The Institute, whose member actuaries work for insurers rating risks and setting premiums, notes that the lack of adequate insurance coverage for floods and/or its prohibitive cost, are key issues which must be addressed in any national funding solution.

“One positive outcome of the Queensland events is that flood has finally become a serious subject of debate after many years of being ‘out of sight, out of mind’ or ‘too hard,” according to Peter McCarthy, chairman of the Institute’s General Insurance Practice Committee.

“While flooding and severe rain events have always been common in Australia, compared to say, cyclones or earthquakes, getting insurance can be very difficult or prohibitively expensive. Furthermore, a distinction is often drawn by insurers between flood types, such as riverine versus storm, which can elude consumers,” Mr McCarthy said.

“The issues with flood are that, unlike other disasters, the same properties flood again and again, many high risk areas are known by residents, business owners, governments and insurers, and the scale of damage is greater than for other disasters,” Mr McCarthy said. Flood premiums insurers must charge to provide full flood cover are also extremely expensive. As a simple illustration, a $500,000 property which floods every 30 years may require a premium for flood of up to tens of thousands of dollars.”

The Institute believes that any national solution for flood must begin with an agreed policy goal and an understanding that the issues are broader than insurance. “For example, is the objective to fully compensate everyone affected for their losses or to partially compensate a proportion of those affected?” Mr McCarthy said.

“There’s also a need to decide what property will be covered and to what limits. Will there be compulsory cover? Will private residence and commercial properties be covered? Will government infrastructure be covered?

Defining what ‘flood’ events are covered is also key, Mr McCarthy said.

“There are complexities regarding interaction of flood with other natural hazard covers. For example, flood damage which occurs when rain is still falling creates an overlap between ‘storm’ and ‘flood’ covers. Or, in the case of Cyclone Yasi, damage caused by wind is likely covered but damage from a river flooding caused by rain from a cyclone may not be covered and storm surge is normally not covered.”

A realistic assessment must also be made about whether it’s affordable to implement the solution long-term. The collection mechanism (tax, levy, or premium), level of compulsion to contribute and amount required to reinstate damaged assets, may also limit options.

“To manage affordability, options must address the level of cross-subsidies from owners of properties that are not in flood prone areas to owners of properties which are,” Mr McCarthy said.

And, to estimate costs and address issues associated with a funding solution, modelling of flood impacts is required, but the limitations of this must also be recognised, he said.

“Floods referred to as a ‘1-in-100 year’ or similar event may be more like 1-in-25 levels.  And, changes in land use (eg increased urbanisation leading to concrete covering land that was formerly grassland or forest) changes future flood impacts.”

It’s also important that a solution does not discourage research into flood prevention and mitigation, Mr McCarthy said. Changes may reduce the likelihood of flood damage, through changes to building codes or zoning, or reduce incidence or severity of damage through levees, dams or other structures.

Governance and oversight is also important and includes relevant legislation, public reporting and dispute resolution. This includes whose responsibility it will be to ensure property at risk is covered – whether this is individuals, government or both. Any funding solution should also address what relief should be provided to those with no insurance or those who are underinsured,” Mr McCarthy said.

The post Actuaries call for wider debate on solutions for coping with future floods appeared first on AdviserVoice.

Headline developments

• The Australian Government announced that it needs around $5.6bn to help rebuild flood affected areas and that it will source $1.8bn of this from a temporary levy on taxpayers with the remainder coming from spending cuts. It makes sense for the Government to still be aiming to return the budget to surplus by 2012-13 as the economy is likely to be a lot stronger by then. However, given that consumer spending is already pretty soft it would have been preferable to see more of the burden placed on spending cutbacks as opposed to households. While the impact of the levy on average income earners is modest (eg only $250 for someone on $100,000) and it is temporary, news of another impost won’t help consumer spending with households already facing sharp increases for food prices, utility bills, insurance premiums, rents and health costs.
• China announced another round of measures to cool its property sector including increases in required down payments for second homes and a ban on the purchase of second homes in all major cities. Quite clearly the tightening process is continuing in China as it struggles to stop capital inflows associated with its management of the Renminbi from spilling over into consumer and asset price inflation. However, so far the tightening is measured and targeted and so we remain of the view that China will not crunch its economy.
• Japan is the latest major advanced country to see its sovereign debt rating downgraded because of its bleak public debt outlook. However, it’s unlikely to have much impact as Japan is actually a net lender to the rest of the world and 95% of Japanese public debt is held by domestic investors. The longer term concern for Japan though is what happens when more of those domestic investors start to retire, as the Japanese population is aging rapidly, and so start running down their holdings of Japanese bonds.

