How an earthquake or sun spot could cripple Canada’s P&C industry

Canadian property and casualty insurance carriers are well prepared to respond to a natural catastrophe giving rise to claims of up to $15 billion, but a disaster with insured losses of $30 billion or more will overwhelm the industry, suggests a report released Thursday by the Property and Casualty Insurance Compensation Corp.

In its report, titled “Why Insurers Fail: Natural Disasters and Catastrophes,” authors Grant Kelly and Peter Stodolak discuss the possibility of costly catastrophes such as an earthquake in British Columbia or Quebec, an asteroid strike on a major urban area or a solar storm that damages electrical components.

P&C carriers in Canada, by law, are required to be members of PACICC unless they are members of a farm mutual guarantee organization or unless their only product in Canada is a specialty line, such as mortgage, marine or aviation, not covered by PACICC. The organization’s purpose is to ensure that policyholders do not experience undue hardship in case a member insurer fails.

In the report, PACICC suggested in the event of a major catastrophe exceeding $15 billion, it is possible a carrier could pay its claims and remain solvent but subsequently become insolvent due to its responsibility to pay part of the cost of claims made against failed insurers.

The report includes results of model where PACICC predicts the number of insurers who would fail at various industry-wide catastrophe losses under various conditions. For each model, it predicted the number who would fail due to the catastrophe itself and the number who would become insolvent due to their PACICC assessments.

For example, at $20 billion, the model predicts seven carriers would be insolvent due to the catastrophe and one additional carrier would become insolvent due to PACICC assessments, using currently industry capital and reinsurance.

However, when accounting for the industry capital and reinsurance coverage predicted in 10 years, the model predicted that with a $20 billion catastrophe, five carriers would become insolvent due to the catastrophe itself and one additional insurer would become insolvent due to PACICC assessments.

But the picture becomes bleaker when modelling for a $30-billion event.

“PACICC’s model suggests that multiple large insurers become insolvent at $30 billion,” according to the report. “In the case of a $30 billion event it is estimated that PACICC assessments on surviving member insurers could approach $25 billion. This assessment is so large that every PACICC member across Canada would fail the regulatory solvency tests.“

But PACICC added few perils actually have the potential to result in $30 billion in losses. Examples would include a large earthquake in Vancouver or Montreal.

“A large subduction earthquake in B.C. would cause economic damage equivalent to 5% of Canada’s 2011 GDP, and would result in approximately $30 billion in insured losses,” PACICC said. “More than half of the insurers would fail the regulatory minimum capital test (minimum capital test or branch Adequacy of Assets Test of less than 150%) before management action.”

Other examples of $30-billion catastrophes could include an asteroid strike on a major urban centre and an “extreme space weather event.” PACICC noted in 1859, sun spots larger than any observed in 500 years, observed by amateur astronomer Richard Carrington, resulted in damage to telegraph machines.

“Research to understand and help manage the risks associated with the next solar superstorm, like the 1859 Carrington event, has been under way for about a decade, but the implications for society and potential impact on the insurance industry is only emerging,” according to the report. “The impact of an extreme space weather event on the Canadian insurance industry is unknown, but there is some risk that it could result in several tens of billions of dollars of claims, potentially exceeding the industry’s financial capacity.”

The report also referred to the explosion over Tunguska, Russia in 1908, from either an asteroid or comet, that destroyed trees over a 2,000 square kilometre area. PACICC says there is a 5% to 10% chance of a similar strike on earth in the next 50 years. But rather than hitting a major city, the report suggests, a more likely result of such a strike would be a tsunami because about 70% of the earth’s surface is covered by water.

PACICC notes it has never been required to respond to multiple member insolvencies. In 60 years, only two Canadian carriers — National General Insurance Co. and Mennonite Mutual Hail Insurance Co. – have failed due to natural disasters. National General closed in 1952 after major flooding in 1950 on the Red River in Manitoba, while Mennonite Mutual Hail, which had a “major reduction in capital” after hail storms in Manitoba and Alberta, was shut down in 1984.

The report said the three costliest natural disasters in Canadian history, in order of insured losses, were the ice storm in Ontario and Quebec in 1998 ($1.295 billion), the fire in Slave Lake, Alta. in 2011 ($700 million) and a storm in Toronto in August, 2005 ($590 million).