Split Personality

What if?

Making a convincing argument to prepare for and secure coverage in the event of “what if?” can be challenging. Consider, for example, Canada’s experience with regard to earthquake risk, awareness and insurance up-take.

One would need to be living under a rock not to have heard or read at least something about the impact quakes have had around the world in the last few years: Japan, New Zealand and Italy, among other regions.

True, Canada is likely not viewed as an earthquake hotspot, although seismologists locate an average of 1,500 quakes each year in the country. And perhaps with only a portion of these, about a 100, felt by humans, Canadians likely can be forgiven for considering the potential unlikely, the possibility remote and the peril an unreal threat.

But that is the thing about earthquakes. One cannot predict exactly when they will happen; one can only consider past history and current conditions.

If that is the test, it has been estimated there is a 30% chance of an earthquake strong enough to cause significant damage in southwestern British Columbia in about the next 50 years, and a 5% to 15% chance of such a quake somewhere from the St. Lawrence River Valley to the Ottawa Valley.

Those in Canada’s p&c insurance industry are considerably more well-versed on the topic than Canadians in general, understanding that a severe quake could produce adverse ripple effects that touch everyone from policyholders to the industry, government and the Canadian economy.

In 2016, both the Conference Board of Canada and C.D. Howe Institute put forward recommendations that the federal government adopt a last-resort, emergency back-stop mechanism for a catastrophic earthquake.

The conference board argues the impact of a 1-in-500-year loss event is sure to produce long-lasting economic losses and could put the national economy in jeopardy. The C.D. Howe report, for its part, further called for bolstering the Property and Casualty Insurance Compensation Corporation (PACICC), which would help reduce the likelihood that a federal financial commitment would be triggered.

Getting buy-in from individual policyholders, however, continues to be a challenge. It is hoped that enhancing public awareness of earthquake risk and understanding of the importance of quake endorsements will help move along insurance uptake issue.

A severe quake will, no doubt, make demands of everyone involved in the insurance chain. By ensuring that policyholders have a firm grasp of potential costs and ramifications, the hope is this may tilt them towards greater uptake, thereby avoiding being a weak link that has implications all the way down the chain.

UPTAKE, UP OR DOWN

“Earthquake insurance is available across Canada as additional coverage and covers the loss or damage to your property and its contents caused by the shaking of the earth,” says Don Forgeron, president and chief executive officer of Insurance Bureau of Canada (IBC). “Coverage for earthquake damage is not included in a standard home insurance policy, but can be purchased as an add-on to your existing policy,” Forgeron notes.

“Take-up in Quebec is negligible, with only about 2% of households buying the coverage despite the high seismic risk in the region,” he says. Compare that to British Columbia where “approximately 40% to 45% of households have coverage,” he adds.

Joel Baker, president and chief executive officer of MSA Research Inc. and Catastrophe Indices and Quantification Inc. (CatIQ), and Carolyn Rennie, managing director of CatIQ, suggests that “it seems there is still a lack of communication about the risk in eastern Ontario and Quebec.”

“Property owners need to be aware of earthquake risk in order to buy insurance,” Balz Grollimund, Swiss Re’s head of underwriting for Canada and the English Caribbean, points out.

Beyond a lack of awareness, Philipp Wassenberg, president and chief executive officer of Munich Reinsurance Company of Canada, suggests that low uptake may be as a result of a number of false attitudes and perceptions: government will cover costs; an earthquake will not happen in the person’s location or during his or her lifetime; and cover is already included in the policyholder’s homeowners/property insurance.

“While there has been quite a lot of talk about earthquake risk and potential costs, it rarely moves people enough to purchase earthquake insurance – at least to a degree that would show a notable increase in uptake,” suggests Maiclaire Bolton, a seismologist and senior product manager, global earthquake products for CoreLogic.

In addition, earthquake “cover is not easily sold; it is costly even in low-risk areas and there’s no incentive/mandate, such as earthquake insurance requirements for mortgages,” Baker and Rennie maintain.

Grollimund would likely agree that price is a stumbling block to uptake. “The premium for earthquake insurance can be considerable even with a substantial deductible.”

