The London market is taking stock of Canada’s earthquake exposure. Following recent major earthquakes in Chile, New Zealand, Haiti and Japan, Canada’s own vulnerability to earthquake risk has increasingly come into focus.
As if to underline the potential threat, the Queen Charlotte Islands region of British Columbia experienced a magnitude 7.7 earthquake on October 27, 2012 with, reports the U.S. Geological Survey, 10 further aftershocks recorded, the largest of which was magnitude 6.3.
What used to be regarded as a 1 in 500-700 year event, forming the basis of most rating assumptions, no longer seems as reasonable an estimate as it once did. This has produced increased uncertainty within the London insurance and reinsurance markets which, in turn, has led to some capacity being withdrawn from Canadian property risks and brokers unable to complete all their programs.
With London representing the largest concentration of capacity for commercial property in British Columbia, for example, a reduced appetite on both the primary and reinsurance sides could have a long-term impact on the availability and pricing of (re)insurance coverage for Canada’s commercial and residential property. While this plays out, the growing concentration of risk in the hands of fewer domestic players may also create coverholder unease over the domestic market’s ability to meet the cost of a major, catastrophic event.
IN THE ZONE
In 1946, an earthquake of magnitude 7.3 hit Vancouver Island and became the largest event loss in Canada, while as Risk Management Solutions, Inc. (RMS) reports, a repeat of the 1700 Cascadia earthquake could result in losses of US$40 billion in Canada alone. Research by AonBenfield suggests that although the average recurrence interval for subduction zone earthquakes in Cascadia is 550 years, there have been three in the last 1,000 years alone, with clustering of as much as five events expected between longer quiet periods. As such, there could potentially be further events in this current phase.
Although British Columbia may have the highest earthquake risk in Canada, Ontario’s earthquake in June 2010 proved that other parts of the country also have exposure. It continues to be a case of when, not if, for the country’s next major earthquake.
Despite this very real risk in Canada, it is earthquake activity elsewhere that is doing more to make underwriters nervous. The experience of countries like New Zealand, which shares many topographical similarities with Canada, has illustrated just how much damage earthquake can cause. Entire stretches of land in New Zealand have effectively been “retired” because of the liquefaction of ground following earthquake activity. This has caused underwriters to think again about the earthquake risk in areas such as Richmond, British Columbia, which could experience a similar pattern of destruction to that seen in parts of New Zealand.
IMPACT ON PRIMARY MARKET
The consequence of this growing awareness, at least from a primary insurance perspective, has seen some brokers struggling to complete their Canadian property programs as the London market has pulled back. London market insurers are now far more aware of their overall aggregate limits, contrasting heavily with a few years ago when some insurers operated without set aggregate limits. This is certainly no longer the case.
Other changes include a move toward buying separate reinsurance programs for Canadian property books, enabling London market insurers to write more business than their risk appetite would otherwise allow.
There is also a greater degree of postal code rating being applied, and areas that were previously not seen as such high risk are now attracting a much higher rating. New modelling is showing that Victoria is just as exposed as Richmond. This is where changes to earthquake rating scales are having the most dramatic impact.
Additionally, there is evidence that some underwriters have shifted primary insurance capacity from homeowners to commercial business, owing to a much worse premium to aggregate ratio on homeowners’ business because of the high automatic limits for contents and other coverages.
The overall reduction in appetite from London, however, has provided more opportunities for domestic insurers to pick up this business, which suits many of those insurers who are striving for market share and are prepared to offer the reductions that London will not give. This does have some ramifications for coverholders who, given the insurer consolidation that has taken place in Canada, may be less comfortable seeing a concentration of risk in fewer hands.
There are signs, though, that those lower domestic rates are slowly catching up with rates being offered from the London market.
REINSURERS PUSH UP RATES
The primary markets are, of course, only half the story. London provides something like 20% of Canada’s overall reinsurance catastrophe capacity of some $22 billion, with the balance supplied domestically in Canada, as well as from the Bermuda and United States markets.
Canadian treaty renewals largely take place in January, with 2012 showing a marked change upwards in rates and pricing at the top layers setting the precedent. One reason for this was a change in the long-held perception that Canadian catastrophe reinsurance business does not correlate with that of the U.S. But natural catastrophes do not stop at national borders and there is a growing realization that Seattle and Vancouver, in particular, could be affected in the same event. There is also concern that the clustering of earthquakes could mean a major earthquake in California makes one in British Columbia more likely.
This increase in reinsurance rates made capacity easier to come by in contrast to the primary side, although given the concern around overall aggregates, there were also signs of some reinsurance providers in London pulling back. Signings on lower treaty layers increased significantly at renewal, typically with percentages from the mid-40s to 50s, up to the 90s. This means that any further reduction in treaty capacity or increase in demand at the forthcoming January 2013 renewal may result in treaty programs not getting completed or requiring significant rate increases.
Another factor to take into account has been the regulatory impact of Canada’s Office of the Superintendent of Financial Institutions requiring domestic insurers to increase their reinsurance purchasing to allow for the greater likelihood of a major earthquake being more like a 1 in 400 year event, as opposed to a 1 in 500 year event. The effect of this action has been a greater demand for reinsurance from cedents, albeit on a gradual basis.
The overall impact of global earthquake activity together with specific changes — such as a rapid rise in residential property values in Canada, model changes or increased demand for reinsurance, for example — have reduced the London market’s overall appetite for Canadian property insurance business as rates in some areas struggle to meet expectations. Some insurers have moved their entire Canadian earthquake capacity from direct to treaty business. For treaty business, returns are perceived to be better and tail risk (to extreme events) is lower as most treaties will have exhausted limits at the 500-year level, while losses from a direct portfolio grow exponentially with higher return periods.
That is not to say there are not some great opportunities to do business in Canada, and there are still plenty of committed London players on both the insurance and reinsurance sides. Underwriters, though, will want to see the right ratings and brokers in London may still find, in the short to medium term at least, that they struggle to complete all of their Canadian property programs until pricing gets to the right levels to match the growing perception of earthquake risk in Canada.