Risk of insurers failing increases following earthquake aftershocks

Insurers are taking a simulation model to Ottawa to show the escalated contagion risk of a major earthquake — and its expected aftershocks — bankrupting Canadian insurers.

Insurers have already explored the “contagion risk” of multiple insurers failing as a result of a single-event major earthquake in Canada.

However, recent risk modelling conducted by the Property and Casualty Insurance Compensation Corporation (PACICC) shows that the risk of systemic failure is even higher following quake aftershocks, which are a regular occurrence after earthquakes.

“We asked the people of Natural Resources Canada to give us a [quake] scenario, and they gave us a scenario that scared the wits out of us. And they assured us it was not the one that kept them up at night: it was easily in the range for them,” Alister Campbell, PACICC president and CEO, told brokers attending the Insurance Brokers of BC Leaders’ Conference on June 11.

Campbell outlined NRC’s full scenario as follows: “The big 9.0 Cascadia [quake] happens. It’s the worst thing that’s happened to Canada since the colonizers arrived. It’s terrible. It causes maybe $40 billion of losses, but only $20 million will turn out to be covered.”

PACICC’s systemic quake risk model includes all Canadian P&C insurance companies, which are anonymized.

In a matter of months, the mega-quake causes three small, regional insurers — each with a high concentration of quake risk in their book of business — to go under, PACICC’s simulation shows.

Under those circumstances, Campbell said, PACICC has the authority to invoice its member insurers for funds required to pay the claims of the three insolvent insurers.

“And so, the PACICC board, which has eight insurer directors and seven independents, votes unanimously to send out that assessment for $860 million; and that is allocated by market share to all the folks licensed in B.C.,” Campbell said. “And they have to pay that assessment, cash on the barrel, within 60 days or they lose their license. And they have to pay it on top of all the earthquake claims they’re paying.

“It’s extremely unwelcome news. The good news is it does not bankrupt any company.”

But then the aftershock happens.

Aftershock quake scenario

In the NRC’s scenario, six months after the Cascadia quake hits, a Magnitude-6.8 aftershock quake happens right between Nanaimo and Vancouver, in the Georgia Strait. It’s a totally different mix of losses. It mostly has adverse effects on pre-weakened structures, and the infrastructure repairs from the initial quake haven’t happened yet.  

The aftershock event causes another $20 billion in insured losses.

“So, in the course of June [the month of the modelled aftershock], we can already work out that there are many more insurance companies in deep, deep trouble,” Campbell says “Happily, some of them are members of large international groups who are part of bigger Canadian groups, and there’s money. Those ones do not fail.”

However, three more insurers would be in trouble, Campbell says. Worse, a large company would be affected.

“We have confidential discussions with OSFI,” he said. “They tell us that a nationally supervised, Top 20 insurer, a [company] with no other capital access, is going to report a 38% MCT [Minimum Capital Test score] at the end of June. One hundred and fifty percent is the supervisory minimum. One hundred percent is the legal minimum. [This one would be] 38%.”

Consequently, PACICC would send out another assessment, this time for $1.2 billion, taking the MCT scores of some companies that don’t even write in B.C. down to below 100%.

Campbell said PACICC is allowed by regulation to employ a “circuit breaker” option, which is designed to protect the industry’s financial collapse after a quake.

“It basically says if a PACICC assessment is going to cause financial difficulties for the rest of the industry, we have the option simply to say, ‘Too big, we’re out,’” as Campbell explained. “Our board had no option in this simulation but to pull the circuit breaker and say, ‘No mas. We can’t fight. We cannot respond.’ It was a very sobering day.”

Reputational risk

Campbell noted the desktop exercise showed huge amounts of uninsured loss in this scenario. He said the aftershock scenario “totally terrified us,” because many policyholders were exposed to earthquake deductibles for both the quake and the aftershock, not just one.

“From a reputational impact for the insurance industry, and for the insurance broker sector, that’s awful,” said Campbell. “We are in the protection business, and we do not do a very good job in this case. We fail our policyholders.”

The model shows “a massive risk of potential contagion,” added Aaron Sutherland, Insurance Bureau of Canada’s vice president of the Pacific and Western region.

“Our industry is extremely well-capitalized for a one-in-500-year event, everything up to that 9.0 [Magnitude quake scenario would suggest], about $45 billion in damages. But there’s a significant risk. We see something larger than that, as we look at picking up the pieces for those [companies] that do fail.”

Campbell urged Canadian brokers to lobby the federal government for a quake backstop.

“You are one of the most powerful lobby groups in Canada,” Campbell told brokers in the audience. “You obviously have to choose how to use this great power…

“There is a desperate requirement for some form of public-private partnership to share risk so that we can get more people to buy better coverage without these [high] deductibles and perhaps with fewer of these exclusions,” he said.

“There is an opportunity in the discussion right now between the provinces, Ottawa, and our industry, to get to that public-private partnership. Part of that solution is…an industry backstop, some form of liquidity mechanism, so that I don’t bankrupt the entire industry when I’m helping try to solve this problem.

“Every developed nation on earth with this [quake] exposure has solved this problem. There are examples to look at. I would urge this group, in pure self-interest, to fully engage on this file and be ready to use your lobbying power in alignment with the insurance industry and PACICC to help solve this problem for Canada,” Campbell said.

“I don’t know that you have too many bigger policy files. You might have more annoying ones, more right-in-the-moment ones. But I don’t think you have a more important one.”