Bracing for The Big One

It is an uncomfortable reality to confront, but one day Vancouver, Montreal or Ottawa are likely to be hit by a major earthquake that could cause loss of life, property damage and economic disruption on a huge scale.

More than 4,000 earthquakes are recorded every year in Canada, according to a report from the Ontario-based Institute for Catastrophic Loss Reduction (ICLR). Most of them are small and will only be felt by sensitive monitoring equipment. But experts agree a major earthquake in Canada is inevitable, and it is most likely to happen in the West, in the fast-growing region including the cities of Vancouver and Victoria. There is at least a 30% chance that an earthquake strong enough to cause significant damage will occur in southwestern British Columbia within the next 50 years, according to the ICLR. The region is vulnerable because the Cascadia subduction zone is located west of Vancouver Island, where the North American and Juan de Fuca plates meet.

In Canada’s interior, a 5% to 15% chance exists of a damaging earthquake striking southern Quebec or eastern Ontario sometime during the next 50 years. This region includes Montreal, Ottawa and Quebec City. In southeastern Canada, two to three potentially damaging earthquakes greater than Magnitude 5.0 are experienced each decade on average. Ottawa, Montreal and Toronto residents felt a moderate earthquake, measured at Magnitude 5.0, in June 2010. But seismologists believe the region could one day be hit by a massive magnitude 7.0 earthquake.

Taken together, these regions of Canada, where there is a high or moderate risk of a major earthquake striking a large urban centre, are home to almost 40% of the people and businesses in the country.

Risk model reaction

Since a big, destructive earthquake has not hit Canada in living memory, too many risk and insurance managers in Canadian industry dismiss the risk. At Swiss Re Corporate Solutions, we don’t rule out the possibility, however remote. We monitor and model earthquake exposure in Canada and rate it as we do fire or flood risk. We use a proprietary modeling system supported by our expert knowledge of the risk and the latest scientific data from recognized authorities such as the United States Geological Survey to develop loss estimates on a risk or portfolio basis over varying recurrence periods.

But it does not end there. We also compare and validate our findings against results from third-party software that some insurers and insureds use. Our historical diligence for assessing and modeling earth movement events did not cause us to revise our loss estimates, as some insurers did, following recent upgrades in some third parties’ modeling products. Many insurers felt they were overexposed after running the catastrophe model revisions; they reacted by curtailing capacity or decreasing lines. Unfortunately, that created a potential problem for some insureds, which, as a result, saw the limits on their coverage reduced.

In Canada, property policies are ‘all risks.’ Losses resulting from earthquake are included in that definition. But the earthquake component of the cover can be sub-limited to less than the full limit and many insureds take this route to keep the premium cost down and within budget.

Deductible decisions

It is important for insureds to identify their probable maximum losses accurately before deciding how much cover to buy. Having sufficient cover could one day make the difference between a business surviving or being wiped out by an earthquake.

Achieving the most effective structure for an insurance program can be critical. Decisions about deductibles, for example, should be tailored to the insured’s operations. If, for example, businesses have most of their assets in a limited geographical area, such as a single city, a single event could affect all of these assets. These businesses might be tempted to buy as high a deductible as possible to keep their insurance costs down. But the consequences of this strategy could prove to be disastrous. If the deductible is stated as a percentage of the value-at-risk, it could turn out to be a very big number indeed, especially if all of its facilities are affected.

The recent tragic events in New Zealand and Japan should have been a wake-up call for Canadian businesses, and many companies did in fact review their catastrophe insurance coverage. But for many insurance and risk managers, the increased cost of insurance for an event that may or may not occur in the near future proved hard to justify to a chief financial officer or a CEO.

Forewarned is forearmed

There has been a big debate, especially at the federal level, about Canada’s level of preparedness for and resilience to a powerful earthquake. The government has taken action to improve the dialogue between different stakeholders.

But insureds have to take some responsibility for loss prevention and mitigation. Businesses have to make sure they are up to date in terms of building standards, for example. If they are not up to date, they should consider upgrading or retrofitting their property assets. Upgrades are particularly important in the context of fire following an earthquake. Insureds need to make sure that their sprinkler systems will still function after an earthquake, for example.

Also, businesses need to inform their underwriters about any upgrades they make. The granularity of insurance submissions is important, since insureds can benefit from providing insurers with information that truly reflects the risk. We always ask our insureds to submit detail about their properties. This includes the age and type of construction and if earthquake upgrades have been carried out. If our underwriters don’t have that kind of information, then model results will have a greater degree of uncertainty and therefore may not accurately reflect the exposure.

Ultimately, if a big earthquake hits Canada, we all want the same outcome. We want insurance coverage to play the most effective role possible in the recovery of our businesses, communities and the national economy.