“For many years, there has been a fear of earthquake insurance being too expensive, because the deductibles have traditionally been quite high,” Bolton says. “With the rising cost of housing, especially in the urban areas of B.C., it can be a bit daunting to the average homeowner,” she adds.

“While many Canadians are moderately or highly exposed to earthquake risks, many still underestimate them and choose not to increase their home insurance protections accordingly,” says Valerie Lamarre, a spokesperson for Desjardins Insurance.

“This is a concern for Desjardins Insurance, as we want our members and clients to be well-protected,” Lamarre points out.

Calling earthquake underinsurance a critical problem for the country, “post-quake recovery will be more gruelling, prolonged and costly to taxpayers than in other countries where quake cover is more prevalent,” Baker and Rennie contend.

“Uptake of earthquake policies would reduce the negative effect on the economy by providing liquidity to the end-consumer and solvability to the insurer,” suggests Wassenberg. “There is no capital shortage in providing earthquake coverage. Risk can be passed directly through insurers to reinsurers, where the risk is further diversified to global reinsurers,” he explains.

Although reinsurers, most of which are global, would largely be able to absorb the losses, that may not be the case for primary insurers with significant exposures, Baker and Rennie say.

However, “a catastrophic earthquake off the coast of B.C. would cause big issues for the insurance industry in Canada,” they say, citing estimates from the Property and Casualty Insurance Compensation Corporation (PACICC) that “cascading failures of insurers will likely take place once earthquake losses breach $30 billion.”

Add Baker and Rennie, “There’s currently no formal government back-stop for the industry so a major quake would imperil swathes of the p&c industry, leave many consumers in the cold (because most aren’t insured), dent the banks and the larger economy, and leave governments and taxpayers holding the bag.”

“One benefit of insurance is it helps move the discussion on mitigation forward, which, ultimately, could reduce the cost of the event when it occurs,” Bolton suggests. “Once you are able to address the cost of an event and the ability to mitigate the impact of the severity, you can move forward with preparedness to manage the risk from both a public safety and an insurance perspective,” she suggests.

DAMAGE TOLL

David Harvey, president of the Structural Engineers of B.C. and a bridge specialist with Associated Engineering (B.C.) Ltd., says quake-related damage will depend on numerous factors. What is the type of soil at the site? How do the soil and structure interact? How do they respond to earthquakes? Where is the earthquake’s epicentre? How deep is the earthquake? For how long do the strong motions continue?

“While ‘magnitude’ is used to describe the energy released at the hypocentre, ‘intensity’ refers to the observed effect of the quake at the surface,” Wassenberg says.

“An earthquake will only have one magnitude, but will have different levels of intensity at each site,” Bolton explains. “If you look at intensity at each site, in general, you can say that intensity, specifically Modified Mercalli Intensity (MMI), of level 7 (on a scale of 1 to 12) is where structural damage generally begins,” she points out.

“A small, shallow earthquake in an area with soft soil will have more significant intensity (or shaking) than a larger, higher-magnitude quake that occurs deep in solid rock. It’s the shake that does the damage,” Wassenberg says. As well, building age and local building codes “will also determine the extent of damage,” he notes.

“Damage is determined not by magnitude, but by the severity of shaking at the location of exposed properties and by the level or preparedness of exposed structures,” Grollimund points out. “For instance, the most damaging of the Christchurch, New Zealand earthquakes ‘only’ had a magnitude of 6.3, but the epicenter was located very close to Christchurch’s central business district. Therefore, there was a lot of damage.”

“Depth is also important,” says Bolton. “Deeper earthquakes generally cause less damage than shallower earthquakes, because the ground motions decay a bit as they travel up to the surface,” she notes.

“In British Columbia, the construction type (and age of construction) of the building stock is very different than the building stock in Montreal or Quebec City, especially the old, beautiful historic buildings, which are very vulnerable types of buildings,” Bolton comments.

“Shaking can cause both structural and non-structural damage,” Bolton says. “Secondary impacts include damage due to fire following earthquake, sprinkler leakage, landslides, liquefaction, tsunami and additional impacts, including infrastructure damage – which can contribute to the longer recovery,” she adds.

