The Big Jolt

Dominating the news since Saturday morning has been the devastating earthquake that struck Christchurch. Our thoughts are with all those people and businesses that have suffered a horrific disruption to their lives. On a disaster of this scale, the disruption could continue for many weeks. There will also be a lot of emotional damage to work through.

Earthquakes and floods cause massive damage world wide. Normally we see earthquake images from largely undeveloped countries. Invariably this is also associated with the tragic loss of thousands of lives. Contrast this to developed countries such as New Zealand, and a number of years ago in Californiawhere freeway over bridges collapsed, yet there are seldom any related deaths. Perhaps the odd heart attack, but few deaths from crushing as buildings collapse. The differences are usually associated with standards imposed by central and local government for construction and engineering. In other words we pay for a large measure of protection from events like earthquakes as part of the construction cost. We also have standards to retrofit historical buildings to similar earthquake safety levels.

Canterburyproperty investors may be facing financial problems as a consequence of the earthquake. While their properties are uninhabitable they are unlikely to receive any rental income from their tenants. Those property owners who opted for an extension under their house policy to cover loss of rents will most likely be covered. This optional extension is a low cost investment of around $100 per annum. Tenants who had contents insurance policies should also be covered for alternative accommodation costs.

One investment principle is to diversify your investments. Having, for example, four rental properties in the same area provides minimal diversification in the case of earthquakes. If one gets severely damaged the chances are that some of the others will also be damaged. Recently it was reported that listed company Goodman Properties had around $190M of its property portfolio in Canterbury. It appears that few of their properties had any significant damage, and it would probably be business as usual for the tenants. The situation would probably have been a lot worse if their properties were old.

The share market seemed to take the earthquake in its stride. In fact, it appeared to be positive for a number of stocks, particularly those associated with the construction and infrastructure sector. Of course the earthquake was negative for insurers. This may have been an over reaction, as the insurers invariably have reinsurance cover themselves, meaning that they may only have a minor exposure. In the case of Tower its exposure is capped at $5M which equates to 0.7 cents per share. IAG which owns State Insurance has no exposure as the claim costs will be totally covered by reinsurance arrangements. However losses from subsequent events in 2010 would be capped to AUD$175 M.

There will be a lot of uninsured properties.  People choose to be uninsured for a number of reasons. Those properties with mortgages on them usually have to be fully insured. Some people may not be able to afford insurance cover, whereas others make a deliberate choice to self insure. This is where the government faces a moral dilemma. Why should the tax payer provide cover for the uninsured? Philosophically choosing to be uninsured is similar to choosing not to be vaccinated against a number of serious illnesses. The difference is that the tax payer effectively pays for your medical treatment if you suffer an illness that you could have been vaccinated against at minimal cost.

We live and invest in a society where we know that there are risks and that outcomes may not be a good as one would hope. However we have choices to make. One of the choices is to protect your assets in order to reduce risk. Diversification and insurance are effective tools to reduce risk.