873
|
$236,365
|
|
|
HOWI premium BSA3
|
|
|
|
$1,240
|
$1,692
|
$1,789
|
|
|
HOWI % of new house price
|
|
|
|
0.591
|
0.759
|
0.757
|
|
|
HOWI % increase over the
period
|
|
|
|
|
26.71
|
5.42
|
|
1. Based on unpublished ABS building
approvals data
|
|
2. Premiums taken from
industry insurer
|
|
3. Taken from warranty
premiums charged by the QBSA
|
|
source: Housing Industry
Association, submission 60, p.5
|
5.7
The NSW Office of Fair Trading (OFT) publishes reports on its HWI
scheme including premium and claims information supplied by insurers. According
to the latest report, in NSW in the March 2008 quarter average premium per
project certificate including charges was $723, and average premium per
thousand dollars of project value was $3.60 for new single dwellings and $5.27
altogether. These figures have declined steadily since 2006.[3]
5.8
The Victorian government apparently does not know what premiums
are in Victoria, which is regrettable. It said 'it is understood that Victorian
premiums are on average less than those in Queensland.'[4]
5.9
Vero said that 'Queensland average premium financial year 2006/07
was $688 (a 22 per cent increase on the previous year) and trending up; compare
NSW calendar year 2007 of $639 (premium including charges) and trending down'.[5]
5.10
Vero is the largest HWI insurer.[6]
Vero gave the committee confidential information about its own average premiums
in recent years. Its figures are not the same as but are broadly consistent
with the figures above.[7]
5.11
Against this, the Builders Collective of Australia provided Vero
2007 rate cards which appear to show much higher premiums: for example, a
'standard premium' of $2,029 for contract value $250-300,000 (single dwelling,
category 1 (least risky) builder).[8]
5.12
These rate cards do demonstrate some inconsistency in the
comparative cost of premiums by state as provided in evidence to the committee.
It may be that the cards are intended as a guide rather than a firm quote, and
are subject to negotiation in the individual case. These rate cards are
contradicted by the weight of other evidence which the committee has no reason
to doubt.
5.13
The Builders Collective also claimed that 97 per cent builders
are in category 3 (more risky, higher premiums). Vero advised that about 30 per
cent of its builders are in category 1 and 30 per cent in category 2.[9]
Availability of insurance
5.14
Five insurers now offer home warranty insurance, and all
insurance is mediated by brokers. Those supporting the last resort system argue
that falling prices demonstrate the increasing competitiveness of the market.
5.15
Dr Silberberg of the HIA said that home warranty insurance has
'fallen off the radar' as an issue for most builders:
We survey our members regularly and we have in excess of 40,000.
We ask them what are the issues that occupy their minds, that keep them awake
at night. Home warranty has dropped off the radar. For many builders it is a
past issue....[10]
5.16
In response to criticisms that the demand for deeds of indemnity
or bank guarantees prevents builders from entering the market, Vero advised
that its use of formal security 'has never exceeded 10% of builders with HWI
eligibility and the current proportion is closer to 5%':
The Builders Collective suggest that, after the collapse of HIH
and withdrawal of Dexta, Vero “took advantage” of the situation by applying a
general policy that all builders must provide guarantees. This is not true. Guarantees
and securities have always been used as a selective tool to underpin the eligibility
requirements of builders and are often required of builders who have chosen to hold
assets outside of the building entity by using trusts. At no stage has Vero's
use of formal security ever exceeded 10% of builders with HWI eligibility and
the current proportion is closer to 5%....[11]
5.17
Vero said in 2005 that 'security is only required if a builder
does not meet the minimum financial tests of soundness such as holding net
assets of 10 per cent of annual turnover.'[12]
Vero told this committee it 'does not support the underwriting of trust
structures without formal security from the beneficiaries as the structures are
primarily designed to protect assets from attachment by creditors, including
homeowners.'
Our ability to pursue the builder [personally] is a vital aspect
of all HWI schemes, including first resort schemes. Without it, builders are
more likely to hide behind “phoenix" companies or simply walk away from
their contractual responsibilities.[13]
5.18
Vero advised that recoveries from builders have never exceeded
5-6 per cent of claims paid.[14]
5.19
On the cost of a bank guarantee to the builder, Vero said: 'Many
builders prefer this option rather than face the tax/trust complications
associated with boosting their balance sheets/ changing their business
structure.'[15]
To use an example: If a builder’s turnover is $2million p.a.,
the bank guarantee is for 10% of turnover or $200,000, and the fee is 2.0% of
the security or $4,000. At an average contract value of $160,000, the number of
contracts in a year would be approximately 12.5 and the cost of the bank
facility, spread across these contracts, would be $320 each. Set against the
opportunity cost of tying up $200,000 in net assets, the price is not onerous.
