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Reinsurance takes hard look at quake threats

Canada’s property insurance gap is about $2.1 billion between insured losses and economic losses

When the earth thundered in Italy’s Irpinia region back in 1980, it killed almost 3,000 people and left another 300,000 homeless. “Reconstruction funds from the central government dripped in very slowly” while the papers were full of scandals over financial misappropriation, recalls Veronica Scotti. Some of her relatives were evacuated to the area around Milan while a few stayed behind, working with victim rescue efforts and the cleanup operations. Today, Scotti is the CEO of Swiss Re Canada, and she can still remember vivid details from that ordeal.

“My grandparents had to leave their house in 1980 because it was deemed unsafe,” recalls Scotti. “The building stood there for years untouched as that would impair access to government funds. Eventually, it was demolished and reconstructed. My grandfather never stepped back in it. My grandmother returned to a much different dwelling in 1991, and we are still in litigation over poor construction erected while she was away.”

In a recent blog post, Scotti pointed out that in “the last few days of 2015 a magnitude-4.7 quake struck about 20 kilometres north of Victoria, and while thankfully no one was hurt and there was no damage it got me thinking about Canada’s property insurance gap—a difference of about $2.1 billion between insured losses and economic losses, assuming an average catastrophe loss year.”

As it happens, she’s not the only one noticing the gaps in North America—sometimes chasms— between coverage and what might be losses that could take companies down with the buildings (there’s a cautionary tale in the example of Sears, which granted, had infamous mismanagement in the 1990s, but which blamed part of its financial spiral on enormous claims for damage to its real estate holdings after Hurricane Andrew). Los Angeles, in fact, has adopted new regulations that require retrofits on more than 15,000 of its buildings.

Read: Is the industry ready for an earthquake in Quebec?

And last July, the New Yorker ran a long feature, “The Really Big One,” about the high possibility of a Cascadia region quake for which few seem prepared. Among its “let’s scare the living crap out of you” vivid details, it mentions how an elementary school in Gearhart, Oregon has limited escape routes and is only protected by a 45-foot-high ridge—far too short if a tsunami results from a quake. The article generated quite a buzz in the insurance industry.

But there are those like Veronica Scotti who don’t have to imagine the outcome because they’ve seen it before, and they know that there are lessons available from Europe. She worked and lived for more than a decade in Switzerland where, as she points out, “you have mandatory—what we call basic—insurance for natural catastrophe, and that’s very enlightened, and it’s managed. It’s a partnership between insurance companies and government, and it’s one where the individual is not left in doubt. Now you can choose to ensure more than the basic, but at least you have a fundamental level of protection, and because everyone is insured, it becomes, if you will, the cost of insuring. It’s very well distributed.”

But here, you’re left with an aggregated risk. “Currently in Canada there is so little insurance, so little explicit protection, because this is what it is… making an effort to explicitly protect today, at terms that you understand… versus hoping that someone will step in and do you good, but most likely you get 50 cents on the dollar, right? Because the government will say, ‘Well, socially, we have to redistribute it,’ and you’re not going to get the property that you had before.”

“Insurance companies sell a promise, we sell a promise,” argues Tim Fisher, senior vice-president and Canadian branch manager for reinsurance at XL Catlin. “At the end of the day, how good is that promise? And really, that’s the balance between how much risk you’re taking and your financial resources. So I think OSFI has done a very, very good job setting benchmarks and limits, so on and so forth, to help to ensure that in the high-stress scenarios, the Canadian insurance market and also the reinsurance market is able to honour their obligations under the contracts. So what we’ve seen over the last few years has been insurance companies recognizing, I guess, the magnitude of the exposure and really being very active in managing that exposure.”

Fisher claims there can be “marked variances” in the proportion of personal lines customers who buy the earthquake endorsement by zone in British Columbia, but on average the take-up ratio for such coverage is close to 50 percent in the higher risk zones.

A lack of will

But there is a whole other danger zone on the other side of the country to worry about. Philipp Wassenberg, president and CEO of Munich Re Canada, says he actually read the New Yorker article three times and told his audience at a recent conference that only four percent of Montrealers have quake insurance for their homes and only about 45 percent for their businesses. That means Montreal and Istanbul have roughly similar take-up rates.

Wassenberg is incredulous that a major city in the developed world allows a whole earthquake-prone region to basically go without coverage. Having been in Canada for only two years, he’s asked “many insurance companies in Montreal and Quebec” about the situation.

“And they all say, ‘Well, we would like to sell more, but we can’t.’ And I always say, ‘Why not?’ Well, because it’s expensive. That’s the first answer I get. And I say, ‘Well, but it’s related to the exposure. Is it relatively expensive or absolutely expensive?’ And they say both, because an average premium might be $800 on a homeowner’s policy, and you need to add the same amount again for including earthquake. So in absolute terms it would probably double the premium for the average Montreal homeowner, which, considering the exposure is not unfair at all.

‘The second answer I get is ‘We would like to, but we can’t be the first mover.’ So there is a general awareness and fear of if they were the first mover, they’d get a competitive disadvantage and would lose all the business. Which is a Catch-22. If the insurance industry doesn’t unite and force sales of the product, it will not be sold on its own.”

Wassenberg insists that the reinsurance industry is perfectly able to swallow up the entire extra capacity. “So you don’t even have to bear it. And then they said, ‘Yeah, but reinsurance becomes more expensive,’ and I said, ‘Guys, you’re just passing it on. We’re not making extra money on it.’ So the reinsurance industry is totally, easily capable of adding a couple of billion in capacity onto such scenarios, which we do on other scenarios.”

He sees “little political will” on the subject, “because it’s seen as consumer unfriendly to impose more insurance load on the people… And my solution is always, ‘Well, then at least force the banks to include an earthquake coverage for their mortgage protection. So if the banks told the mortgage loaner, ‘Guys, as with fire, you need earthquake protection for us to give you a mortgage, that would at least bring the burden off the balance sheets of the banks.”

Given the stratospheric tab that could come with a devastating quake on either seaboard, it’s reasonable to ask: at what point does a reinsurer walk away and say it’s all too much and not worth the risk?

“There’s no exact tipping point, obviously, because there’s always the question of how much money the homeowners are willing to pay,” replies Wassenberg. He says the insurance industry is basically willing to cover everything—but according to the models. “So if it requires $75,000, we want $80,000, because the recurrent, the anticipated loss plus some extra money for the administration. So for us there is really almost no walkaway point. The question is: Is enough premium built for us to get it overall?

“And there is a mitigation in itself by insurance companies having very bad and very good risks, and throwing it all into one pool and reinsuring it. We obviously then make a median, and so for us it doesn’t make a difference. But we count, obviously, everything together… But for us it’s all about the calculation of the anticipated loss. And if we get enough money for the anticipated loss, we’ll do it. That’s pretty much our business model.”

Veronica Scotti believes the industry has the ability to put a price on action or inaction. “So I will not be of the school of thought where the industry should sit back, look pretty, and not take risks, because if you don’t take risks, then you don’t pay losses. That’s very much at the core of what insurance is about: understanding risk, assessing it, and offering protection that is commensurate to the nature of the risk.”

Copyright © 2016 Transcontinental Media G.P. This article first appeared in the April 2016 edition of Canadian Insurance Top Broker magazine

Transcontinental Media G.P.