Bomb Fire: briefing paper on reforms to the fire service and the costs

BOMB FIRE: BRIEFING PAPER ON REFORMS TO T HE FIRE SERVICE AND THE COSTS

Your Money, Your Voice Promoting sensible restraint of government expenditure

1

SUMMARY • The proposed reforms to the New Zealand Fire Service will result in a 40% increase in fire levies paid on insurance policies. While there is a projected annual increase in insurance-levy revenue of $115m, we have been unable to identify any comparable increase in the levels of service New Zealanders will receive.

• Efficiency gains of amalgamating the fire services are no more than 12% of the forecast increase in levy revenue over the next 5 years (despite efficiency being one of the key principles of the Bill).

• Overseas experience strongly suggests that centralisation of fire services are accompanied by large increases in expenditure.

• The funding model inequitably targets insurance holders and does not categorise by fire risk. Instead of moving to a propertylevy funding model or fee structures based on fire risk, the proposed reforms move in the opposite direction.

This paper was prepared by Mac Mckenna for the New Zealand Taxpayers’ Union.

1

INTRODUCTION On 1 July 2017, the New Zealand Fire Service, the National Rural Fire Authority, 12 Enlarged Rural Fire Districts and 26 Territorial Rural Fire Authorities will merge to become Fire and Emergency New Zealand (FENZ). The Fire and Emergency New Zealand Bill will repeal the two existing Acts governing the fire services and “give effect to a single, unified fire services organisation in New Zealand.”

The Bill is “the most significant reform of New Zealand fire services since the 1940s”.1 This briefing paper examines the key changes and concerns of the proposed reform - currently before Parliament.

The Bill states that in formulating the operating principles of FENZ, the organisations board must take into account “the importance of providing evidence-based, efficient, and effective services.”

The responsible Minister, Hon. Peter Dunne stated, “It will deliver a flexible, modern, and efficient fire and emergency service”.2 Our attention was first brought to this Bill by reports of a 40% hike in insurance-levies for individuals, commercial, and non-commercial entities. We sought to find out whether the 40% increase was accurate and whether the higher costs are to be accompanied by an equivalent increase in fire services.

Our economic analysis concludes that the reports of insurance

levies increasing by 40% are correct. In addition, the levels of service are almost certainly not enough to justify the higher costs, and are particularly aggravating considering that levy revenues have been increasing each year since 1999 as insurance cover goes up. Levy revenue has increased by 55.7% (after inflation) since 1999, and 16.1% since 2008.

original form, fire protection was only offered to those who paid fire insurance, whilst those who did not were simply not protected.

The current funding model for the New Zealand fire service is still based on a private insurance charge but with protection offered universally. It is a public good funded as though it is a private good.

“The current funding model for the New Zealand fire service is still based on a private insurance charge but with protection offered universally. It is a public good funded as though it is a private good.”

It is particularly worrying that the cost of insurance is needlessly going up in a time when insurance is becoming more and more valuable. Given New Zealand’s recent experience with the Christchurch and Kaikoura earthquakes, the Government should be looking to avoid deterring insurance.

It is not clear why New Zealand is choosing to be an outlier and avoiding the international trend to move towards a fire service that is funded through a property-levy collected by local government entities.

1 Department of Internal affairs, 2017 2 Press Release, Hon. Peter Dunne, 29 March 2017 (www.beehive.govt.nz/release/ levy-rates-fire-and-emergency-servicesannounced)

The fire service in New Zealand was born out of private insurance motivation to mitigate risk. In its

2

CURRENT STRUCTURE Under the current fire service model, the urban fire services are managed as a centralised organisation (The New Zealand Fire Service) funded entirely by a fire-levy on insurance policies.

“Insurance levy revenue was $372m in 2016, compared to $278m in 2008.

After adjusting for inflation, this is a real increase of 16.1%�

Individuals are currently charged a levy of 7.6 cents per $100 insured, to a maximum cap of $100,000 of buildings insurance and $20,000 of contents insurance. Irrespective of whether a policy covers a residential

2400

building to the value of $100,000 or $10 million – the same levy is applicable.

