Extreme Perils

Natural disasters such as extreme weather, a volcanic eruption or an earthquake, are often quaintly referred to in the insurance world as “Acts of God”, adverse events which are seemingly unexplainable or beyond man’s control. Noticeably, the economic and insurance cost associated with natural catastrophe events under “Acts of God” have escalated substantially, with the total worldwide cost for 1998 amounting to approximately US$93 billion compared with a mere US$10 billion in 1960. Canada’s experience has mirrored this trend with combined government and insurance expenditure over the last six years averaging Cdn$1.5 billion a year compared with Cdn$750 million a year in the 1980s and early 1990s. Further telling is that Canadian cat expenditure averaged a mere Cdn$500 million a year in prior decades. The irony to this disturbing picture is that the increasing severity of natural catastrophes is more likely due to “Acts of Man” rather than God, and that the impact of such events is not totally beyond our feeble control. With this objective in mind — and armed with improved technology and a greater desire to open communications — the property and casualty insurance industry through the Insurance Bureau of Canada (IBC), the recently formed Institute for Catastrophic Loss Reduction (ICLR) and the federal government, have kick-started a national loss prevention initiative with earthquake and flood exposures on center stage.

In a paper delivered at a national earthquake conference recently held by the Institute for Catastrophic Loss Reduction (ICLR), Jane Voll, policy manager at the Insurance Bureau of Canada (IBC), highlighted the financial risk posed by earthquake and flooding to the insurance industry.

She notes that, in a 1994 report dealing with natural disasters, the insurance industry indicated that it was largely prepared to deal with most significant potential catastrophes countrywide except for flood and earthquake risks.

While advancements have since been made on the earthquake front through improved risk modeling and the new reporting and reserving requirements introduced by the Office of the Superintendent (OSFI), considerable effort has to be made by the provincial and federal governments to invest in natural disaster prevention, she observes. After years of lobbying to this end, which Paul Kovacs of the IBC and executive director of the ICLR describes as “very frustrating to get awareness going,” the insurance industry is about to be granted its wish — but one which could be received with mixed blessing.

In April this year the federal government established a sub committee from the National Finance Committee under the leadership of Senator Terry Stratton of Manitoba to investigate mitigation of natural disasters. Stratton’s five-member investigation team plan on holding public hearings with various government agencies, community and political groups across the country in coming months, with a final recommendation report expected by the beginning of 2000. No one, including Stratton, has any idea at this stage what the committee will put forward in its report.

However, high on the insurance industry’s agenda in terms of its lobbying efforts and interest in Stratton’s investigation, is to motivate the establishment of a national government disaster protection fund. The idea would be to use government funding to invest in projects either preempting or limiting a loss resulting from a potential natural disaster. The insurance industry has asked for a combined $150 million to be set aside by the federal, provincial and municipal authorities toward the fund (which Kovac’s hopes will come about within the next year and a half). Comparing this amount with the billions forked out annually by the various governments in disaster recovery and cleanup, the cost of prevention, if effective, would seem highly appealing.

Flood insurance mooted

A disaster prevention fund is not, however, the only consideration put forward to Stratton — a hot item on the committee’s list is flood insurance which technically is non-insurable in Canada under the current legislation. Should the committee perceive sufficient national support for flood insurance, a form of “cost-shared” mandatory coverage, similar to the National Flood Insurance Program (NFIP) underwritten by the U.S. government and administered by its disaster recovery agency FEMA, could be on the cards for Canada.

While the NFIP is fully underwritten by the U.S. government and most cover sold through private insurers (which the companies administer and receive a handling commission), a Canadian system may go further and involve underwriting participation by private insurers. Stratton confirms that, what he refers to as a “cost-sharing program” similar to the NFIP has been brought to the committee’s table. However, he is quick to point out that the committee is not working to a pre-formed list of actions. “A national disaster protection fund has been put forward as well, but it’s too early to jump to any conclusions.”

Stratton confirms that flood risk is the committee’s main focus, largely due to the cost of this particular peril to communities. And, as he phrases, “because we can do something about it”.

In terms of its broader mandate, Stratton says the committee will not be backtracking the technical research and data collection already carried out by the ICLR and IBC into natural disasters. From what he has seen, the insurance industry has done an excellent job of researching the potential hazards and associated costs facing Canada, “it’s all very technical, our objective is to put a ‘human face’ to it”.

In turn, Kovacs is happy to have the committee stick to its communication building role. “Our goal with the senator is to keep their [the committee members] objective focussed and not go off on tangents. The Senate committee findings will be a powerful voice, and so far we’ve had a very positive response from them,” he adds.

Kovacs does not believe that a form of compulsory flood underwriting is likely to be on the cards. “I think that the government is starting to realize that insurance is not the answer to the problem, that cover just transfers the cost of risk, it doesn’t take care of the problem.”