Following a severe quake, Baker and Rennie point out, “government services will be impaired, water, hydro, sanitation, etc. – recovery can be very long and extremely costly,” they maintain.

Ultimate damage will reflect many factors, including “the relative severity of the initial and subsequent events, the number of aftershocks and their duration,” Harvey says. With the Canterbury, New Zealand quake, for example, “the most damaging event may actually be an ‘aftershock’ following an initial, less severe earthquake,” he notes.

“When it comes to earthquakes, both the quake itself and the post-quake events can severe and concerning,” suggests Amy Graham, property leader at RSA Canada. “For example, if you look at the earthquake which happened in Japan in 2011, the damage from aftershocks, fire, and/or tsunami was catastrophic,” Graham adds.

Each earthquake will have a unique effect on local soil conditions, says Wassenberg. “In-land quakes will increase the risk of soil liquefaction and landslide; off-shore tremblers increase the risk of tsunami. Aftershocks are common, further weakening those buildings already affected,” he points out. “Fire after an earthquake is common as gas lines breaks are ignited by damaged electrical lines.”

Wassenberg says an earthquake policy would cover a person’s home and contents against any shake damage resulting from a quake.

“Standard property insurance only covers fire damage, which may result from an earthquake,” adds Grollimund. “However, past earthquakes have shown that fire-related losses are only a small portion of the total damage. The vast majority of earthquake damages are, therefore, not covered unless an earthquake endorsement is purchased,” Grollimund explains.

“Numerous earthquake models of recent vintage are available to assess Canadian earthquake risk for all relevant types of property,” says Grollimund. “Therefore, given the right underwriting expertise, it is possible to price Canadian earthquake coverage appropriately for all locations and types of properties,” Grollimund adds.

PERSONAL OR COMMERCIAL?

“Taking a look at catastrophic losses from the 2013 floods in Calgary,” Baker and Rennie say, CatIQ’s most recent industry loss estimate indicates about 66% of claims are commercial, 30% personal and 4% auto. “As a significant earthquake would cause similar damage, and considering underinsured personal lines, we would expect costs to break down somewhat similarly (with significant additional living expenses and business interruption losses),” they add.

Making clear it will always depend on the particular event, where the quake occurs and the insurance that is in place, Bolton says that “for most typical events, the breakdown is one to one for personal property and commercial property. This has been observed in catastrophic events like the 1994 Northridge earthquake, 2011 Tohoku Japan earthquake, as well as 1992 Hurricane Andrew and 2012 Superstorm Sandy.”

“Internationally, there have been examples of earthquakes with primarily commercial insurance losses, such as the 2010 Chile earthquake, but also earthquakes with primarily residential losses, such as the 1994 Northridge earthquake in California,” Grollimund says. “The latter impacted areas mainly covered by suburban sprawl.”

That said, “the majority of the insurance claims burden for a large earthquake would, ultimately, be carried by reinsurance. International experience has shown that the reinsurance industry is well-prepared to handle claims from large earthquake events,” Grollimund says.

He cites as examples the 2011 Tohoku earthquake in Japan, the 2010/2011 Christchurch earthquakes in New Zealand, and the 2010 earthquake in Chile.

MODEL PERFECT?

“Numerous earthquake models of recent vintage are available to assess Canadian earthquake risk for all relevant types of property,” Grollimund reports. “Therefore, given the right underwriting expertise, it is possible to price Canadian earthquake coverage appropriately for all locations and types of properties,” he maintains.

Harvey points out that seismicity is still developing, although site risks across Canada are broadly understood.

“Less clear is how existing structures will actually respond because so many factors influence performance,” he suggests. “Even less clear,” he adds, “is whether the structure is repairable after the event (life safety is required, but post-earthquake use is not addressed by the building codes). Occupant (tenant) losses are virtually unknown because there are so specific,” he contends.

Acknowledging that models are improving, Baker and Rennie say, nonetheless, “models are just that. Pricing is based on the latest science and actuarial data. We don’t believe that companies are actively undercutting this cover.”

“Canada is one of the top countries in the world dedicated to a higher regulatory compliancy for earthquake risk,” Bolton says. “The goal of the Canadian regulatory environment is to help reduce the probability of ‘risk of ruin’,” she says.