Non-residential insurance is levied at the same rate as residential but with no maximum cap.

Because of increasing levels of insurance cover the levy revenue has been increasing despite not increasing the rate of levy since 2008 (see graph below). Insurance levy revenue was $372 million in 2016, compared to $278 million in 2008. After adjusting for inflation, this is a real increase of 16.1% without even having to increase the rate of levy.

The New Zealand Fire Service Commission has no incentive to reduce the rate of levy or return excess revenue through a levy-holiday, even if levy revenue is higher than necessary.

From an economic incentive perspective the key disadvantage of this funding model is that there is no association between risk and cost. Those properties most susceptible to fire risk do not have to pay any more than a property with

Revenue

little to no fire risk. This means that there is a reduced incentive for private-property owners to self-insure through better facilities and management of risk. The costs are socialised.

The funding of ACC levies is better incentivised to risk. ACC is charged to different groups depending on the expected costs they will incur, such as higher levies for motorcyclists due to higher risks of injury. Whilst there is certainly scope for more specific targeting of ACC levies as well, the ACC system is superior to the fire-service model.

Rural fire services are decentralised and operated on a mixed-funding model. Funding is generated through local council contributions and fees paid by forestry companies and the Department of Conservation (DOC).

The total cost of funding rural fire protection is estimated to be $35 million annually. Forestry companies contribute $10.6 million of the total cost.

Rate of Levy

Index

2100 1900 1600 1300 1000 700 1994

3

2001

2008

2015

PROPOSED STRUCTURE The Bill modifies the funding model so that all fire services (urban and rural) are funded through a single insurance levy. Consequently, the levy charged on residential and non-residential insurance will rise significantly. The increase is to superficially cover the reduction in revenue from councils/forestry companies and to control for increased expenditure as a result of the merger.

Peter Dunne has stated, “Local government will also no longer fund the costs of rural fire services, approximately $30 million nationally, from local rates� and has attempted to sell this reform as saving local communities money through a small increase in private levy insurance. The increase is approximately 40% on current levy rates. Because of the maximum cap, this increase is relatively small for a residential insuree ($36.20 annually). However, non-residential insurance does not enjoy the same protection of a maximum cap, so a 40% in-

Current Insurance Levy

crease in levy will be a significant cost increase for those with high insurance cover (see table below).

Increasing the levy rates by 40% is projected to increase levy revenue by $115.2 million in 2017/2018.

Non-residential policy holders will pay an additional $66.4 million next year, and residential policy holders will pay a further $43.2 million. It is evident that the $115 million increase imposed on insurance holders is significantly larger

than is requried to cover the current cost of rural fire servicing, which is estimated at $35 million by the Martin Jenkins report and $30 million by Hon. Peter Dunne.

It is misleading for Mr Dunne to justify the levy hike as compensation for lost contibutions from local councils and forestry. The extra revenue is at least $80 million more than is necessary.

Fire Levy Revenue Current 2016/2017 Levy

Proposed Insurance Levy

Proposed 2017/2018 Levy

Change

Residential

$134m

$177m

$43m

NonResidential

$ 218m

$284m

$66m

Motor Vehicles

$16m

$22m

$6m

Total

$368m

$483m

$115m

Maximum Insurance Cap

Current Proposed Levy Maximum ($) Maximum ($) increase (%)

Residential Buildings

7.6c/$100

10.6c/$100

$100,000

$76

$106

39.5%

Residential Contents

7.6c/$100

10.6c/$100

$20,000

$15

$21.20

39.5%

NonResidential

7.6c/$100

10.6c/$100

-

-

-

39.5%

Vehicle

$6.08

$8.45

-

-

-

39.0%

4

THE ISSUES

1

not forecast until the fifth year, but the savings will only be $48 million. It is not clear from the projections whether these efficiency gains are a one-off or will continue beyond the fifth year.

However, in the next five years these efficiency gains will only amount to 12% of the expected increase in levy revenue that will be met by insurance paying New Zealanders.

Where are the economies of scale?

