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PACICC warns of ‘risk of financial contagion’ if earthquake losses exceed $30 billion


September 6, 2016   by Canadian Underwriter


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Property and Casualty Insurance Compensation Corp. is urging federal finance minister Bill Morneau to “carefully look” at recommendations made last month in a C.D. Howe Institute report, including a suggestion that Ottawa make arrangements to provide financial assistance to PACICC in case of severe events.

On Aug. 3, the C.D. Howe Institute released the report Fault Lines: Earthquakes, Insurance, and Systemic Financial Risk.

In the report, Nicholas Le Pan, former federal Superintendent of Financial Institutions, suggested that a catastrophe such as an earthquake “would exceed the existing capacity of Canada’s insurance industry and would exceed PACICC’s ability to meet policyholder claims” if losses were to exceed $30 billion.

Toronto-based PACICC, which is run by the industry, is a financial guarantee fund for property and casualty insurers.

Significant historic earthquakes in Canada (Insurance Bureau of Canada)

Significant historic earthquakes in Canada (Insurance Bureau of Canada)

Among Le Pan’s recommendations are to “strengthen PACCIC so it can intervene before insurance companies in financial difficulty become insolvent,” he wrote in the C.D. Howe Institute “For example, PACCIC should have the ability to isolate earthquake business from other insurance business. This might require legislative changes.”

However Le Pan added that unless PACICC “has a federal guarantee similar to that” of crown corporation Canada Deposit Insurance Corporation, the PACICC “will be limited in the financial assistance” it could give.

CDIC protects deposits of up to $100,000 in case of failure of a financial institution.

“In the case of a catastrophe, a liquidity problem can become an industry-solvency crisis as assessments on healthy companies turn out to be too much for them to bear and maintain solvency requirements,” Le Pan wrote. “As well, PACICC’s need to pay current claims over a short time horizon leads to material pressures on other companies, a liquidity event that becomes a solvency problem.”

 

 

PACICC “welcomes the findings” of Le Pan’s report, PACICC CEO Paul Kovacs stated in a press release Sept. 6. “We urge the Minister of Finance to look carefully at his policy recommendations.”

Paul Kovacs, chief executive officer, Property and Casualty Insurance Compensation Corp.

Paul Kovacs, chief executive officer, Property and Casualty Insurance Compensation Corp.

One of Le Pan’s recommendations is to ensure that PACICC has the capability to borrow to reduce its liquidity needs in a crisis.” This, Le Pan wrote, “would bridge more effectively the time between paying claims against failed companies and when assets to meet those claims are available. It would also lessen the PACCIC’s necessity to ‘up-front’ assessments on the insurance industry, thus lessening knock-on financial effects that could cause a systemic crisis.”

Therefore, Le Pan added, “the possibility of borrowing from the federal government should be explored.”

The federal government “has traditionally not wanted to make PACCIC a crown agent like CDIC with a full government guarantee,” Le Pan reported. “Doing so would have broader implications and moral-hazard issues. However, the federal government could consider putting in place arrangements in advance that give it the ability to provide financial assistance directly to PACCIC in case of severe events, which would increase PACCIC’s ability to solve problems with less knock-on impact.”

Canada’s P&C companies can “likely” pay “as much as $30 billion” from insured losses from a major earthquake, Kovacs stated Sept. 6.

“Beyond this threshold, however, the risk of financial contagion rises sharply because the financial health and stability of surviving insurance companies becomes threatened by the need to fund the compensation paid to the policyholders of insolvent insurers,” Kovacs added.

The Canadian p&c industry “currently has claims paying capacity for earthquake coverage somewhat higher than regulatory requirements,” Le Pan wrote in the C.D. Howe Report. “Industry scenario analysis indicates that, for events with losses materially above this level, many insurers would fail and the industry as a whole would be unable to meet claims, including earthquake claims and business and homeowner claims more generally.”

Founded in 1988, PACICC “honours policyholder claims in failed companies up to certain limits and collects any losses, after the fact, through assessments on other member companies,” Le Pan noted. Unlike CDIC, “PACICC has only intervened after a company has failed. It takes over all the covered claim liabilities of a failed company, then assesses other industry members for the estimated compensatory payouts. Then, it must wait for liquidators and the courts to value and distribute assets of the failed company, a process that typically takes from two years to ten years.”

In his report, Le Pan referred to AIR Worldwide’s Study of Impact and the Insurance and Economic Cost of a Major Earthquake in British Columbia and Ontario/Québec, released in 2013.

In its report, commissioned by Insurance Bureau of Canada, AIR modelled the effects of two hypothetical earthquakes affecting Canada, was commissioned by the Insurance Bureau of Canada.

The “western scenario” is a quake at a depth of 11 km under the Pacific Ocean, 9 on the Richter scale, 75 kilometres off the west coast of Vancouver Island. Total insured losses were modelled at $20.4 billion.

The “eastern scenario” at 7.1 on the Richter scale, occurs in the St. Lawrence River Valley nearly 100 km northeast of Québec City. Total insured losses that scenario were $12.28 billion.

“Modern engineered structures should perform well, but poorly-built masonry buildings in particular will experience serious damage,” AIR wrote of the eastern scenario. “The historic unreinforced masonry buildings that are so prevalent in Québec City’s upper and lower towns for example, are particularly at risk.”

In the City of Vancouver, damage to “well-built modern buildings” would be “relatively slight” but the suburbs of Richmond, Delta and Surrey “will be worse hit” because they are “built on silty and sandy sediments.”

In Victoria, there will be “considerable damage to ordinary buildings in areas with the most violent ground motion, and severe damage to poorly built structures,” AIR said in 2013. “Frame houses will move on their foundations if not bolted down and some loose panel walls will be thrown out. Chimneys, towers and elevated tanks will likely twist and fall. Unreinforced masonry buildings will feel the worst effects, including widespread damage to chimneys and some partial collapses. The historic heritage and vintage buildings that give so much character to Victoria and Duncan for example, are particularly at risk.”

Near Esquimalt, B.C., wood residential buildings “will suffer significant damage from landslides and certain areas in Gordon Head, in the northern part of Victoria, may expect substantial landslide damage,” AIR predicted. “Substantial to very heavy flooding damage from the tsunami is expected south of Esquimalt and near Sooke Harbor. Similar levels of tsunami-related flood damage are anticipated in some areas along the Haro Strait, such as Cordova Bay.”

There may be business interruption “for a few months” in Victoria, AIR added at the time.

At Quebec City, “the only bridges to span the St. Lawrence River will be severely impacted,” AIR noted in 2013. “The Pont Pierre Laporte is expected to experience moderate to extensive damage in the form of significant residual movement at connections and damage to the anchorage or to steel members and connections. This extent of damage will require a few months for a full restoration, and as a result the bridge may be closed to traffic for a considerable amount of time. The Pont de Québec carries both a highway and a railroad. Both are expected to experience moderate damage and full restoration is likely to take several weeks.”