Water Logged

When one peril accounts for at least 40% of all home insurance claims, and the average claim for that peril has risen by well over 100% over 10 years, actuaries tend to focus attention on the problem and work towards a viable solution. The problem? Water damage.

The chart on page 21, based on a presentation by the Insurance Bureau of Canada (IBC), looks at Québec personal property claims and helps illustrate the issue.

The expensive impact of water on Canadian homes and businesses was the subject of a recent Canadian Institute of Actuaries (CIA) report, Water Damage Risk and Canadian Property Insurance Pricing, available at the Canadian Institute of Actuaries website.

 Water has replaced fire and theft as the largest source of claims costs to Canada’s property and casualty insurers. Systematic under-pricing of water damage risk can have a negative impact on the profitability of insurers, and can lead to underwriting decisions that make it more difficult for consumers to purchase personal and commercial property coverage.

FACTORS TO CONSIDER

Looking back may be less helpful in a changing environment – Currently, actuaries start with historical claims and adjust them for inflation in order to form the basis for the premiums to be charged.

However, the report – which was produced by consulting firm KPMG and involved a literature review, plus questionnaires sent to actuaries, claims professionals, underwriters, regulators and catastrophe modelling firms – found that there are many reasons to believe that historical claims may no longer be predictive of future claims, such as the following:

• climate change;

• aging and inadequate infrastructure;

• lifestyle changes;

• construction-related issues; and

• human behaviour.

Most interviewed actuarial pricing practitioners believe that there is currently too great a reliance on past experience. While historical claims still include useful information, property and casualty actuaries would like to have access to more reliable external data.

Specifically, actuaries are seeking information on how to adjust historical claims for the effect of weather changes, aging or inadequate infrastructure and lifestyle changes.

Climate change – Across Canada, annual mean precipitation has increased by about 12% over the past 50 years. There is evidence that the number of days of heavy precipitation has increased by 1.8 days nationally, a statistically significant change. The increases in these two important factors could be causes of increasing water damage loss for the industry.

Aging and inadequate infrastructure – Over the last 15 years, the lion’s share of infrastructure investment was for new construction, while renovation and restoration work represented a small slice of the available resources. For example, new construction consistently took up about 80% of investment budgets for highways and roads, leaving just 20% for renovating the road network.

Renovations are required not only for visible assets such as roads and bridges, but also for hidden ones like sewer and wastewater systems. A mix of allowing the deterioration of these assets – through a combination of aging and being operated beyond their planned design life – and not investing in boosting their capacity may increase water damage risk in the event of system failure. When sewers back up, for example, basements will flood.

The responsibility for sanitary and storm sewers rests with municipal governments. However, funding for upgrading or expanding current sewer systems is a matter of joint partnership between the various levels of governments and, sometimes, the private sector.

In Canada, the value of the gross stock of sanitary and storm sewers was the second largest public asset after highways and roads. This stock has been growing at an average annual rate of 1.0% since 2001. However, despite this increase, the average age also continued to climb, reaching its all-time high of 18 years in 2006.

The federal government’s Economic Action Plan 2013 proposes to provide federal support of more than $53 billion, including over $47 billion in new funding over 10 years, starting in 2014-2015, for provincial, territorial and municipal infrastructure projects.

The plan provides interesting details of where the money will be spent, but does not provide any evidence that water collectors and sewer systems will be a priority. This investment seems particularly important to mitigate water damage risk following the occurrence of major events such as the Alberta and Toronto floods of 2013. Also, people should remember that another major flooding event happened in 2005 in Toronto.

Interestingly, in its recent budget, the federal government announced a plan to provide $200 million over five years starting in 2015-2016.

“This program will support investments in structural mitigation measures, such as infrastructure to control floods that can reduce the impact of severe natural disasters,” notes The Road to Balance: Creating Jobs and Opportunities.