One of the key selling points of the reforms is claimed efficiency of a merged fire service. But based on the financial projections issued by the Government, there appears to be no savings or economies of scale.

The Minister trumpeted that this Bill would result in greater efficiency.3 In fact, the only projected efficiency gains are

In effect, the best-case scenario according to the Government’s projections is New Zealanders will pay at least $400 million extra over the next five years for only $48 million in savings.4

“If efficiency is the objective, it appears the current arrangements are serving New Zealand well.”

Centralisation of urban and rural fire services in Australia has been accompanied by large increases in costs. For example, in 1979 the State of Tasmania (a similar climate to New Zealand) unified the rural and urban fire services.

The cost of delivering the fire service in Tasmania in 2015/2016 was $293 (NZD) per person. The cost in New Zealand during that same period was only $86 per person, significantly less than Tasmania. The average across all Australian states was $180 (NZD) per person, more than double the cost in New Zealand.

If efficiency is the objective, it appears the current arrangements are serving New Zealand well.

3 Press Release, Hon. Peter Dunne, 29 March 2017 (www.beehive.govt.nz/release/ levy-rates-fire-and-emergency-servicesannounced) 4 This $400m figure is calculated assuming that the $80m extra in levy revenue ($115m - $35m) projected in the first year remains constant for the next four years. This will understate future revenue increases as it does not account for increased insurance coverage over time.

Cost Per Capita ($) (2015/2016 NZD)

300 250 200 150 100 50

Table Source: Australian Government Productivity Commission, 2017

5

NZ

AU S

NT

AC T

Ta s

SA

W A

Ql d

Vi c

NS W

0

2

diverge significantly in cost per capita and cost per incident.

Timaru spends approximately $158 per capita compared to $31 in Blenheim (as of 2014). The difference is exacerbated when cost per incident is considered.

In Timaru, the cost per incident is $9,879 compared to only $897 in Blenheim. Even if service levels in the two towns differ (the population difference is less than 3,000) this cannot justify a price per person difference of more than 400% or a price per incident difference of more than 1,000%.

No internal competition, accountability or transparency

The Bill makes very clear that the national strategy supersedes local needs: “FENZ must undertake, for each local area, local planning that demonstrates how the local allocation of resources by FENZ fits in with the national plan” (cl 21A). This prevents regions from targeting resources to the specific needs of the area when those needs do not fall in line with the national strategy.

A concern of merging the urban fire service with the rural fire services is the escalation of the loss in accountability. The cost variation between fire brigades reveals substantial differences in per-capita and per-incident expenditure.

Under the current system which fire brigades are financially effective and which are not can be identified. Under the merger, accountability of each individual fire brigade is likely to be submerged as part of the broader

For example, Timaru and Blenheim, two similar size urban communities in the South Island,

Masterton

Timaru

Kawerau

Ashburton

FENZ entity. Without any provision in the Bill, inter-department comparison may become increasingly difficult.

“In Timaru, the cost per incident is $9,879 compared to only $897 in Blenheim.

Even if service levels in the two towns differ...this cannot justify a price per person difference of more than 400% or a price per incident difference of more than 1,000%” Blenheim

Te Awamutu

Cost Per Capita

$155.60

$158.10

$341.40

$50.10

$31.30

$39.80

Cost Per Incident

$3,697.00

$9,879.00

$6,225.00

$519.00

$897.00

$542.00

Table Source: Official information Request to New Zealand Fire Service in 2015.

6

3 Inequitable funding

The current insurance-levy regime imposes the burden of funding the fire service on those people and businesses prudent enough to take out insurance. It is poorly designed and mistargeted.

The insured are subsidizing the non-insured. All States in Australia (excluding Tasmania) have recognised the flaws in this system and have either shifted to a property-levy or generaltaxation scheme.5 The Insurance Council of New Zealand (ICNZ) supports calls to shift away from this out-dated regime.6 In 2013, ICNZ requested a report from the New Zealand Institute of Economic Research (NZIER) into the funding of the urban fire service. The report recommended replacing the

7

current insurance-levy with a property-levy collected by local government, based on property values.7 Instead of shifting away from the insurance-levy system - as supported by the large share of experts - this reform actually strengthens the role that the insurance levy plays in funding the fire service in New Zealand.