Major global economic releases and implications

• US economic data was generally solid. While house prices remain weak reflecting the lagged response to the ending of the first home buyer tax credit, pending home sales and new home sales rose adding to confidence that the housing sector has found a base. On top of this, consumer confidence rose strongly in January, underlying durable goods orders are continuing to rise and the ISM business conditions index for December was revised up suggesting that manufacturing conditions are even stronger than thought. While unemployment claims spiked in the last week this was mainly due to bad weather. Meanwhile, despite the improvement in the economy it’s still not enough to satisfy the Fed, particularly with underlying inflation measures trending down and unemployment still high and so as a result it is continuing with its quantitative easing program (QE2). President Obama’s State of the Union address also went down well with investors as it continued the shift to a more pro-business stance that has been evident since the Democrats drubbing in the mid term elections late last year. Good economic data, a dovish Fed and an increasingly pro-business President are all good news for investors and US shares in particular for the year ahead.
• US earnings results continued to surprise on the upside, with so far 72% of results coming in better than expected. December quarter 2010 profits are on track to come in 32% above year ago levels.
• Euro-zone data was positive with solid readings for business conditions and confidence in January and a strong rise in industrial new orders. UK GDP fell in the December quarter (partly due to bad weather) adding to confusion over the outlook for the UK economy with inflation surprising on the upside. This confusion was evident at the last Bank of England meeting which seemed to come close to raising interest rates. With the UK yet to feel the impact of recent fiscal tightening, a monetary tightening at this stage would be very dangerous.
• Japanese economic data was mixed with less price deflation than expected and an unexpected fall in the unemployment rate but weak retail sales. Tightening to control inflation continued in Asia with the Reserve Bank of India raising its key interest rates by another 0.25%, with further tightening likely.

Australian economic releases and implications

• Australian inflation data for the December quarter was surprising benign and leaves inflation comfortably within the RBA’s 2 to 3% target range. While food prices are rising solidly, discounting is keeping a lid on inflationary pressures generally leaving plenty of scope for the RBA to leave interest rates on hold in the face of uncertainty caused by the floods. We expect rates to remain on hold out to May at least.

Major market moves

• Share markets generally rose over the last week helped by positive economic and earnings news. The lower than expected rise in Australian inflation also helped the Australian share market by further taking pressure off interest rates.
• Commodity prices were mixed, but with the gold price continuing to fall as the improving global growth outlook is reducing investor demand for assets like gold that benefit from monetary reflation and provide a hedge against a falling US dollar. The Australian dollar and euro rose against the $US.

What to watch in the week ahead

• In the US, the key ISM business conditions survey (due Tuesday) is likely to show a further strengthening in the manufacturing sector and payroll employment data (Friday) is likely to show a gain of 150,000 jobs. Data for personal income and spending (Monday) will also be watched closely but is likely to confirm the pick up in consumer spending evident in other data. December quarter earnings results will continue to flow.
• The European Central Bank meets Thursday, but is likely to leave rates on hold. The EU leaders’ summit on Friday may be more important given the issues around extending the European sovereign debt rescue fund.
• The Reserve Bank of Australia is likely to leave interest rates firmly on hold. Recent economic data has had a soft tone and the benign December quarter inflation data has provided plenty of leeway for the RBA to sit back for several months and assess the impact of the floods on the economy. We expect rates to remain on hold out to May at least but for rate hikes to resume from mid year as flood rebuilding activity combines with mining related investment to push economic growth back up again. The RBA’s Statement on Monetary policy will likely be watched for more clues as to how the Bank sees the floods impacting the economic outlook. Australian data for private sector credit (due Monday) will be watched for further signs of improvement, December quarter house price data (Tuesday) is likely to show flat house prices in the final quarter of the year and building approvals data (Thursday) will be watched for any signs of a rebound after the fall in November. The NAB business confidence survey for December will also be released on Tuesday.
• In Australia, the December half earnings reporting season will start with Crane, NewsCorp and Tabcorp due to report. The results are likely to reflect the two speed Australian economy with resources and related stocks doing very well on the back of the surge in commodity prices but non-bank industrials likely to be much more constrained and at risk of further earnings downgrades reflecting the slowing housing and retail sectors and the strong $A.

