Canadian Underwriter

Quake Conundrum

January 31, 2014   by Craig Harris, Freelance Writer

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The earthquake threat in Canada is rising to the surface. Several recent studies have identified the exposure in regions of the country and provided detailed economic loss scenarios. A study by catastrophe modeling firm AIR Worldwide, released in October 2013 and commissioned by Insurance Bureau of Canada (IBC), put the total economic loss of a “realistic” earthquake event in coastal British Columbia at $75 billion.

Another report published in January 2014 in the Bulletin of the Seismological Society of America suggested that the sedimentary nature of the Georgia Basin underneath Vancouver could make the ground shake three to four time greater if a quake occurred within 100 km of the city.

“The shaking in (Metro) Vancouver would be greater because of the presence of the Georgia Basin, especially when the earthquake occurred to the south or southwest,” lead author Sheri Molnar, of the University of British Columbia Civil Engineering department, told the Canadian Press.

Even the Canadian federal budget released in February got in on the action, pledging $200 million over five years to create the National Disaster Mitigation Program, including $11.4 million to upgrade earthquake monitoring.

Mid-January also represented the 20th anniversary of the Northridge earthquake in 1994, the most devastating example of a tremblor close to home. That 6.7-magnitude quake in Los Angeles killed 57 people, injured thousands and cost $42 billion in total damages – still the second costliest disaster in U.S. history after Hurricane Katrina.

More recently, of course, there was the March 2011 magnitude 9 Tohoku earthquake and tsunami in Japan, which resulted in more than 18,000 deaths and a worldwide record total economic loss of $300 billion, of which $40 billion was insured. In February 2011, a powerful 6.3 magnitude quake in Christchurch, New Zealand caused widespread damage to buildings and left 185 people dead. The ongoing costs of rebuilding amount to over $40 billion. And a magnitude 8.8 earthquake that struck central Chile in February 2010 claimed more than 500 lives and led to total losses of about $30 billion.

“As adjusters, we need to be prepared for a ‘worst case’ scenario, such as was seen most recently in Japan, New Zealand and Chile,” notes Jim Eso, senior vice president, property & casualty, Crawford and Company (Canada) Inc. “Crawford has specialized adjusters with significant experience responding to earthquakes. We also have our own business continuity plans to do what we can to ensure that our own operations in an earthquake zone can recover quickly after an event.”

Albert Poon, director of operations for Cunningham Lindsey Canada Claims Services Ltd., says his firm was heavily involved in helping to handle the more than 40,000 claims from the Christchurch quake.

“We have a relatively high level of EQ risk awareness in Canada because of our deployment to assist with the losses in New Zealand,” Poon notes. “Cunningham Lindsey Canada provided assistance through 25 adjusters, with an average stay in Christchurch of three months; some staying up to a year. Our adjusters handled 9,000 out of the 40,000 claims, of which 50% was commercial.”

With the statistics and examples of earthquakes around the world, one might think that residents in B.C. and Quebec-Ontario would have a similarly high level of awareness of the threat in Canada and insurance options. Yet, according to the Office of the Superintendent of Financial Institutions (OSFI), the market penetration of earthquake insurance is low, even in the high-risk regions. In B.C., 45% of residential properties and 85% of commercial properties are insured against earthquake. In Quebec, those figures are, respectively, 4% and 60%, according to OSFI.

“Unless people perceive it has some value for them, they won’t pay the extra money for it (earthquake insurance)” says Fred Plant, president of Plant Hope Adjusters Ltd. “Most people would say, ‘yes, earthquakes happen sometimes somewhere else, but nothing major has ever happened here.’ For many, it is ‘out of sight, out of mind.'”

Other factors may play into the relatively low take-up rates for earthquake insurance, such as recent premium increases, high deductibles (typically 10% of total insured value) and the possibility that fire following an earthquake could be covered even without quake insurance in place. But Eso agrees that the mindset of many Canadians is to not take the threat of a major tremblor too seriously.

“My own thought is that the reality is more likely a combination of ‘out of sight out of mind’ and ‘the government will cover it anyway’ as the reasons why people don’t want to pay the now significant cost of the optional coverage,” Eso observes. “There is a significant opportunity for increased education and awareness of the value of the optional coverage.”

There are many signs that the risk of a major earthquake is quite real in specific regions of Canada. Natural Resources Canada reports that Vancouver Island and parts of the St. Lawrence Valley are at a 30% risk of a significant quake in the next 50 years. Other parts of B.C., Quebec and Ontario face a 15% risk of a major tremblor during the same period.

In fact, Western Canada experiences more than 1,000 earthquakes a year. There have been more than 100 quakes of magnitude 5 or higher off Vancouver Island in the past 70 years, including the 6.1 magnitude quake that struck off the B.C. coast in September 2013.

