Model proposition

A model may be a standard or example for imitation or comparison – although when it comes to preparing for natural catastrophes, it sometimes feels more akin to a hope and a prayer.

But even hopes and prayers can be based on solid information that provides the best chance of weathering whatever storm happens along.

It is likely with that view of being prepared (financially and otherwise) and able to cope with whatever exposure presents itself that the Office of the Superintendent of Financial Institutions (OSFI) has issued its final revised earthquake exposure guideline. The stuff of public consultations since last August, Earthquake Exposure Sound Practices (Guideline B-9) seeks to update the information and understanding that was available in 1998.

There was plenty to discuss, including emphasizing and strengthening the principles-based approach to managing earthquake exposure; updating the description of best practices in earthquake exposure management; and increasing OSFI’s flexibility in the collection of relevant data. The guideline is scheduled to take effect January 1, 2014.

OSFI has refreshed its guidance to reflect the lessons learned and technological changes that have taken place since 1998, Mark Zelmer, assistant superintendent of the regulation sector, has said. It “will help Canadian insurance companies continue to be well-prepared for the financial consequences if a major earthquake were to occur in Canada,” Zelmer noted.

OSFI will work with the Insurance Bureau of Canada and provincial regulators to incorporate any future changes to the Minimum Capital Test (MCT) Guideline.

Being prepared is critically important in light of the high costs, both insured and to the economy in general, that can occur. Aon Benfield notes in a recent report that, in 2012 U.S. dollars, the Japan earthquake and tsunami in 2011 was the catastrophe with the highest economic loss since 1950, at $217 billion, and an insured loss of $36 billion. Hurricane Katrina in 2005 had a lower economic loss, $146.1 billion, but a higher insured loss, $78.2 billion.

Different events, different exposures perhaps, but surely the same message. The need to prepare for what may/will happen must be top of mind.

The before/after is evident in countless efforts, including everything from a San Francisco ordinance mandating seismic safety retrofits for certain wood frame, soft-storey residential buildings to the partial reopening of New Jersey’s Island Beach State Park in January, a testament to recovery and clean-up efforts after Sandy.

With increasing urban development in areas that may be seismically active, coupled with older buildings and aging infrastructure, costs following catastrophic events perhaps should be expected to be higher than expected.

Models are key to not only reflect information that is currently available, but also to indicate where that information may lead in future.

But there are cautions about how much faith should be attached to models – be these for earthquake or other catastrophes. “Models will always be wrong and there will always be non-modelled factors,” notes a recent report from brokerage firm Lockton. Insurance professionals are encouraged to account for factors such as a concentration of exposures, location of critical suppliers and the time since the last catastrophe in an area, Lockton states.

A report from Fitch Ratings adds Sandy is likely to inspire some companies to revisit if pricing in the northeast United States is adequate and if contract wording is appropriate for the risk being assumed. “There were several areas related to flooding risk exposure that the models did not fully capture and companies did not fully anticipate, despite robust modelling” for the region. The below-hurricane status landfall event was able to cause an extensive level of damage and a significant dollar amount of insured and uninsured losses, it adds.

Models must be based on the most current information, but also need to be viewed as living things, constantly evolving to have a chance at addressing the what-ifs.