It is often the reason why builders choose to use securities.[16]
Financial assessment by insurers is of benefit to consumers
5.20
The Insurance Council of Australia argued that the insurer's role
in scrutinising builder applicants is beneficial for the consumer:
A key benefit for consumers of privatised home warranty schemes
is that the initial eligibility assessment process aims to allow only
technically competent and financially sound builders to operate.[17]
5.21
Vero argued that it is not unreasonable for insurers to have this
role:
Licensing [by government] concentrates on technical ability,
transferring the assessment of financial and business risk to those better
placed, ie insurers.[18]
Claims that insurers are making excessive profits
5.22
It was sometimes suggested that insurers are making excessive
profits from home warranty insurance.[19]
This would presumably be because of lack of competition. It was sometimes
implied that this is enabled because (allegedly) home warranty insurance is
exempt from some APRA oversight that applies to other insurances (in fact this
is not true, as discussed in chapter 7).[20]
5.23
In reply supporters of current last resort arrangements argued
that with five insurers currently selling home warranty insurance the market is
competitive, and this has led to declining prices and better value for
homeowners.[21]
5.24
According to the reports of the NSW Office of Fair Trading
(OFT), in recent years average premium including charges per thousand dollars
of project value has been declining (for a new single dwelling, from $4.97 in
June 2006 to $3.60 in March 2008.[22]
On the state of competition the latest OFT report says:
As at 31 March 2008 there were five groups of licensed insurers
providing home warranty insurance in New South Wales. There appears to be
competition among insurers with no one group having more than a 40% market
share in providing cover for builders (in terms of reported total written
premium including charges) and with each of the other groups holding between
10% and 20% of the market.[23]
5.25
The OFT reports do not show the full history of premium revenue
since the present scheme started on 1 July 2002. Since June 2006 the premium
written per quarter has trended down from $13.9 million to under $9.7 million
including charges; from $11.1 million to $7.3 million excluding charges (the
latter figure is the amount retained by the insurer for claims, expenses and
profit).[24]
5.26
In relation to project certificates issued since 1 July 2002, the total claims payment to the end of 2007 has been $16 million, and
insurers estimate a further $7 million payments in respect of claims already
accepted.[25]
5.27
These figures do not include claims yet to be made. The NSW OFT
stressed that because of the long-tail nature of the insurance (cover lasts for
six years after completion, and claims may be on foot for up to ten years) it
is not possible to draw conclusions about profitability from the information to
date:
Premium collected in 2002 could still be drawn down by claims
made this year. As a result of this characteristic of the scheme, the fact is
that we do not know the true profitability of the written premium in 2002 and
will not until at least the end of 2009 or possibly 2010.[26]
5.28
While the profile of claims development over time in the past may
be a guide, it is not a reliable one, as claims vary with the business cycle:
insolvencies will be more common when there is a slow down in the building
industry. The long period of cover exacerbates the uncertainty:
One of the main consequences of long tail lines of business is
that deteriorations in claims experience can take some years to materialise
and, if they are not properly monitored, can have a sizeable impact on the
feasibility of the scheme. For example, if reserves were built up at a 60% loss
ratio for 4 years and it was then discovered that the underlying loss ratio was
85%, then the best part of a full year's premium would be required to be added
to the reserves. This could have a devastating impact on the capital base
supporting the business.[27]
5.29
Vero gave the committee confidential information about its loss
ratio on home warranty insurance business over the last ten years. The loss
ratio is the ratio of claims expense to premium revenue, and is one of the key
measures of the profitability of insurance. A lower figure is a better result
for the insurer, with the proviso that in the case of long tail insurance the
trend over a number of years must be considered. A better result in later years
may be needed to pay for a worse result in earlier years.