To get a better handle on earthquake exposure in Canada, IBC commissioned the AIR Worldwide study, the first such report since a Munich Re analysis in 1992. AIR modeled two 1-in-500 year earthquake scenarios, both attributable to established seismic sources and similar to earthquakes known to have taken place in the past:

• Western scenario ( a magnitude 9 Western Cascadia Subduction event); and

• Eastern scenario (a magnitude 7 Eastern Charlevoix Crustal event.)

In the Western scenario, AIR modeled the impact of a major earthquake occurring 75 km off the west coast of Vancouver Island, 300 km from downtown Vancouver. In that event, the overall economic losses would total $75 billion, with $59 billion due to direct property damage and roughly $13 billion attributable to interruptions in supply chains and economic activity.

AIR also looked at insurance claims in this scenario, which amount to $20 billion or just over one-quarter of the total losses. Of the insured losses, 58% related to commercial coverage and 40% residential, with most of these losses linked to building (54%), contents (33%) and business interruption (13%). In this mock event, shake is the leading cause of insured losses (85%), followed by liquefaction and landslide, tsunami (5%) and fire following (0.1%).

For the Eastern scenario, AIR examined a magnitude 7.1 earthquake 10 km beneath the St. Lawrence River and 100 km north of Quebec City. Overall economic losses in this model are $61 billion, of which only $12 billion would be insured (mainly because of low earthquake insurance penetration). While the distribution of losses is similar to the Western scenario (57% damage to commercial property, 42% to residential), virtually all of the insured losses would be due to ground shaking. The rest of the losses would be due to localized fire following.

In this model, AIR notes that the infrastructure and pubic assets are at risk, representing 7% of total direct losses. This means that roads, pipelines, bridges and tunnels in Quebec City and east along the St. Lawrence River would remain closed for weeks, and potentially months. Significant losses would also be experienced by the electricity and telecommunication sectors.

With the documented extent of the potential damage arising from a major quake, independent adjusters don’t have the luxury of complacency when it co
mes to preparation and awareness.

“I think adjusters in general and at Crawford specifically have a fairly high level of awareness of the risks of an earthquake,” Eso observes. “Some might say that adjusters are too often pessimistic or cynical about risk and damages, but in this case, the reality of ‘when, not if’ is one that adjusters see every day in their work. We understand the reality that a significant event could occur at any moment, and will most certainly occur eventually.”

One of the main reasons why earthquake risks are unique from other natural catastrophes is the devastating impact in a relatively small geographic area, according to Poon.

“EQ risks are different primarily because of their profound effect on infrastructure, namely bridges, tunnels, airports and roadways,” Poon notes. “Whether it be government imposed or physical damage restricting passage, damage to this type of infrastructure severely impacts our ability to get to the scene. Other unique attributes of EQ risk include government’s involvement with new rebuilding standards, restrictions to building reconstruction and their prioritizing of reconstruction.”

Eso agrees that sending adjusters to an earthquake-ravaged region presents a range of obstacles. “The logistical issues will start with the immediate destruction of critical infrastructure such as roads, water mains, sewage and power distribution,” he says. “If we are talking about a major quake in the lower mainland of B.C., air traffic to YVR may also be disrupted. All of these factors will make insurance assessments a challenge and deployment of adjusters will be delayed while emergency workers deal with the immediate needs of the residents.”

Earthquake damage also presents specific coverage interpretation, assessment and investigation issues for independent adjusters and their clients.

“Coverage issues, especially relating to the ‘fire following’ that may occur, as well as application of deductibles and damage to property other than the insured building should be identified and prepared for as part of the catastrophe response plan” says Eso. “Earthquake damage caused by shaking has a significant ‘hidden damage’ component to it, as damage to supporting structures in a building may not be immediately apparent, but may be significant and require extensive engineering investigation.”

Poon also notes that factors like deductibles and cause of loss can muddy the waters of any earthquake loss event.

“Unique coverage issues pertain to deductible and the ability of the homeowner or business owner to cover the cost of the deductible,” says Poon. “In many regions of B.C., EQ deductible is a percentage of the total insured values with significant minimums. This can cause real issues with funding reconstruction. When you add business interruption to this mix, the problem is compounded.”

The complex logistics, emergency response and coverage interpretation issues of a massive earthquake represent formidable obstacles to any working CAT plan for adjusters, according to Plant.

“Frankly, we don’t have a clue what it would look like if half of Quebec City caved in tomorrow because of an earthquake,” Plant notes. “You would have chaos at every level: municipalities, provincial governments, insurers. I am sure they would all do their best in terms of forecasting what their response would be, but in the end it would be every man for himself – at least for awhile.”

