‘Ottawa’ Insurance Sector Vulnerable to large-scale Earthquake, Former Bank Regulator Says
TORONTO — Canada’s economy is vulnerable to the impact of a major earthquake, and policymakers and the insurance industry should be taking steps to avert a chain of events that would send fissures through the financial system, the former head of the country’s top banking regulator warned Wednesday in a report from the C.D. Howe Institute.
“Since the 2007/08 financial crisis, policymakers have paid much attention to the buildup of risk in the banking system. However, no equivalent discussion exists for the impacts of natural disasters to Canada’s economy,” said Nick Le Pan, the report’s author.
He says a federal emergency backstop arrangement is needed for the country’s property and casualty insurers, to minimize the systemic financial impact that would result from a catastrophic natural disaster on those affected and on the economy at large.
Some 40 percent of Canadians live in areas classified as “moderate” or “high” risk, according the report. In British Columbia, for example, there is at least a 30 per cent chance of a significant quake in the next 50 years. The risk in the Quebec City-Montreal-Ottawa corridor, meanwhile, is 10 to 15 per cent.
The report suggests a large-scale catastrophic natural disaster would cause some of Canada’s property and casualty insurers to fail, putting immense pressure on those remaining and overtaxing the industry-funded Property and Casualty Insurance Compensation Corporation, which steps in when a member insurer becomes insolvent.
Le Pan, who led the Office of the Superintendent of Financial Institutions, which oversees federally regulated banks and insurers, from 2001 until 2006, suggests a federal last-resort backstop guarantee could kick in beyond an industry-wide trigger of expected losses.
The insurance industry as a whole could handle losses in the range of $25 billion to $30 billion, but several smaller companies would likely fail, according to the report, which recommends strengthening the Property and Casualty Insurance Compensation Corp. to allow for intervention before insurance companies in financial difficulty become insolvent.
“PACICC has effectively handled individual company failures in the past, but would need to enhance its emergency response capacity for such a catastrophe, as it has never dealt with multiple members in financial difficulty at the same time,” the report says.
The inevitability of an earthquake in Canada poses a similar systemic financial risk for the insurance industry and the economy as a whole
Beyond $30 billion, the catastrophic losses would exceed the existing capacity of Canada’s insurance industry and would exceed the insurance compensation corporation’s ability to meet policyholder claims.
“One or more national insurers would fail,” the report says, adding that PACICC would have to step in to pay claims of the failed companies beyond those related to earthquake exposure. Tapping remaining insurance companies would be likely to reduce their capital below regulatory minimums.
In the report, Le Pan urges other financial players such as banks, regional credit unions, and mortgage insurers to take the risks to the insurance industry into consideration in their own stress testing.
The report notes that the availability of insurance is key to the functioning of many businesses and individuals, including homeowners, renters, and drivers. As a result, “the health of the insurance industry is critical to ongoing economic activity,” the report says, noting that medical services were temporarily curtailed in Australia after the collapse of one of that country’s largest general insurers rendered it unable to meet potential medical malpractice liabilities.
Le Pan suggests lessons be taken from the policy response to the crisis banks faced during the 2008 financial crisis to better prepare the Canada’s insurance system to deal with natural disasters.
In the banking industry, the focus was on building “resiliency and shock absorbers to minimize the impact of financial shocks on the real economy,” he writes. “The inevitability of an earthquake in Canada poses a similar systemic financial risk for the insurance industry and the economy as a whole, and similar remedial efforts are required.”
The report also urges insurance industry agencies and governments to initiate awareness programs to encourage Canadians to evaluate the merits of disaster insurance coverage, particularly in the Quebec City-Montreal-Ottawa where only about two per cent of homeowners have earthquake coverage.
The C.D. Howe Institute is a not-for-profit research group that aims to raise living standards by fostering economically sound policies.