Nuked Covers?

Insurance and reinsurance companies are trying to get on the same page when it comes to exclusions, particularly for fire following nuclear incidents. According to sources, it’s a work in progress.

Primary insurers are caught between a classic rock and a hard place when it comes to reinsurance treaty wordings, exclusions and provincial legislative requirements. Insurance legislation in all provinces excludes “fire following” only for specific named events, such as war, riot or insurrection. But, that leaves the door open for the “big three” potential catastrophic incidents – earthquake, terrorism and nuclear explosion.

Currently, primary insurers have statutory obligations to provide fire following coverage for all events not named in legislation. Only Quebec’s civil code specifically cites earthquake and nuclear explosion as events excluded from fire following coverage. Canadian operations of international reinsurers are not bound by provincial legislation. Since they do not deal directly with the public, they are licensed and supervised at the federal level by the Office of Superintendent of Financial Institutions (OSFI). And reinsurers are increasingly willing to model extreme catastrophic scenarios, such as a nuclear explosion in an urban setting. This broader conception of risk is filtering its way into changed treaty wordings and a tough stance on exclusions.

In Canada, this has set off a flurry of discussions about how specific exclusions should apply, particularly for nuclear fire following. Last November, the Reinsurance Research Council (RRC) released #20″, which is a suggested nuclear incident exclusion for the voluntary adoption of its members. Reinsurers advised primary companies last fall that an exclusion on nuclear incidents may be mandatory for treaties when they renew in January 2004.

REINSURERS SKITTISH

“In reality, once one reinsurer adopts the exclusion, others will follow,” says Gord Crutcher, vice president at Sutton Reinsurance. Neither side is particularly comfortable with the resulting waiting game, which represents a distinct gap between primary companies’ statutory obligations and reinsurers’ need to limit exposures. Individual insurers are in the precarious position of being forced to pick up any potential fire following tab for a virtually “unquantifiable risk”.

“As it stands now, any exclusion [for nuclear incident] we suggest as a model wording for primary policies will likely not apply,” says Randy Bundus, vice president, general counsel, Insurance Bureau of Canada (IBC). “But that doesn’t apply to reinsurers.”

For some insurers, the nuclear exclusion is another sign of reinsurer skittishness in the absence of any proven threat or specific history of loss. “Reinsurers used to follow the fortunes of primary companies, now in many cases, they do not,” said Larry Harrington, senior vice president, underwriting for CGU Canada at a recent conference. “This has resulted in some negativity.”

Bundus points out, “it’s a lot easier when the ‘follow the fortunes’ principle is in place”. However, reinsurers insist that “follow the fortunes” is a technical principle that applies to individual reinsurance contracts. “The concept has always been that the reinsurer would follow the technical insurance fortunes of the cedant, except as specifically excluded in the treaty agreement,” notes Bruce Perry, vice president at Partner Re Canada. “From time to time, risk exposures are identified that could seriously impair the ability of insurers or reinsurers to survive. Fire ensuing from a nuclear incident fits that category.”

Andre Fredette, Canadian general manager at Caisse Centrale de Reassurance (CCR) and chair of the RRC underwriting committee that drafted the exclusion, says that an absolute exclusion typically “overrides the follow the fortunes principle”.

TERROR FACTOR

Nuclear generating plants have existed in Canada for decades and, indeed, have been covered by the Nuclear Insurance Association of Canada (NIAC), albeit only for damage from explosion, not fire following. So why are these exclusions being introduced now?

The short answer is terrorism. After 9/11, the scope of potential disasters, including biological and nuclear terrorism, at least in the minds of reinsurers, has changed dramatically. “Right now, we have U.S. president George Bush talking about the threat of nuclear terrorism,” observes Fredette. “Many people say this is pretty far-fetched, but I’m sure three years ago they thought the idea of commercial airplanes being hijacked and flown into the World Trade Center was pretty crazy as well.”