Outlook for markets

• Share markets are vulnerable to a short term correction. After very strong gains since August last year many technical indicators show that shares generally are overbought, measures of investor sentiment are at high levels suggesting that a lot of good news is factored in and the seasonal tendency is for share market strength in December and January to be followed by weakness in February.
• However, shares are likely to put in good gains through 2011 as a whole so any short term pullback should be seen as a buying opportunity.  Shares are cheap, the run of better than expected global economic data is continuing suggesting that 2011 is on track for strong economic growth which should in turn drive another year of solid profit growth, the global liquidity backdrop is highly favourable underpinned by very easy monetary conditions in key countries, the corporate sector is cashed up and US mutual fund investors are starting to shift out of bond funds into share funds.
• The Australian dollar is at risk of a further correction in response to ongoing uncertainty about the impact of Chinese tightening on commodity prices and as a result of the negative impact on local growth from the floods. However, the broad trend is likely to remain up as the $US and the euro remain under downwards pressure, interest rates in Australia remain relatively high and high commodity prices keep the terms of trade near early 1950s highs. By year end the $A is likely to have reached $US1.10.
• The risk of a sharp back up in global bond yields at some point this year is very high. Bond yields in key advanced countries are still well below longer term sustainable levels, at some point market expectations are likely to swing back towards monetary tightening in the US and Australia and the record inflows into bond funds seen in recent years are now reversing.

The post Weekly market & economic update 28 January 2011 appeared first on AdviserVoice.

• The Prime Minister has proposed a levy on higher-income Australians to assist in meeting the damage bill from the east coast floods. The levy will apply in 2011/12 and will raise $1.8 billion.
• The estimated cost of the floods to the Federal Budget is estimated at $5.6 billion (over four years). The Government will make an upfront payment to Queensland of $2 billion.
• The cost to the Australian Government of rebuilding flood affected areas outside Queensland is estimated at $1 billion. Rebuilding flood affected areas in Queensland itself is estimated to cost $3.9 billion.
• The Government has announced a $5.6 billion funding and skilling package for flood rebuilding.
• Treasury’s preliminary estimate is that GDP growth in this financial year will be around half a percentage point lower due to the floods.

What does it all mean?

• If a levy had to be applied, this is the right levy for the times – modest in size, temporary, progressive and applying to those on higher incomes, rather than across the board. But while most people are unlikely to miss a couple of dollars a week, many will question why it has to be applied at all. The levy will raise just $1.8 billion, but at a time when families are facing pressure on budgets from higher food prices, rising petrol prices and hikes in utility, council and public transport charges. Consumers are already reluctant to spend and this is unlikely to change in the short term.
• While the government has estimated the budget cost of the floods at $5.6 billion, it has provided no detailed estimates of the infrastructure affected. In light of previous Government programs such as spending on school infrastructure and home insulation, there is value in the Government releasing more details of the infrastructure to be repaired.
• While there is a cost to the Federal Budget in repairing or replacing infrastructure, government revenues will also be boosted by the extra workers employed in the rebuilding work and GST revenues will be boosted by the spending on homes such as replacing carpets, curtains and kitchens. It is not known whether the government’s cost estimates have been made in gross or net terms.
• The Government has a Contingency Reserve. The reserve is budgeted at $2.4 billion in 2011/12. $3.1 billion in 2012/13 and $5.9 billion in 2013/14. The government hasn’t made it clear why the contingency reserve can’t be applied to meet the cost of the floods. While the reserve is generally applied for cost over-runs of projects, clearly it should be available for unforseen events like the floods.
• There is no economic imperative or urgency for the budget to be brought into surplus. Australia’s budget deficit and government debt levels are very low in relation to advanced and developing nations across the globe. The Government has made a commitment to move the budget back into surplus and it is determined to meet the goal despite the questionable justification. It would be a different story if Australia was at the top, rather than the bottom, of the global government debt leader-board.
• There have been some dubious and sensational estimates of the impact to the economy from the floods. The Government has set the record straight by its estimate of half a percent negative effect in the first half of 2011. However there is no estimate of the boost to activity in the second half of the year from the rebuilding. We had previously estimated the cost of the floods to the economy at $3-5 billion and see no reason to change the estimate.