Costing flood risks

The prospect of having to participate in flood coverage drew a mixed response from industry representatives. On one hand, insurers are unlikely to wholeheartedly embrace dealing with a volatile and costly area of exposure (Kovacs agrees that flood is by far the costliest natural disaster in Canada due to the frequency of events). That said, being in a position to “market” government underwritten flood coverage could open up new opportunities for private insurers. Furthermore, as Ray Medza, director of the IBC’s Montreal office points out, insurers in the province already indirectly carry a substantial burden of flood related losses through sewerage backup coverage and certain other lines. “If we could get the government to agree to investment in prevention measures, then private flood coverage could become reality.”

Kovacs confirms that Quebec is the one province which has raised the issue of compulsory private insurer flood coverage, “this issue has been raised over the years, whether it has been brought back on the table, I don’t know,” he comments. But, in the bigger picture, most of the commentators surveyed in this article agree that dealing with floods, and flood insurance, is becoming an unavoidable issue, particularly in light of the major floods over recent years. And, with the threat of possibly the worst flood to face British Columbia’s Fraser Basin currently hanging in the balance as the mountain snow packs begin melting after an unusual period of cooler temperatures, the damage of flooding could end up on the media’s center stage.

In addition, as the NFIP’s principal underwriter, Arturo De La Cruz observes, “nearly 80% of U.S. natural disaster claims can probably be connected to flooding in some way”. The point being made by De La Cruz is that storms like hurricane cause considerable water damage which is almost impossible to distinguish from being wind/storm related or flood. “With hurricane claims we use the same claims adjuster as the other insurers involved and often agree to split the value of the claims as it is impossible to determine the real cause of the damage.”

IBC/ICLR prevention strategy

The IBC/ICLR’s approach in campaigning for disaster prevention involves several actions, explains Kovacs. Over the past year since the formation of the ICLR, the institute has held industry and business workshops across the country to evaluate concerns and build awareness.

While these workshops will be ongoing, the ICLR has stepped up political lobbying, both through the Stratton committee and directly with provincial, municipal and federal government offices. It has also enlisted the support of non-government organizations such as the Fraser Basin Management Board (formed in 1994 with government assistance to investigate flood control programs for the region) which have independently been lobbying Ottawa for financial support. The objective is to create a united cause for disaster prevention and to tie in the various pockets of expertise to create a shared resource, Kovacs says.

A question which has come from these political interactions is what the insurance industry is willing to bring to the table, he adds. “We’re not shy to spend on prevention, the hail suppression project in Alberta is an example. The way we see it, it’s smarter to spend some money than spend a lot on cleanup which doesn’t make much sense.”

What makes a lot of sense, Kovacs stresses, is the creation of a central financial resource to enable affected communities to react. The Fraser Basin Management Board is a prime example where considerable effort in terms of research and planning has been invested, but there is nowhere to go for money, he observes.

The impact of increasing severe weather, presumably as a result of global warming, will be felt in every province and across nearly every business sector, observes the Canada Country Study (CCS).

The CCS, compiled by Environment Canada and based on several international reports and computer modeling, was released toward the end of 1997. It is the first national long-term Canadian extreme weather report. The CCS points out, “all sectors within Canada are vulnerable to climate change to some degree”. The report follows on with the following comment about the insurance industry, “of serious concern is the possibility that abrupt climate change, resulting in more frequent claims disasters, could produce higher and more frequent claim payments before adequate reserves are built up…Property insurance is most likely to be directly affected…stronger building codes are being advocated as one means of reducing sensitivities.”

Revving up the businesses community

George Anderson, president of the IBC, has in recent months been engaged in several across country presentations on natural disaster mitigation. Anderson’s objective is to push business awareness of mitigation while the ICLR focuses on the political drive, Kovacs says. And, he observes, public support seems to be behind natural disaster prevention, in a poll carried out by the ICLR, more than 80% of respondents agreed that a national partnership between government and the private sector is needed on natural disaster prevention.

In a speech to the Halifax Metropolitan Chamber of Commerce last month, Anderson emphasized the important role a natural disaster fund would play. “Over the past three years, governments in Canada have spent, on average, Cdn$500 million a year on disaster response and recovery. It only makes sense to try to reduce this continual expense by setting aside money to reduce Canada’s long-term vulnerability to natural hazards.”

A significant gain was made this year when the federal government allocated $50 million from the budget for flood control measures in the Red River Valley in Manitoba. “While this is an important precedent for the federal government, it is just a first step — we have much more work ahead.”

Highlighting the effectiveness of natural disaster prevention, Anderson refers to the success achieved with the Winnipeg Floodway. Built in the 1950s after severe flood damage to the city, the floodway has saved millions, he notes. “At the height of the 1997 flood, it [the floodway] diverted 59,000 cubic feet of water per second and, as a result, greatly reduced the damage to the city. At the time the floodway was built, it was expected to have a benefit-to-cost ratio of two to one. In other words, if it prevented a once-in-a-century flood, it would pay for itself twice over. What has happened since? It has been used to reduce flood loss on 17 different occasions.”

Similarly, the hailstorm which struck Calgary last summer generated roughly $70 million in claims. On this particular occasion, the clouds had been seeded, Anderson notes, “by our rough estimate, it would have cost as much as the 1991 Calgary hailstorm which cost insurers almost $400 million had those clouds not been seeded”. As to the cost of the cloud seeding project — that is about $1.5 million a year, Anderson says.