A demand surge is when the demand for goods and services exceeds the region’s ability to supply them. This is true for both Christchurch after earthquakes and the east coast of America following Hurricane Sandy. This phenomenon is common after natural disasters. All affected policyholders are subject to a demand surge. This is because the demand for recovery supplies and disaster relief increases dramatically because of increased demand and shortages. As people rebuild, the price of these goods will rise. Although insurance dollars flood into affected areas after a disaster, rebuilding is difficult due to shortages of materials and workers. This can lead to higher wages and sometimes significant material price rises. Costs and materials for construction (e.g. Steel, timber, cement and building materials (e.g. gib) are the most affected by a demand surge, but oil prices may rise.
The demand surge after disasters can be seen all over the globe, regardless of whether it is caused by flooding, windstorm, hurricane, earthquake, or other natural disasters. It is evident that supply and demand are not in balance. There have been many examples of earthquakes that saw demand surges, such as the 1886 Charleston Earthquake (U.S.), which caused a far greater demand for labour than the local supply. Both skilled and unskilled labour saw their wages rise dramatically beyond pre-earthquake levels. This resulting in a rise in wages and a shortage of labour had a knock-on effect. Owners were left with a long list of repairs to do. This not only caused extreme hardship but also increased the property’s loss (due to further damage or deterioration) which then led to poor and inadequate repairs. This is exactly what Christchurch is currently facing. Residents face frustrating times ahead if there is no strong mechanism to control construction quality, labour prices, and materials.
Other demand surge problems were presented by the 1906 San Francisco Earthquake and Fire (U.S.). Insurers suffered greater losses due to higher construction costs. Price fluctuations due to limited labour and material capacity drive price fluctuations. Reconstruction costs rise as more contractors are hired to repair the damage. Due to a shortage of labour and materials, repair costs are rising, leading to increased claims. The more extensive the damage, the higher the cost of rebuilding resources. Contractors raise their bids for reconstruction projects, which leads to amazing price increases, sometimes twice the amount they would have paid in a market with more competition.
The 1994 Northridge earthquake (U.S.), there were not enough claims adjustors so the insurers hired people from all over the country and abroad. The same thing happened to us. This was because they were not properly trained in seismic damage. They were not able assess the severity of the damage accurately and could not price it appropriately.
According to reports, rebuilding costs in Australia increased by 35% after the Newcastle earthquake. Building costs rose by 75% after Cyclone Tracey, in Darwin. In the ACT, bushfires of 2003 saw building costs rise by 50% between November 2002 to January 2003. Preliminary reports from Cyclone Larry in Queensland showed that there was an increase in local building costs following the disaster. Insurers estimated that building costs would rise by at least 50% within 48 hours.
The size of the disaster determines the extent of the demand surge. It is clear that there is a demand surge in this area. A remote, isolated country such as New Zealand, where transportation and supply are difficult, has been suggested as a reason for large demand surge events.
How economically can reconstruction materials, labour and equipment be brought to the affected areas? This is crucial. These are the elements that will affect the rebuilding and repair of Christchurch. All must be readily available locally. The labour force will be paid higher wages if the demand is greater than the supply. The demand surge will be determined by the amount of work required in the area. Additionally, the local building codes will dictate the skill and level of repair needed.
Insurance companies may not have adequately considered changes in building codes requirements (e.g. When determining the amount of property replacement, it is likely that insurers have not adequately accounted for changes in building code requirements (e.g. strengthened foundations). The reality of work schedules and their ability to be met will impact the amount and speed of the work. This will have an enormous impact on the final costs.
Delaying repairs can lead to more expensive repairs due to the property’s deterioration and other damage, as well as changes in materials pricing, labour rates, and overheads. These surges can reach up to 70% according to overseas experience. Reconstruction will be affected by the efforts of both local and national governments. We have seen a slow start to the recovery phase. This could lead to large surges in residential and commercial construction. Well done National!
My message to insurers is that they must deal with uncertainty surrounding claims costs after disasters. They view themselves as having a legitimate right to only pay the amount they have calculated and charged for a premium. Policyholders must ensure that demand price spikes are included in their final claim settlement. Otherwise, they could find themselves severely out of pocket and unable to replace what they have lost.
Quantity surveyors and engineering firms with a reputation for excellence have begun to include pre- and post-tender escalation rates that reflect these surges. These figures can fluctuate and will only increase.
If you lose your house in 2010, and rebuilding is impossible until 2015, and you haven’t taken into account a demand surge of %, then you will suffer a significant loss and your total replacement plan will fail to deliver.
The message is clear: make sure you have enough money to cover the demand surge in the final settlement.
