Fort McMurray and the protection gap

A preliminary study by an economist at Edmonton’s MacEwan University reports that the direct and indirect economic costs from the Fort McMurray wildfire currently sit at about $9.5 billion, and that the estimate will likely go higher as new data becomes available.

The figure includes “the expense of replacing buildings and infrastructure as well as lost income, profits and royalties in the oil sands and forestry industries…early estimates on indirect costs such as environmental damage, lost timber and physical and mental-health treatment,” according to lead investigator Dr. Rafat Alam.

Alam said that it can take up to 10 years to get a complete picture of everything that will be paid out by the numerous players that were affected by what is now Canada’s most expensive natural disaster by far. Insured damage for the fire currently sits at $3.73 billion, making it the costliest wildfire in world insurance history.

The insured damage figure makes up not quite 40% of the $9.5 billion economic loss figure, which is about par for the course for the insurance protection gap in Canada as events here tend to generally abide by the 40% insured/60% uninsured split. Globally last year, the split was roughly 30/70, according to preliminary figures published by Swiss Re.

But this gap doesn’t need to be.

According to information about the study on MacEwan University’s website, “Direct impacts of the [Fort McMurray] fire include – private and public property loss, labour income loss, production loss in oil sands, private business revenue loss, evacuation and fire suppression cost, emergency management cost, displacement cost, forest industry loss, public sector production loss, donations, public sector revenue loss, etc. Hardly measurable indirect costs include environmental cost, ecosystem loss and mental health cost.”

Not only can most – if not all – of these components of economic damage be theoretically insured, there are many examples throughout the world where they already are.

Let’s take a brief look at a few of these:

Public property loss

We already know that private property can be – and, in Canada, largely is – insured, but few seem to know or realize that the same could be said of government assets – federal, provincial and municipal. Governments already commonly insure some asset classes, like buildings and vehicles. But there are entire asset classes that governments do not insure, like critical infrastructure. And while an entire paper can be dedicated to the reasons why this is the case, it is enough to say that coverage for such things as roads, bridges, culverts, drainage and water systems etc. can quite easily be provided, either through traditional (re)insurance or non-traditional solutions, including capital markets instruments.

In Canada, there is not a long tradition of governments working with private insurers and reinsurers to obtain coverage for these and other assets, but that could easily change with a change in attitude (it has much more to do with will than with technical capability).

Production and income loss – public and private

While traditional business interruption cover is commonplace in private enterprise, it was a surprise to many (including me) to learn that none of the major oil sands operations in the Fort McMurray area where covered for contingent business interruption. All were covered if their physical operations were directly impacted by the fire but it appears that none were covered for events that did not directly impact their operations but nevertheless made it impossible for them to stay online. In the case of this fire, while virtually no oil production facilities were damaged or destroyed, employees were unable to report to work due to the mass evacuation (and in at least one case due to the loss of a work camp). It is unclear if the lack of this coverage was planned (perhaps due to cost-cutting as a result of the prolonged drop in the price of oil) or if it was just simply missed. But the lack of contingent business interruption coverage exposed a large gap in these companies’ risk management programs and proved to be very costly (Suncor alone reported a $735 million net loss in 2Q 2016 largely due to the wildfire). Contingent business interruption is a common product, and purchasing such a cover would have been easy and relatively inexpensive.

Business interruption and contingent business interruption covers are virtually nonexistent in government operations. As noted earlier, there is not a long tradition in Canada of governments going to private (re)insurers to purchase certain coverages for certain assets or risks. Part of this is due to the fact that governments pay for all facets of disaster damage out of public coffers, and don’t really consider capital as having a cost. Changing this mindset would be a large undertaking, but not impossible. Indeed, some governments in Canada have already signalled a desire to get out of – or at last curtail – their exposures to certain disaster-related costs, such as disaster assistance.

Expenses related to response and recovery

While many costs associated with evacuation and displacement of citizens are already covered by private insurance (usually under the Additional Living Expense, or ALE, portion of a homeowners policy), virtually all of the government (i.e. taxpayer-borne) expenses associated with response and recovery are not covered. But, again, they could be.

Imagine an insurance product that kicks in if a city’s snow removal expenses from a given winter exceed a certain threshold, or one that reimburses a municipality or public utility if storm-related overtime costs or debris removal after a flood or ice storm exceed a certain amount? How about a simple stop-loss cover that kicks in if federal Disaster Financial Assistance Arrangements (DFAAs) exceed a certain amount, or what if the DFAAs were laid off to the private reinsurance industry altogether? What about a parametric cover that kicks in if a rainstorm, windstorm or snowstorm of a certain size affects a community?

On the fire suppression cost side, it is very possible for governments to purchase a traditional reinsurance product such as a stop-loss to cover firefighting costs that surpass a certain level in a given fire season. For several decades the state of Oregon has purchased insurance from Lloyd’s of London to help it defray fire suppression costs and several years ago the province of Alberta entered into such an agreement with a number of reinsurers in the Canadian market. The cover was only in place for a year or two (and actually paid out to the province) when it was abruptly cancelled.

For more on this, see Insuring black holes (Canadian Underwriter, Nov 1 2015).

Forest industry loss

While forestry companies likely purchase business interruption (and possibly contingent business interruption) covers as many businesses do, they are exposed to a unique threat that few other companies are exposed to: loss of access to marketable product (in this case timber) that doesn’t belong to them, but which they have been awarded access to via agreements with the Crown.

While forestry companies in Chile, for example, are able to purchase insurance for loss of marketable timber due to wildfire, it appears that Canadian companies typically do not follow suit. Part of it may have to do with the fact that such companies operating in Canada normally don’t actually own the asset, as most forests that are culled for timber belong to the Crown, with access by loggers being provided via leases or licences. This would likely be an obstacle that is easy to surmount by insurers.

Conclusion

Much is being said these days about the need to narrow the protection gap, for good reason. Uninsured damage adding up to 60 or 70% of total damage is not only unacceptable, it is unsustainable. Further, it is largely unnecessary as society now has access to the expertise, products and capital it needs to transfer risk, loss and damage off the backs of governments (read: taxpayers) and place it onto the balance sheets of the world’s largest and most capable risk transfer experts. If we can insure a star pitcher’s arm or a movie star’s smile, we can insure anything, we just need to discard outdated and outmoded ways of thinking.

We must do it for the benefit of all:

• Narrowing the protection gap for companies better ensures continuity of operations, and protects the economy, the tax base and pensions, among other things.
• For individuals, narrowing the gap protects personal assets, livelihoods and health.
• For governments, narrowing the gap protects the economy, removes the cost burden associated with natural disasters from taxpayers, smooths volatility related to costs and provides stability in budgeting, and allows governments to use funds for more productive undertakings.

When we narrow the protection gap, everybody wins.