Canadian Underwriter

Stop the Gap Measures

February 1, 2016   by Veronica Scotti, President and Chief Executive Officer, Swiss Re Canada

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If someone was approached with an investment opportunity requiring an outlay of $60, but promising a return of $30,000, should that person take it? Such a proposition, while hypothetical, has relevance in the real world.

Manitoba’s Red River Floodway cost $60 million to build and, to date, has prevented $30 billion in flood damage. Granted, there are several more zeros and a whole host of risks in the real-life example, but it shows the pay-off for prevention.

Protection of assets and lives requires foresight and planning, and demands everyone pulling together to keep the nation resilient.


Disaster cost relative to insured assets

The protection gap illustrates what happens when the amount of insurance in force is inadequate to completely fund recovery and resilience. Defined as the difference between economic losses and insured losses, at approximately $2.9 billion, Canada’s protection gap ranks 11th in the world.

Some of the country’s most expensive natural catastrophes recently – the southern Alberta floods and the southern Ontario flash flood, both in 2013 – are clear examples of how big the protection gap can be. Specifically, about one-third of the more than $6 billion of economic losses from the Alberta floods and $1 billion of the almost $1.5 billion in total loss from the Ontario flood was covered by insurance.

Uninsured natural catastrophe risk, which has been rising steadily over the past several decades, makes up much of the protection gap. In Canada, disaster cost relative to insured assets has tripled since 1970, with 55% of weather-related losses being uninsured during the 1980 to 2013 period.

The typical culprits are earthquakes, floods and windstorms, particularly in densely populated areas with higher concentrations of property value. Bush fires, however, are also becoming a growing threat to economic resilience in Canada, notes Fueling resilience: Climate and Wildfire Risk in the United States, released last year by Swiss Re and prepared by students of Johns Hopkins University, School of Advanced International Studies.

Who pays?

When insurers do not have sufficient skin in the game to assist in recovery, the remainder of the burden falls on governments, individuals and local communities.

Average annual Disaster Financial Assistance Arrangements (DFAA) spending has ballooned from $36 million in 1970 to more than $1 billion in this decade. As government programs grow, citizens may be asked to pay higher taxes and communities may also feel the pinch when there simply is not enough money in their coffers to rebuild infrastructure.

Taking it seriously

In the case of flood, for example, industry stakeholders continue to accept the status quo and pray the rain will stop soon. Catastrophe risks still are not being taken seriously enough and there are two fundamental reasons why:

1. “It is not that bad” – This is faulty and ill-informed risk perception. It is difficult to convince someone to take precautionary measures or pay a premium for an uncertain return when the sun is shining and the horizon is free of storm clouds. When average citizens hear the words “1-in-100 year flood,” they simply do not believe the event will occur in their lifetimes.

The (re)insurance industry, as a whole, has a responsibility to practise effective communication and understand its audience. Customers are not risk managers, so industry stakeholders need to make sure to use language that is more relevant and understandable when describing perils and their consequences.

Even experts sometimes fail to understand the underlying risks and accumulation scenarios – a deficiency that is being addressed by more sophisticated maps and models. That said, even with the most contemporary models, underinsurance occurs when risk managers undervalue their assets.

A recent sampling of 630,000 property units in the United States and Canada revealed that properties with limits below US$20 million were undervalued by an average 26%, indicates Swiss Re’s 2015 sigma report, Underinsurance of property risks: closing the gap.

2. “It is not my responsibility” – Society is often hampered by a reluctance or unwillingness to accept ownership of risk. A homeowner may believe there is no need for insurance because the government will bail him or her out even if the home’s foundation cracks from an earthquake. But governments should not be expected to serve as the funder of last resort.

Unfortunately, there is no correlation between disasters and the state of the economy. While the Alberta government was able to respond to the 2013 floods because the economy was in relatively good shape, it cannot be assumed that the government will always be in top fiscal shape when, say, oil prices plummet (they recently fell to 50% of the 2013 values).

Respect the risk

Closing the protection gap starts with a healthy appreciation of floods, earthquakes and other perils. A few statistics underscore their gravity.