Pointing out that the Office of the Superintendent of Financial Institutions (OSFI) regulates the minimum amount of reinsurance limit required for the peril of earthquake, Bolton says that “as of 2016, Canada is up to a return period of 450-year loss, with the goal of getting to 500-years, which from a solvency perspective, is nearly double than most countries around the world.”

Says Forgeron, “While modelling has improved, it can still be uncertain – a small error could lead to serious implications for Canadians and governments when it comes to risk and preparedness.”

GETTING EDUCATED

“In terms of earthquake insurance uptake, Canada is a country of extremes,” says Grollimund. “While British Columbia is among the regions with the highest take-up rate for earthquake insurance of private dwellings, eastern Canada is among the lowest. Tackling the considerable earthquake protection gap is key to ensure eastern Canada, and Canada as a whole, is better prepared,” he emphasizes.

That makes policyholder understanding of the risks and potential costs all the more important.

“Preparedness is vital in the event of an earthquake. Individuals, businesses and government all have a responsibility to prepare for the worst,” Wassenberg says. “Public education and awareness needs to continue. It’s not a matter of if it will happen, but when,” Wassenberg adds.

“Insurance incentives would encourage designers and building owners to build better-performing buildings,” Harvey argues, citing the fact that base-isolated buildings in Japan – base-isolated buildings and non-structural components were undamaged in the Kobe earthquake and occupants were able to recover very quickly – “have attracted premium prices and rental rates,” he reports.

“Risk-appropriate pricing should incentivize property owners of buildings with earthquake-resistant design,” Grollimund adds.

In California, “the California Earthquake Authority has recently begun offering reductions in premium for retrofitting. This is a great way forward. Incentives will definitely help,” Bolton notes.

“Appropriate building standards are the best way to mitigate damage,” Grollimund contends. “Building an earthquake-resistant building does not add much extra cost when considered during the construction phase,” he points out.

Retrofitting existing properties can be costly. “This is especially true for unreinforced masonry buildings, which are prevalent in eastern Canada and which tend to fare poorly during earthquakes. However, the cost of fixing a building after it’s been damaged by an earthquake is often more costly than the initial retrofitting,” he says.

“As an insurer, earthquake damage at the catastrophic level is a preoccupying risk and cannot be covered by the insurance industry alone,” Lamarre maintains. “Therefore, we believe there is a strong need for establishing a federal government emergency back-stop mechanism that could come into play and complement the insurance industry coverage when such a catastrophic risk occurs,” she notes.

“In order to facilitate putting such an arrangement into place, a minimum of uniformity in the insurance industry earthquake product offer is desirable,” Lamarre suggests.

Harvey’s take is that “insurance rates should reflect potential damage loss, which could be more 100% replacement value for a (barely) code-compliant building, and little or no loss for an immediate post-seismic occupancy building.”

LOOKING FORWARD

“The risk of earthquake in Canada is real. Whether it’s in the east or west, a significant over-modelled quake will have a significant negative effect on Canadian insurers, and the Canadian economy as a whole,” Wassenberg cautions.

For a super-catastrophic quake, one beyond a 1-500 year event, “there is a growing awareness that Canada may be unprepared for an extreme event,” he says.

“While the insurance industry can, and will, do its part, there is a need to formalize the role government can play in helping to manage the financial and economic impact of a super-catastrophe. Several earthquake-prone countries around the world have their governments playing a key-role in co-managing earthquake risk,” Wassenberg adds.

Bolton regards earthquake insurance as “an important part of earthquake preparedness by giving consumers (whether it be homeowners or commercial property owners) the financial strength to rebuild following an earthquake.”

Addressing current gaps in public policy and consumer protection “can only be possible if industry and government work together on earthquake preparedness. A strong capitalization regime on its own is not sufficient,” argues Forgeron.

“Better building codes at the provincial and municipal levels and a viable framework for sharing financial risk at the federal level are needed in order to have a strong safeguard against the effects of a major quake,” he maintains, adding the approach “mirrors what most other earthquake-prone jurisdictions have already done.”