“The incentive for forestry to selfinsure through suppression services will diminish in favour of relying on funding from others via the insurance levy.�

Furthermore, it would seem logical that individuals or businesses more susceptible to fire are required to foot a larger share of the bill. In almost all forms of insurance, those most at risk are required to pay larger premiums, as the probability of

requiring compensation is larger.

Most people would agree that this concept is fair. Yet the same rationale has not been applied to the funding of the fire service.

Quite remarkably, the proposed reforms will actually reduce the relative financial burden on one of the largest users of fire service, the forestry sector.

The president of the NZ Farm Forestry Association (NZFFA), Dean Satchell, has welcomed the changes.

The forestry sector provides significant contributions to fire service funding under the current regime. Estimates from a Martin Jenkins report suggest that forestry contribute approximately $10.6m in forest fire protection each year. 38% of what the forestry sector currently contributes will now be covered by the insurance-levy. The incentive for forestry to self-insure through suppression services will diminish in favour of relying on funding from others via the

5 New South Wales, Queensland, Victoria, Western Australia, South Australia and ACT are all under a property-levy model.

Northern Territory is funded through state general taxation. Tasmania is funded through a hybrid of an insurance-levy and residential rates.

6 www.icnz.org.nz/issues-submissions/ issues/the-fire-service-levy/ 7 Dunn & Gill, Better ways of funding fire services in New Zealand, 2013

insurance levy. The Bill shifts the responsibility of fire funding away from high-risk groups (forestry) and towards low-risk users. To make things even worse, forestry sector operators are usually uninsured so will be able to escape the insurance levy and not be responsible for funding the fire service at all.

Perhaps the most inequitable outcome of the reform will be the significant increase in levy burden on non-residential insurance. For example, an apartment building that is half-residential and halfcommercial where the residential and commercial halves are equal in value - $10 million each - and have been insured for the equivalent amount. If there were 10 residential occupants in the building they will pay a combined fire levy of $910 (house and contents). The commercial half of the building will on the other hand pay a total of $7,600 a year in fire levy.

After the reform, the residential occupants will have to pay an extra $362 (or $36.20 each). The

commercial half will have to pay an extra $3,000. This is unfair.

“The Bill shifts the responsibility of fire funding away from high-risk groups (forestry) and towards lowrisk users.�

Further, the Bill will prevent any cost recovery by those who cause fires or those who cause false alarm call-outs. Instead, the burden is now solely on those who pay insurance. This clearly reduces the incentive to maintain fire alarms and good practices, as the costs of not doing so are no longer there.

The new changes will now apply the levy to all policies

that cover material damage (not just fire damage). This has the extraordinary implication of capturing travel insurance - even though this is for overseas travel where FENZ is not available.

We support calls to replace the funding structure of FENZ with a property-levy system. This way every property owner in New Zealand will be responsible for the upkeep of a service they all have access to in the event of a fire. This property-levy scheme should be more expensive for high-risk properties and businesses so that low-risk users are not subsidising a service they are very unlikely to require.

By shifting the burden of levy collection away from insurance providers and the New Zealand Fire Service Commission there will be administrative savings. The NZIER report argues that because local councils already collect rates and have property value information, the marginal cost of collecting a property-levy will be minimal. We endorse that view.

References Australian Government Productivity Commission. (2017). Report on Government Services 2017.

Department of Internal Affairs. (2017). Proposals for Fire and Emergency NZ regulation. Discussion Document.

Dunn, M., & Destremau, K. (2014). Funding the Fire Service Levy in commercial real property. NZIER. Dunn, M., & Gill, D. (2013). Better ways of funding fire services in New Zealand.

NZIER. Hunn, N., Carlaw, N., & Borren, T. (2017). Cost of Rural Fire Servicing. Martin, Jenkins & Associates Limited.

8

www.taxpayers.org.nz 9