Another reason for the imminent nuclear exclusion is Canada’s incongruous regulatory environment. Most jurisdictions in Europe exclude fire following from nuclear incidents and international reinsurers are looking for consistent wordings in all treaties. In the U.S., about half of the states exclude it in legislation, according to Fredette.

“I think there is pressure from reinsurer head offices to treat Canada the same as the rest of the world,” says Bundus. “And Canada is a relatively small player in the global insurance market, with about 2% of worldwide premiums.” That leaves the issue squarely in the hands of regulators. But, the provincial response to lobby efforts by IBC to change legislation has been muted. This is particularly true in British Columbia, where the bureau has tried repeatedly to spur legislative change for earthquake fire following.

Bundus says IBC and member companies are turning up the heat on fire following nuclear incidents with a lobby campaign. The bureau contacted the Canadian Council of Insurance Regulators (CCIR) earlier this year to ask for a concerted effort at changing insurance legislation, but the council deferred to provincial decision-makers.

Bundus says the focus now will be on provinces with extensive nuclear generation plants, such as Ontario and New Brunswick. “Some provinces have been more receptive than others,” says Bundus, who adds that lobbying is still in the early stages, but will pick up steam as renewal season approaches.

RISK ATTITUDES

Nuclear fire following is certainly not the first topic on which insurer and reinsurer perspectives have differed. Insurers have expressed concern about how reinsurers consider terror mapping accumulation. In addition, recent exclusions on mold depend on whether you read primary insurance wordings (all risk) or reinsurance wordings (named peril).

Bundus acknowledges that “communication between insurers and reinsurers was not as strong as it should have been on the mold exclusion. But we have addressed that through the IBC’s ‘Standards and Practices Committee’. We have better representation and communication through RRC representatives now. We may not always agree, but we will at least know the reasons why.”

Whether that communication will result in clarification of the nuclear fire following issue remains to be seen. The drafting and interpretation of exclusions are particularly relevant due to the legal concept of “concurrent causation,” says Fredette.

A recent Supreme Court of Canada decision held that a loss would no longer be excluded under a liability policy where both a covered event and an excluded event caused the loss. If the policy covered one of the perils that contributed to a loss, the insurer was liable for the entire loss. That is why “concurrent causation” is referenced in the RRC nuclear incident exclusion. Without it, if a nuclear blast occurred, followed by a shock wave that destroyed property and an ensuing fire (insured under the policy), the insurer would be liable for 100% of the damage. And, in all likelihood, it would be left to the courts to apportion liability after any potential catastrophic nuclear incident. “When courts determine coverage issues, the sympathy is generally not with the insurance company seeking an exclusion, but rather the person whose home or business lies in rubble,” says Bundus.

REGULATORY STANCE

Fredette mentions another issue to the nuclear fire following debate – sound corporate governance and disclos ure. “We shouldn’t as an industry give the impression that we can cover this, from a corporate governance perspective,” he says. “The financial capacity just doesn’t exist.” The unquantifiable risk and the need for transparency in coverage wordings lend an air of urgency to the issue. “Does it accomplish anything if regulators let this drag on and bring with it potential insolvency issues?” asks Fredette. “Would it be better if a bankrupt insurance industry couldn’t afford to pay auto insurance claims?”

It is the reinsurers that have fired the first salvo with the proposed nuclear exclusion. Perry says that “like earthquake, insurers appreciate the seriousness of the [nuclear] issue, but it took initial prompting by the reinsurance community to spur them to action. We sincerely hope the actions being taken to amend provincial insurance legislation bear fruit.”

The regulatory response could go two ways – an amendment to provincial Insurance Acts listing new incidents from which fire following will be excluded. Provincial governments have shown reluctance to make this change, mainly for political reasons. Or, legislation could be amended to require reinsurance contracts to correspond to provincial statutes. This is certainly not the result reinsurers anticipate, and could prompt a massive withdrawal of reinsurance capacity from Canada.

For primary insurers, the only way out of this “rock and hard place” is quick regulatory resolve on a province-by-province basis. And that is not something that happens often in Canada.