The Fire This Time

In a year in which the Canadian insurance industry has seen it all, a 6.4 earthquake struck west of Vancouver Island, B.C. in September.

The tremor could be felt on the island, in the Greater Vancouver Area and as far as Kelowna, B.C. No tsunami warning was issued and Earthquakes Canada reported no major damage.

Coincidentally, the quake happened within a week of the Fraser Institute issuing a report warning of the dangers of splitting insurance coverage for a natural disaster. Thankfully, the earthquake on Sept. 9 was not strong enough to test the inherent weakness in how insurance coverage in B.C. and Alberta currently deals earthquakes and the fires they ignite.

As it stands now, B.C. and Alberta homeowners are covered under their standard homeowner policies for damage caused by any fires following an earthquake. But they are not covered for damage caused by ground shaking unless they purchase separate earthquake coverage.

To eliminate this split coverage, insurers have proposed to exclude coverage for fire following an earthquake from standard homeowner policies. Instead, they would offer comprehensive earthquake coverage that would include coverage for fire damage caused by earthquakes.

Alas, the B.C. and Alberta Insurance Acts currently do not allow fire following an earthquake to be excluded from standard homeowner policies. Nor do they seem likely to in the future. The issue is complicated, and both the B.C. and the Alberta governments seem resolved to maintain the status quo.

In their defence, the provinces say that if an exclusion were to be made for fire following earthquakes, then consumers who currently have coverage for fire following earthquakes under their standard homeowner policies would suddenly have no coverage unless they purchased the optional earthquake coverage.

To that we would say that if consumers live in an earthquake zone, they should probably be purchasing earthquake insurance anyway. Indeed, some have argued that earthquake insurance should not be optional; it should be part of the standard homeowner policy. That of course raises the issue of higher premiums for consumers and higher deductibles, obviously a non-starter for governments that seem to be bent on maintaining fire coverage at all costs, even if it means splitting insurance coverage for earthquakes.

The status quo, however, is bad news for consumers. Take-up on optional earthquake coverage is about 60% in B.C. and Alberta, and less than 5% in Ontario and Quebec. So for a substantial minority of the population in western Canada, and an overwhelming majority of the population in eastern Canada, homeowners will receive insurance coverage for fires following an earthquake, but no coverage for damage caused by ground shaking.

This is going to lead to all kinds of confusion and trouble in the future, as the Fraser Institute points out in its study, Preventing Disaster After a Disaster: Lessons for Canada from U.S. Experience.

The study outlines what happened to U.S. policyholders when Hurricane Katrina wiped out major sections of Louisiana and Missouri in 2005. U.S. homeowners had coverage for wind damage in their standard policies, but not for flooding.

The result was a whole lot of litigation against insurers, as adjusters tried to distinguish between damage caused by wind and water. This is not an easy task: adjusters were often looking at cement slabs where houses used to be before the hurricane hit.

The lawsuits resulted in claims payment delays, skyrocketing premiums, larger deductibles and insurers withdrawing coverage in certain catastrophe-prone coastal areas. Why? Because public authorities, through litigation and settlements, were essentially asking insurers to pay for flood damage, even though insurers had not collected premium for the flood risk.

It’s not hard to conceive of something like this happening in Canada as well. Governments and the industry should discuss how to avoid split coverage in the event of an earthquake.