Earthquake: The risk that could take the industry down

When the CEO of the largest insurance company in the country warns of a risk that could take down the industry, it’s time to take notice. In an article published in the Globe and Mail’s Report on Business, Charles Brindamour, CEO of Intact Financial Corp., commented, “We sailed through the financial crisis with no issues. And this led us, at the time, to say: ‘What is a big issue for us? What is the systemic risk for the industry?’ There was one in my mind. And it was quake… As far as I’m concerned, this is the risk that could take the industry down, and could have a significant macroeconomic impact for the country … In the extreme [earthquake] scenario that I’m concerned about … I think that it is not a stretch of the imagination to think that an economic area could lose a decade rebuilding.”

Mr. Brindamour is by no means the only senior executive who is concerned about what a severe earthquake would do to the Canadian economy and to the property and casualty insurance industry. Earlier this month, the C.D. Howe Institute published a report authored by Nicholas Le Pan, the former federal Superintendent of Financial Institutions. The report focuses on the risk to the economy, and the property and casualty insurance sector in particular, in the event of a major earthquake.

According to the report, there is at least a 30 percent chance that such an event will strike British Columbia within the next 50 years. Industry experts estimate that a magnitude 9.0 earthquake off the coast of Vancouver would trigger total losses in the range of $75 billion of which approximately $20 billion would be insured. The report also discusses the fallout from a magnitude 7.1 earthquake occurring in the Montreal/Quebec City corridor. The report estimates the economic impact of a quake in that region to be in the $60 billion range with insured losses of around $12 billion. These figures are drawn from a study conducted by AIR Worldwide in 2013 at the request of the Insurance Bureau of Canada.

Of course, all these numbers are just estimates. No one really knows what the full economic impact of a catastrophic quake would be. The C.D. Howe report notes that ‘more catastrophic West Coast events have been modelled with insurance claims of up to $95 billion (PACICC 2013)’.

To help put these figures in perspective, Aon Benfield’s Impact Forecasting recently published a report that pegged the economic loss from the Fort McMurray wildfire at US$5.5 billion of which US$3.2 billion was insured. At the current rate of exchange, the insured losses from Fort McMurray would be just over $4 billion.

According to the C.D. Howe Institute’s report, the Canadian insurance industry can fully withstand a $15 billion event. In the $25 to $30 billion range, several smaller, otherwise healthy companies would fail. Once the $30 billion threshold is crossed, ‘the catastrophic losses would exceed the existing capacity of Canada’s insurance industry and would exceed PACCIC’s [the Property and Casualty Insurance Compensation Corporation’s] ability to meet policyholder claims. One or more national insurers would fail.’

The report makes three recommendations, all dealing with PACCIC. The report recommends (1) strengthening PACCIC so it can take action before an insurer becomes insolvent, (2) allowing PACCIC to borrow in order to reduce its liquidity needs in the event of a crisis, and – after these changes have been made –  (3) having PACCIC rerun its scenario models.

As noted by Paul Kovacs, CEO of PACCIC, the insurance industry ‘‘has a limited amount of money. At some point, it’s paid everything it’s got.”

The science of tectonic plates is well understood. What cannot be predicted with any certainty is exactly when and where a major event will take place. As a result, all industry leaders can do is prepare for the aftermath of a major earthquake. It is encouraging that senior leaders in the industry are talking about the need to put plans in place that will allow the industry to withstand, as well as possible, the shock of a catastrophic earthquake. We can only hope that talk translates to action.