Quake Complacency Costs
The Insurance Bureau of Canada's earthquake study is a wake-up call for Canadians about the need for better economic preparation for a major quake in Canada
The tsunamis never came and the earthquakes themselves didn’t cause severe damage. But they were the latest in a number of global incidents that should serve as a wake-up call for Canadians, who industry insiders say are not taking the likelihood of earthquake catastrophe in this country seriously enough.
“Canada is one of the few earthquake-prone countries where the federal government has no role at all in the occurrence of a super catastrophic event,” says Gregor Robinson, chief economist at the Insurance Bureau of Canada (IBC). “We need some kind of policy in place at the national level to deal with a super catastrophic event, something that would support a robust institutional response.”
The Canadian government—unlike those in other countries—doesn’t have any kind of capital fund in place that would finance economic and infrastructure reconstruction in the wake of an event.
Additionally, while the insurance industry itself is well-capitalized to cover insured losses following a catastrophe, an alarmingly high number of Canadians in quake zones don’t have earthquake insurance in place. Unlike flood loss— which falls under the banner of government relief because insurance is not available in the private sector—individual loss from earthquake is entirely the responsibility of individuals.
In the absence of government-funded recovery, says Robinson, Canadians are not doing enough to protect themselves through private insurance channels.
The IBC is working to change that. First previewed for delegates at the National Insurance Conference of Canada in Gatineau, Que. last September, the national association representing insurance companies released a landmark study in October, which it hopes will shake everyone out of complacency.
The Study of Impact and the Insurance and Economic Cost of a Major Earthquake in British Columbia and Ontario/Quebec is a $1 million dollar report commissioned by IBC. Executed by modeling firm AIR Worldwide over 20 months, the 340-page report examines two realistic earthquake scenarios—one in the West and one in the East.
“We started by understanding the underlying exposure, looking at historical data available,” explains David Lalonde, senior vice-president at AIR Worldwide. “The scenarios had to have a 1-in-500- year probability of happening.”
An average 4,000 earthquakes are recorded each year by Natural Resources Canada. Over the last 300 years, there have been 24 major earthquakes with a magnitude greater than 5.0 in Canada.
The two regions of the country modeled by AIR Worldwide have historically been most vulnerable.
“There is a 30% chance that a major earthquake strong enough to cause significant damage will strike [in the West] in the next 50 years,” says the report. In Ontario and Quebec, there is a 5-15% chance of a strong earthquake over the next half century.
The IBC study points to an alarming gap between total and insured losses in both scenarios.
The West Coast scenario involves a 9.0-magnitude earthquake with its epicentre 75 km off the coast of Vancouver Island in July, followed by a generous-sized tsunami and subsequent liquefaction, that impacts the Vancouver Metropolitan Area and Victoria. Total losses are around $75 billion, with insurance cover for approximately $20 billion.
The Eastern scenario encompasses the Ottawa-Montreal-Quebec City corridor, with a 7.1-magnitude quake centred in the St. Lawrence River 100 km northeast of Quebec City, with the shock felt across Ontario and Quebec. Total loss is estimated at $60 billion, with insured losses of just over $12 billion.
“An event of this magnitude would dwarf any event we’ve had,” says Robinson at IBC. “The Ice Storm [of 1998] was the largest event we’ve ever had, with insured losses of close to $2 billion.”
Closing the Gap
The positive economic impact of awareness in BC—where commercial earthquake insurance uptake is around 85% and homeowner uptake is less than 50%—is reflected in the IBC scenario study. BC’s infrastructure demonstrates better resilience to total loss than in the eastern scenario, for example. The study attributes this to building codes adapted over the last two decades in the province that account for potential earthquake, higher levels of awareness of risk management practices and insurance penetration on the commercial side.
Despite this, there is a fear among some in the industry that the awareness levels have plateaued.
“Don’t let that 85% stat become complacent,” says Steve Yendall, vice-president, Western Canada, for RSA. “Because it’s their workforce sitting at 30 or 40%, and if they have no home to go to after an earthquake, business will suffer.”
Teck Resources Ltd., a mining company headquartered in Vancouver, offers a best practice example of risk management in this area that insiders would like to see emulated. More than a decade ago, Anne Chalmers, Teck’s vice-president of risk and security, wrote an earthquake preparedness guide for home and office.
“It speaks to the employee about response,” says Chalmers. “Here’s a number of things you need to prepare for home and office in the event of an earthquake, including supplies and general guidance around immediate response.”
Teck’s office is equipped with 72 hours of supplies for every employee, including head lamps and a handful of satellite phones. Each employee must create a custom emergency kit, containing personalized necessities like prescriptions and contact lens solution. The company also educates employees on the level of risk around earthquake and ways to mitigate that risk, including through insurance.
While Teck and many West Coast businesses are taking the threat of earthquake seriously, the preparedness for catastrophe in the East is deficient. Quebec has problems with aging infrastructure that has been patched together for decades and could be a menace in a quake event.