A Calgary Herald article the day after the budget reported, “Alberta Finance Minister Doug Horner welcomed Ottawa’s interest in examining national flood insurance, but questioned whether enough infrastructure dollars are set to flow the province’s way.”

And a Canadian Press story on February 14 noted municipalities are working on their requests for federal infrastructure funds. The story quotes Daorcey Le Bray, a spokesperson for Calgary mayor Naheed Nenshi, as noting in an e-mail, “The province and the federal government both have roles to play in funding the capital needs of cities. Property tax, alone, doesn’t even come close to paying for the infrastructure needs of growing cities (or the maintenance of older cities).”

Will federal funding be sufficient to solve both overland flooding issues and water damage claims arising from urban flooding such as sewer back-up? Time will tell.

Lifestyle changes – These include, but are not limited to, the following:

• an increased number of people living in condominiums;

• an increased number of finished basements;

• extended periods of time away from home; and

• residents’ busy lives, and their attitudes towards prevention.

• Condominiums – There has been tremendous growth in the number of condominium developments in Western Canada and Ontario, particularly in the Greater Toronto Area. Beyond water damage due to issues with the exterior shell of these buildings, rather than having laundry facilities in the basements of these building, many offer in-suite laundry rooms. As well, dishwashers are now common in units. A rupture in a pipe, water seepage or a mechanical malfunction with a machine in one unit can cause serious and costly problems in neighbouring units.

• Basement use – In the past, most homeowners used their basements for storage and laundry facilities. This practice has changed significantly over time, and not in a positive way from the perspective of water damage claims. Families are increasingly using basements as entertainment centres, with expensive furnishings and electronics. As well, basements are often used as rental space, and contain all of the renters’ belongings and appliances. Such usage can increase the frequency and severity of claims.

• Time away from home – Another lifestyle change is that people are spending more time away from home. Increasingly, burst pipes and the resultant seepage are not noticed, and, therefore, not repaired, close to the time of their occurrence.

• Busy lives – The last lifestyle change reviewed is a result of increasingly busy lives. Loss prevention and household maintenance are not seen as high priorities. One study reported that “Internet outage and burned-out light bulbs are fixed more immediately than a leaky faucet or broken pipe.”

Construction-related issues – The CIA report discusses the rapid pace of construction, the age and quality of construction and building codes. Some organizations are calling for changes to the National Building Code, supporting the idea that it needs higher standards.

In terms of reducing water damage claims, the Institute for Castastrophic Loss Reduction notes in the report, Urban Flooding in Canada, that the changes could include “clarifying requirements for lot grading around homes, requiring back-up systems for sump pumps, clarifying requirements related to connection of foundation drainage to sanitary sewer systems and restricting use of manual devices that are designed to reduce the risk of sewer back-up.”

GOOD PRACTICES

The research paper also identifies six good practices for property and casualty insurers to follow. It recognizes that in some circumstances a best practice has not yet evolved, and “good practices” leave room for improved approaches and methods to be integrated.

These include furthering the mutually beneficial partnership between the industry and cities on IBC’s Municipal Risk Assessment Tool (MRAT), identifying and accessing the data required for pricing, and keeping a watchful eye on the development of emerging computer models that would help quantify the risk of water damage.

Some actuaries put a lot of hope on MRAT. This web-based tool allows users to assess the impact of severe weather on urban drainage systems, including the risk level and obtaining a fairly precise location of potential infrastructure failure. They are looking to use the tool as soon as it becomes available to improve their projection accuracy on the water damage risk impact.

FINALLY…

The CIA report explores what has become an increasingly serious problem for the property and casualty insurance industry, Canadians and governments, and was designed to collect creative ideas that may lead to solutions.

These suggestions came from a variety of sources, some deeply scientific and others not. Some are revolutionary and others build on processes and information currently in play within the industry.

The hope is that readers’ curiosity has been piqued, and that a flow of different sources and approaches emerge from sharing this information.