Plant argues that the best sources of information are the adjusters who have been through similar earthquake events. “Those are the people we need to go to, ask the questions and get some kind of idea of what we are dealing with,” he says.

In this case, global adjusting firms have an advantage in either taking lessons from adjusters in affected regions or sending over Canadian adjusters to experience the aftermath of an earthquake.

“We have had Canadian adjusters deployed to earthquakes in regions around the world,” Eso observes. “All of those people have collective knowledge about what works and what doesn’t work after a major earthquake. Our staff has experienced the response in action, in real time.”

Eso notes that some of the principles in claims response may be similar or the same, but there are key differences in local situations. For example, Christchurch had a number of old historic buildings, which impacted the level of damage. In Chile, the wine industry was severely affected, with many of the losses involving business interruption and product loss. Other factors, such as local regulations and language, can also play a role in earthquake response.

“And then there was Japan, which was unlike anything else we have ever seen in the combination of tsunami, earthquake and damage to a nuclear power plant, ” Eso explains. “If you were scripting a worst-case loss scenario for a mock disaster, it couldn’t have been any worse than this. How do adjusters work when you have those kinds of conditions?”

For Eso, it comes down to two things. “You fall back on experience and a well-documented catastrophe response plan,” he says. “Issues like employee safety, communications, logistics are the things you have to walk through one step at a time. You should have a plan in place ahead of time and be prepared to follow it.”

Poon says Cunningham Lindsey’s experience in the Christchurch earthquake imparted several critical lessons for the adjusting firm. These include:

• Pre-planning for earthquake scenarios and response;

• Spreading out specialized teams of earthquake-trained adjusters across the country;

• Having senior, experienced adjusters who know about safety, building construction, by-laws and business interruption;

• Setting up a command centre outside the major EQ zone that coordinates travel, communication, logistics;

• Coordinating catastrophe response by someone not handling claims on a day-to-day basis;

• Understanding coverage issues, damage, deductibles as % of total insured value, escalating deductibles;

• Responding to earthquake with adjusters who are multi-or bi-lingual (i.e. adjusters in New Brunswick for Quebec EQ);

• Committing to stay for duration of EQ event;

• Having an expectation period of 3-4 days before resources are in place in affected area;

• Understanding that local restoration/construction will have limited resources.

For Cunningham Lindsey, several factors must come together in an effective earthquake response plan, according to Poon.

“We’ve already partnered with a number of our key commercial clients, both insurers and insureds, to develop a tailor-made earthquake catastrophe plan,” Poon says. “These plans include the appointment of a CAT Coordinator and key senior commercial lines adjusters, (as well as) experts and vendors such as contractors, engineers and accountants.”

He adds that the firm has also arranged call centre details and protocols for reporting losses and applicable deductible and aggregate limit details, in addition to store/warehouse/building locations and workflow/action plans.

In a severe earthquake scenario, it’s obvious that any working CAT response plan will be put to the test. It has to be flexible enough to adapt to local situations, foresee and accommodate workarounds and consider alternatives, such as bringing in international adjusters and specialists.

The question may be not just how to deal with the claims aftermath of a massive mega-thrust earthquake, but whether the insurance industry can financially weather such a catastrophic event. OSFI’s current regulatory standards require insurance companies to have sufficient capital and reinsurance to withstand a 1-in-500 year earthquake by 2022. But what if a massive earthquake exceeds that level?

OSFI’s 2012 Earthquake Stress Test estimated that a major quake in Vancouver could lead to about $30 billion in insured losses. In that scenario, 55% of insurers would fail their Minimum Capital Test (MCT) requirements and 35% wou
ld become insolvent. The potential for domino effects across the industry and systemic insolvency at that point could be real.

IBC is advocating a national funding model that would provide protection at a time of severe risk. The idea calls for a joint public-private cost-sharing plan for a mega-earthquake that exceeds a 1-in-500 year event. The industry trade group is actively pushing for increased earthquake insurance penetration and a workable funding plan that anticipates this possibility. The response from governments, including at the federal level, has been cautious but open to discussion.

An interesting finding of the AIR Worldwide study was the substantial gap between insured and total economic losses in both the Western and Eastern scenarios. If private insurance only accounts for 20-25% of losses in a major earthquake, that means government is on the hook for the remainder.

One of the key building blocks in any earthquake response and funding plan is a wider embrace of private insurance and a renewed emphasis on earthquake loss reduction programs. The pursuit of such a framework must first address the conundrum of complacency and low public awareness of earthquake risk in Canada. And that may be a tall order for a country that has not experienced a major shake loss in recent memory.

In the meantime, independent adjusters can only prepare as well as they can and ensure their CAT response plans are thorough and flexible enough to cope with the potential of a “big one.”

Time, and the shifting plates of the earth, will tell if and when these plans are needed.

Download the IBC Study [PDF]