The funding and skilling package for flood rebuilding

• A levy will be applied on those earning more than $50,000 in 2011/12, raising $1.8 billion.
• Six Queensland roads projects will be delayed by periods of one to three years. This will save $325 million in the Budget period.
• A number of projects in other states have also been identified where delays and reductions in Australian Government funding will save approximately $675 million.
• Spending on some funding programs will be scrapped, others capped or deferred. These include the Green Car Innovation Fund, Cleaner Car Rebate Scheme, the Carbon Capture and Storage Flagships and Solar Flagships,
  the Solar Hot Water Rebate, Green Start Program, Solar Homes and Communities Plan and the Global Carbon Capture and Storage Institute.
• Capping will be applied to some programs to limit their cost: the National Rental Affordability Scheme and the LPG Vehicle Scheme. And some lower priority education spending, where the desired outcome can be achieved
  through other programs, will be discontinued. This includes the Capital Development Pool and the Australian Learning and Teaching Council.
• The Building Better Regional Cities funding and Priority Regional Infrastructure Program funding will be redirected to flood rebuilding.
• There will be quicker approval for temporary skilled migrants (the 457 visa program) who work on flood rebuilding. There will be extra resources, assistance to employers and simpler processes to ensure a five day turnaround for ‘decision-ready’ applications for workers in a host of nominated occupations to work on rebuilding Queensland.
• There will be a doubling of the pilot of relocation assistance for people on income support and directing it to Queensland. Up to 4 000 eligible jobseekers who want to get a job helping out will now receive support to move to Queensland and make a difference on the ground.
• The Government says that there will be two dollars saved in spending cuts for every dollar raised through the temporary levy.

Details of the proposed levy

• Federal Treasury has provided details on the proposed flood levy.
• “The Government will apply a flood levy to help fund reconstruction in flood affected areas. The flood levy will apply to individual’s taxable income only in the 2011-12 financial year.”
• “A levy of 0.5 per cent will be applied on that part of an individual’s income between $50,001 and $100,000 and a levy of 1.0 per cent will be applied on that part of the taxpayer’s taxable income above $100,000. No levy is payable where the person has income of $50,000 or less.
• Someone on a wage of $60,000 a year will attract a levy payment of 96c a week. For someone on $100,000 a year, the levy payment is $4.81 a week.
• “Those people who have received an Australian Government Disaster Recovery Payment in relation to a flood event in 2010-11 will be exempt. Because not all affected people have yet made claims a precise number is not known. At this stage claims have been received for around 250,000 adults.”
• “Taxpayers will not have to do anything extra to pay the levy. People will make their levy payments through the tax taken out of their regular pay in the same way that people pay the Medicare levy. This will help prevent taxpayers from receiving a tax bill at the end of the financial year.”
• “The Treasury has estimated that the levy will raise $1.8 billion.”

What are the implications for interest rates and investors?

• The flood levy represents more challenging news for retailers and other consumer-focussed businesses. Given the good shape of Government finances, the need for a levy to help meet the cost of the floods must be questioned.
• The fact that the Government is cutting spending and applying a new levy on Australian consumers may reduce the need or urgency for the Reserve Bank to lift interest rates over the year.

The post Flood levy proposed – but is it necessary? appeared first on AdviserVoice.