5.30
Vero's pricing aims to achieve a predetermined loss ratio across
the business cycle in order to derive the required return on capital. Vero
commented that 'the 80 per cent figure that some have suggested is too high
given the credit and surety nature of this product and the front-end load of
resources needed to underwrite it.'[28]
5.31
Vero's results show very high loss ratios for claims from the 1997
to 2001 underwriting years (the year the policy was issued) - that is,
comparing premium revenue and claims expense within the year, the insurance was
very unprofitable. Loss ratios for the underwriting years 2002 onwards have
been lower. Vero commented that a significant proportion of the premium
collected during the underwriting years 2002 to 2006 was collected to pay for
prior years' claims:
Collecting premiums in later years to pay for losses from
earlier years is a typical action for long-tail classes when original
underwriting-year pricing proves insufficient. This is why the New South Wales
scheme data for the current version of that scheme shows a gap between premiums
generated and claims paid.... we are not really comparing applies with apples.[29]
5.32
Comparing with published APRA data on the public and product
liability insurance classes as a whole, from 2005 to 2007 Vero's net loss ratio
on home warranty insurance for those calendar (accident) years has been higher
(worse for the insurer) than all insurers' results for public and product
liability which, with HWI, forms part of the 'long tail' category of insurance.[30]
Committee comment
5.33
The information above does not suggest that there is overcharging
or lack of competition in the market for home warranty insurance.
Claims that commissions are excessive
5.34
It was sometimes claimed that excessive commissions are charged
for insurance:[31]
There were incredible 60 or 70 per cent commissions on these
policies which go back to various associations and agents.[32]
5.35
An example was given of a policy in Tasmania from 2003 which
showed agents' fees of $918.80.[33]
5.36
Home warranty insurance has always been sold through brokers
since it is 'a specialised commercial insurance product, with a relatively low
national premium pool, which lends itself to an intermediated distribution
model', according to the National Insurance Brokers Association (NIBA). About
250 brokers have business in HWI, and according to NIBA 'insurance brokers
compete aggressively in the market to obtain the business of builders'.[34]
5.37
Vero advised that it pays commissions to brokers of 7½ to 15 per
cent depending on the circumstances. Brokers perform the sales and policy
issuance function, and 'commission is a substitute in the large part for
management expenses...with some of the smaller brokers, where we have to do more
of the work, we pay less.'[35]
Vero advised that its average commission payment in the period 2003-2007 has
been about 10 per cent, and commissions are generally lower in HWI than in
other general insurance classes.[36]
5.38
HIA Insurance Services, the largest broker of home warranty
insurance, said it receives 'an average of 15 per cent brokerage from insurance
companies for this type of business.'[37]
5.39
The NSW Office of Fair Trading does not report commissions
separately, but lists total premium revenue with and without charges. 'Charges'
includes not only the commissions discussed above but also charges such as GST,
stamp duty, government levies and credit card surcharge reported by insurers.
Total premium in the March 2008 quarter was $7,337,000 excluding charges and
$9,767,000 - about one third more - including charges.[38]
5.40
The figures above refer to commissions charged by brokers to
insurers, which insurers pass on to the builders. Brokers may also may also
charge a fee directly to the builder. In the case of the HIA Insurance
Services:
The 15 per cent commission, frankly, is not sufficient to allow
us to make any profit—it costs us more to run the business than we get from
commissions—so we do charge fees to clients. So our remuneration comprises two
components: a commission of up to 15 per cent paid by insurance companies and a
broker service charge that we charge directly to the builder.[39]
5.41
These fees are not included in the 'charges' reported by the NSW
OFT, however 'based on information from insurers' the OFT believes that these
fees 'are understood generally to be a flat dollar amount per certificate
ranging from $50 to $400 depending on the volume of business of a particular
broker with a particular builder.'[40]
5.42
HIA Insurance Services' broker service charge to the builder
varies depending on the costs associated with handling the business of the
particular builder. HIAIS gave the committee confidentially figures on its
highest, lowest and average charge. Both the highest and lowest figures are
significantly lower than those suggested in the NSW Office of Fair Trading
reports. The average figure does not support claims that commissions are
excessive.[41]
5.43
On the case of the $918 agent's fee, Vero commented:
Tasmania’s owner-builder HWI regime is and always has been a
first resort scheme. The nature of this insurance is retrospective in that the
homes are already built and probably have been for some years. As a result,
owner-builder HWI in Tasmania requires a pre-insurance inspection; which is a
cost not normally needed for licensed builder HWI. The pre-insurance inspection
is in all probability reflected in the $900 fee that was characterised in the
evidence to the Committee as a commission.[42]
Committee comment
5.44
The committee accepts the evidence that commissions to brokers
are generally within normal industry margins.
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