Fault lines

It may be beautiful British Columbia, but it also serves as the Canadian face of the Ring of Fire.

The 40,000 kilometres of shoreline that encircles the Pacific Ocean contains 75% of the world’s active volcanoes and 90% of its earthquakes. A number of recent events have helped sharpen the focus on just what these events may mean for both B.C. and Canada’s insurance industry.

The shocking images of the devastation produced by earthquakes in Japan, Chile and New Zealand provided a stark reminder of the destruction that could happen here, too.

Add to that reminder that predictive modelling – the technology used by insurers to quantify risk levels – has become more sophisticated and has brought forward new data. Not only is there a 30% probability of a significant quake in B.C. within the next 50 years, recent updates to modelling put the potential epicentres in the Cascadia subduction zone, as much as 55 kilometres farther east than previously predicted, and closer to Victoria and Vancouver.

In a one-year period from April 21, 2012 to April 22, 2013, Natural Resources Canada recorded 4,292 earthquake events in and around B.C., 43 of which were strong enough to be felt by residents in the affected areas. Of the total, 56 quakes occurred near Victoria, three of those felt by residents; four quakes off Haida Gwaii ranged from magnitude 6.1 to 7.7 on the Richter scale, but fortunately caused no damage.

In response to new modelling and other factors, Canada’s Office of the Superintendent of Financial Institutions has updated its B-9 Earthquake Guidelines for insurers. At street level, brokers and their customers have seen some insurers pulling back on their concentrations in certain neighbourhoods in southwest B.C., areas where just a few years earlier they had been keen to take on more business. In response, insurers have had to increase reinsurance and pass along those costs to consumers.

So just when brokers are telling customers about the importance of having earthquake coverage, they are also having to explain the increase in its cost.

RISK PROFILE

Stricter building code

The B.C. Building Code has been toughened up. Residential home construction in 40 locations in southwest B.C.

now requires that walls include lateral bracing for greater resistance to loads resulting from earthquakes. The mandatory bracing system mainly consists of full-height walls sheathed or finished with panels that are well-fastened to the frame. The braced panels must align vertically for each storey, creating a band that extends from the foundation to the roof.

It is anticipated the change will add to the reconstruction costs of dwellings that suffer major losses, although there are no concrete estimates at this point and these would depend on factors such as dwelling size and type.

Population density

Another trend adding to the risk profile is the increasing population density in the province. In 45 years, condominium living has gone from concept to major asset for about half of the people in southwest B.C.

Real Estate Vancouver reported in early 2012 that the city has more condos per capita than any other city in Canada; in 2011, the city witnessed four strata properties being sold for every house.

An academic paper by Douglas Harris, a professor in the Faculty of Law at the University of British Columbia, notes that in 2009, with a population of approximately 600,000, there were about 95,000 condominium units spread between almost 4,100 buildings in the Greater Vancouver Regional District, which includes the municipalities east of Vancouver to the Abbotsford border. The number of condo owners has pretty much doubled each decade.

The concentration of infrastructure – mainly concrete high-rises and wood frame low-rise structures – and the complexity of having a commercial policy for the building and personal policies for unit contents, combine to make this a particularly problematic risk when the potential for shake damage is also added to the mix.

Take-up levels

Across the broad base of habitational insureds, meaning single-family detached and stratas province-wide, it has been demonstrated that interest in purchasing earthquake insurance is low. Anecdotally, brokers report a range of take-up levels for habitational earthquake coverage, depending on where they are located.

Some Insurance Brokers Association of British Columbia (IBABC) members with a substantial strata business in the Lower Mainland report that 100% of the buildings they insure have earthquake coverage. But members have also expressed concern that in the major losses they have handled to date, fewer than half of the affected unit owners had any unit coverage at all.

RECONSTRUCTION CHALLENGES

The day after an earthquake, there will be challenges getting even well-insured buildings rebuilt. A strata corporation that owns a $20-million building with a 10% earthquake deductible will have to come up with $2 million to start repairs or reconstruction, even for a partial loss. Strata owners can purchase deductible coverage as part of their unit policies, but if as many as half of the owners of a building do not have that coverage and need to raise their share of the assessment, reconstruction will be delayed.

It is not yet known to what degree financing will be available to owners for their portion of the deductible; banks were not exactly enthusiastic about financing assessments for leaky condo repairs.

Consider that in Christchurch, New Zealand, reconstruction has not yet begun on some of the worst-hit buildings two years after the quake. It is estimated that it will take 10 years to rebuild many residents’ homes and neighbourhoods.

IBABC representatives have been discussing and raising concerns about earthquake with stakeholders for some time. Solutions will require that industry and government work together. Education from brokers, insurance companies and government is needed to help the public understand its potential exposures to earthquake.

IBABC’s recommendation is that companies include within their policies the actual dollar deductible (as opposed to a percentage) to ensure the figure is more visible and understandable to the client. Companies should also make clear on the declaration page that “earthquake is not covered” when a client chooses not to purchase the coverage to help reduce errors and omissions (E&O) issues down the road for brokers. These two changes should help improve public awareness and help jumpstart a dialogue.

RELATIVE EXPENSE

It is interesting the perception exists that earthquake coverage is expensive. As far as the affordability aspect is concerned, one need look no further than south of the border to see rates and limit restrictions that make the earthquake product in B.C. a godsend in comparison. As prices and deductibles likely continue to climb, the solution is not for clients to remove coverage. This will only create even more expectations that government will need to step in and help should an event occur.

There is also talk of that “golden goose” of coverage known as guaranteed replacement cost (GRC), and whether or not it should be removed from earthquake coverage so as to provide more certainty around the cost of reconstruction. As has been seen with other catastrophic events – Superstorm Sandy being a recent example – the aftermath brings new thinking on how to prevent future losses on such a scale, and potential changes to building codes could add to reconstruction costs to a degree that cannot be foreseen.

On the homeowners’ side, some insurance companies are starting to cap GRC by placing a 120% limit; on the commercial side, some policies that had offered GRC are removing the coverage. For stratas, however, section 149(4) of British Columbia’s Strata Property Act provides that the building policy must be on the basis of full replacement value.

It is clearly time for all stakeholders to have a frank discussion about the whole earthquake issue and make sure that industry is not setting itself up for a huge failure – of both reputation and financial stability.

At its 2012 annual conference, IBABC hosted a symposium on earthquake peril. As a follow-up this year, the conference in June will include a Strata Symposium.

It is already known that every major quake has shown that modelling for the area underestimated the risk, and that resulting damage was significantly higher than predicted. Similar results can be expected in British Columbia.

Areas elsewhere thought to be prepared found efforts to be woefully inadequate – and British Columbia is not even at their levels of preparedness. So this, too, is a discussion that needs to take place among our partners and all levels of government.

The time to act is now. After the fact is not the time to ask and answer these important questions. Let’s hope that every- one can come to the table so that a con- certed plan can be developed for what may be a potentially shaky future.