The IBC study shows a considerable amount of total-loss damage to unreinforced masonry and infrastructure, particularly in Quebec City, closest to the epicentre.
There is also a dearth of insurance in the province. It’s estimated just 3% of homeowners and less than 60% of businesses have earthquake cover in Quebec.
“In Quebec, the numbers [for earthquake insurance uptake] are remarkably small,” says Sharon Ludlow, president and CEO of Swiss Re Canada. “That in and of itself is a cause for industry, consumers and governments alike to take steps to determine why we’re not buying earthquake coverage and how we can increase uptake.”
A Tough Sell
The industry push for greater insurance uptake coincides with a number of external pressures that are making earthquake coverage an increasingly tough sell.
Premiums can represent up to 25% of a homeowner policy and the costs are rising every year. In order to be capitalized appropriately, insurers in this space need to access the global reinsurance market, and the number of catastrophic events around the globe has spiked in recent years.
“The 30-year average of losses is roughly $29 billion in any given year,” says Yendall at RSA. “In 2011, it was over $120 billion. In 2012, it was $65 billion.”
Most losses have been driven by catastrophe in non-peak zones, areas where frequent catastrophes are unexpected—the 2011 tsunami in Japan and floods in Thailand, for example, or recent earthquakes in New Zealand and Chile.
“The capitalization of the reinsurance community collectively was sufficient to cover these events,” says Ludlow. “But we learn lessons with every event that occurs. With Japan, for example, you could literally trace the cause and effect of business interruption around the world—the halting of the company in Japan to someone buying a car in Canada.”
The breadth of restructuring after events like the one in Japan—and the cost of things like supply chain disruption— has caused reinsurers to seek deeper pools of capital. In turn, the federal regulator in Canada wants Canadian insurers to be appropriately capitalized for an earthquake catastrophe. This month, new guidelines from the Office of the Superintendent of Financial Institutions (OSFI) came into effect, imposing a number of changes on the industry.
RSA’s Yendall explains that OSFI, which is responsible for the solvency of P&C companies, is increasing the capital requirement for insurers. Right now, Canadian insurance companies purchase reinsurance based on providing protection against a 1-in-400-year event. Over the next ten years, companies need to move that up to a 1-in-500-year event.”
Prior to the implementation of the OSFI guidelines, all insurers in this space were required to do a full audit on their capacity. Going forward, national insurers that provide earthquake packages must implement vigorous risk management measures, conduct semi-annual catastrophic earthquake risk modeling and seek capital as required.
All this has triggered anxiety in the industry, with some insurers withdrawing altogether. In November 2012, The Economical Insurance and Family Insurance Solutions, for example, announced it would not accept new personal business nor renew existing policies covering earthquake loss in some parts of BC.
The decision to withdraw from specific areas was “based on sophisticated earthquake modelling…which over the past few years has identified higher-risk earthquake areas in BC,” Economical’s chief actuary Linda Goss told Canadian Insurance Top Broker at the time.
Within an ever-tighter market, there is growing concern about catastrophic losses that cannot and should not be absorbed by the industry, something the IBC study brings to the forefront.
“The insured numbers are alarming enough, but the total loss numbers are the real area for concern,” says Ludlow at Swiss Re. “At least some of this belongs with the federal government.”
There is currently nothing set aside in government coffers to pay for infrastructure rebuilding following a catastrophic earthquake.
“Earthquake insurance is only dealt with in the private sector,” explains Yendall at RSA. “It’s incumbent upon private citizens to access this private sector instrument that is integral to their economy or have nothing. Even municipalities need to purchase earthquake insurance in the private sector.”
In Mexico City, Swiss Re worked with government officials to build a publicly traded fund to give government immediate access to capital should catastrophe strike.
“There are a number of securities called catastrophe bonds,” explains Ludlow. “If there’s no event, capital proceeds are returned to investors. If there is an event, the fund is there to pay for reconstruction.”
“It gives the government foresight, gives them an idea of insurance costs year-over-year,” says Ludlow. “The cost of doing this should be less than being stuck with a bill after the event.”
The IBC study shows there is no room for complacency on the issue of earthquake catastrophe, says Yendall at RSA. But people can’t be scared into action.
“Brokers are uniquely positioned to seize safe opportunities to educate and continue to educate their consumers,” says Yendall. “Seize those opportunities where insurance becomes the dinner-table conversation to reinforce what the product is, why you’re buying it and making sure it’s adequate.”
“Clients need to know that the only mechanism Canadians have to deal with a catastrophe is private insurance,” he adds. “Those opting not to carry the product will not have any other options. It’s not like the floods in Alberta, where there was relief money. There won’t be any government money forthcoming after an earthquake.”
Copyright 2014 Rogers Publishing Ltd. This article first appeared in the January 2014 edition of Canadian Insurance Top Broker magazine