By 2100, the 20-year, single-day rain event will potentially occur once every five years. For a person who lives 80 years, that is 16 times in one lifetime.

Despite flooding being the most frequent natural disaster in Canada, awareness of the risk it brings is typically low. As the only G7 country without a mature insurance market for flood – and where the majority of flood risk is uninsured – overland flood exclusions and low sub-limits on residential sewer back-up often leave most property owners with too little to adequately recover and rebuild.

Add to that an inconsistent perception across Canada. This is dramatically evident in the case of earthquake risk: about 60% of Vancouver residential dwellings are insured against quake compared to just 4% of dwellings in Montreal.

The economic consequences, however, do not mirror that disparity: a 2013 study conducted by AIR Worldwide for Insurance Bureau of Canada estimates a 500-year insured loss scenario for a Vancouver Island quake at $20.4 billion and $12.2 billion for a quake northeast of Quebec City. Economic losses can be much higher when low insurance penetration is factored in, particularly in eastern Canada.

A magnitude 9.0 Cascadian quake would be comparable to the 2011 Tohoku quake, yet AIR Worldwide notes the western scenario would result in total direct and indirect loss of $74.7 billion, and total insured loss of $20.4 billion.


Communal resilience

The solution is communal resilience: collaboration among key stakeholders to assess and share the risk and execute pre-event mitigation strategies.

In November, officials from emergency management, public safety, research and finance gathered in Calgary for the 6th Annual National Roundtable on Disaster Risk Reduction to discuss how to construct a “whole of society” approach to managing risks and consequences of disasters.

Swiss Re Canada’s view is that the optimal framework should be based on the fundamentals of the insurance model, where everyone’s interests are aligned and transparency clearly demonstrates where one’s risk begins and others’ ends.

Stakeholders must recognize the three pillars of resilience and play their respective role in upholding those pillars:

• physical – including things such as risk mitigation, building codes and infrastructure investment;

• social – ensuring vulnerable populations are appropriately cared for, as well as an acculturation of sorts, where citizens take responsibility for and invest in the soundness of their properties and personal safety; and

• economic – where physical resilience ends, financial resilience must begin.

Progress to date

With regard to the “physical” pillar, substantive steps are being taken in the stewardship of Canada’s natural resources.

Influential organizations such as the Institute for Catastrophic Loss Reduction – which recently held a workshop in which collaborative watershed management was explored – must continue to advocate for flood plain management to properly manage development in vulnerable areas.

In terms of the “social” pillar, DFAAs have historically paid for all losses. But as overland flood insurance becomes more widely available in Canada, it is expected that the scope of DFAA will change.

Regardless of its future state, however, insurers and emergency management authorities must remain focused on improving building codes and educating citizens on risk prevention and mitigation measures.

And, last, the “economic” pillar requires that governments respond swiftly in the wake of disasters, when infrastructure is compromised and roads and bridges are washed out.

Pre-disaster financing is a viable solution because it makes funds immediately available to not only rebuild, but to activate emergency responders such as firefighters and paramedics.

Currently, provinces may need to wait months or years before they can collect from the federal government funds that they have advanced to their population through pre-paid cards.

Without market-level, pre-disaster financing solutions, the cost of recovery is inevitably borne by the taxpayer to make up revenue shortfalls and other critical services are often reduced or eliminated from the budget.

Those are the roles for government and individuals, but what about insurers? Flood recovery has always been a thorny issue, which is understandable since few carriers offer coverage specific to the peril.

That, however, looks to be changing. More than two years since the waters receded in Alberta and Ontario, there is good news to report: risk awareness and assessment capabilities have greatly improved; Canadian underwriters are using flood zones widely and flood-modelling tools are being rolled out to better assess the accumulation risk.

These advancements are laying the foundation of a private market for residential flood insurance in Canada: several carriers are offering overland water endorsements in selected areas, complete with ways to help policyholders manage their premiums and discounts for customers who take preventive measures.

Ultimately, public/private collaboration is key to closing Canada’s property protection gap. No single entity or organization can act alone.

As a society, everyone needs to understand it is a case of when – and not if – the next disaster will strike. It is everybody’s responsibility to make sure society, as a whole, is prepared.