Shaking things up: Earthquake risk and insurance in Canada

March 2017    |    By Indrani Nadarajah

Canada experiences about 4,000 earthquakes a year, with most too slight to cause any damage. Experts do agree, however, on the possibility of a significant earthquake hitting southwestern B.C. in the next 50 years. While Canadians remain ill-informed about the scope of their cover, there are calls for the media, insurers and intermediaries to do more to boost consumer awareness. Underinsurance may be a problem for homeowners that do have insurance, as a Swiss Re report illustrates. Finally, the seismic landscape of parts of Canada is changing due to fracking.

Industry data reveal that 80 to 90% of commercial and industrial enterprises purchase “all hazard” insurance coverage that includes earthquake damage. As earthquake cover is not automatically included in most homeowners insurance policies, the coverage is lower on the personal side.

Between 60 to 65% of southwest BC homeowners have earthquake insurance, while 70% of Victoria homeowners are insured, and 55% of Vancouver homeowners. Coverage by renters is much lower.

When viewed within an international context, the Canadian West Coast figures are relatively robust. According to the Insurance Information Institute, the take-up rate in California and Washington in 2015 lies in the 10 to 12 % range, down dramatically from the 30% range achieved two years after the 1994 southern California Northridge quake.

For Canadians living outside of the Canadian West Coast area, only about 2% have earthquake coverage. This figure includes residents in the earthquake-prone Quebec City-Montreal-Ottawa corridor.

The underinsurance problem

In late 2015, Swiss Re issued a research report noting that the underinsurance of property risks is a global problem, with most of the gap linked to uninsured global natural catastrophe risk. Swiss Re’s data shows that total economic losses from natural disasters have averaged US$180 billion per year over the last decade, with 70% of that uninsured (US$1.3 trillion in total over the 10 years). Earthquakes, floods and windstorms are the main perils. The costliest disaster in 2016 was the earthquake that hit the Japanese province of Kyushu, resulting in US$31 billion in damages. Eighty-one percent of the damages were uninsured.

Swiss Re also reported that a 2014 sample of nearly 630,000 property units in the US and Canada showed that many properties were valued lower than their estimated replacement value. CoreLogic proprietary analysis showed that properties with limits below US$20 million (representing 95% of the sample) were undervalued by an average of 26%, while properties under US$5 million were undervalued by an average of 38%. A main reason for the more severe under-valuation of smaller properties is the use of depreciated values from accounting records rather than assessing replacement values, the reinsurer explained. Rental apartment buildings were typically undervalued by 14% and wholesale and retail trade properties by an average of 25%.

The report authors inferred from the data that there could also be “substantial undervaluation” of residential property. Here, personal property undervaluation could be driven by the homeowner’s lack of awareness or policy choice based on affordability rather than adequate coverage.

The Swiss Re observations build on findings made in the 2008 Wharton report on managing large scale risks. The authors in that report concluded that the major reason for consumers not buying insurance is underestimating the risk. Homeowners in hazard-prone areas believe that the hazards will not happen to them.

The Canadian perspective

While Canada does experience thousands of minor earthquakes a year, geologically, the phenomenon is not well-understood. Alexander Allman, head of corporate underwriting at Munich Re said his company’s research showed little is known about fault lines in Canada. “Our whole idea of mega earthquakes is related to that one event (in 1700),” Allman said. “We have a very limited idea of low seismicity regions – and Canada is one of them. If you look in the historical record, there is nothing. There’s no loss data, there’s nothing in the east.” An article in the August 2016 issue of BC Broker magazine noted that the issues around earthquakes are “largely untested in Canada.”

A 2015 AIR Worldwide study commissioned by the Insurance Bureau of Canada estimates that the overall losses of a 9.0-magnitude earthquake in British Columbia would total almost $75 billion, with only $20 billion of that insured loss. The same study estimates the losses after a 7.1-magnitude earthquake in the Quebec City-Montreal-Ottawa corridor at almost $61 billion, with just $12 billion of that insured.​​​ Both scenarios indicate a large protection gap of 75% and 80% respectively.

A Conference Board of Canada report, Canada’s Earthquake Risk: Macroeconomic Impacts and Systemic Financial Risk, commissioned by the Insurance Bureau of Canada, says modelling demonstrates that much of the economic devastation of a massive earthquake would not be caused by the earthquake itself, but from the resulting chain of insolvencies and financial services disruptions. The catastrophe’s main impact through the banking system would likely to be through the credit risk effects from uninsured losses on residential and commercial properties, a problem that could be effectively addressed via the appropriate insurance cover: for example, credit unions in B.C, already demand earthquake insurance in order to secure a mortgage.

The report also warns that the financial impact on federal and provincial governments would be crippling (potentially up to $122 billion in new net debt) if emergency disaster relief was required because of insolvencies in the insurance and financial sectors. At the moment though, Canada has no federal financial involvement to limit exposure, provide or facilitate backstop arrangements for very severe earthquake-related events.

A C.D. Howe paper written by former federal superintendent of financial institutions, Nicholas Le Pan, recommends a last-resort federal emergency backstop arrangement for property and casualty insurers to minimize the systemic financial impact resulting from a “catastrophic and likely uninsurable natural disaster.”

The federal government has already taken steps to address tail-risk in the banking sector, by establishing government-backed deposit insurance as well as recovery and resolution plans. There are also measures to deal with the risks associated with nuclear disasters and off-shore oil and gas operations.

Canadian regulators have already developed capital requirements for insurers but this does not address the tail-end of the risk, which is the very low-frequency, high-severity probable events that lie outside the “normal” spectrum of risks.

Among Le Pan’s recommendations:
- Bolster the Property and Casualty Insurance Compensation Corporation's (PACICC) mandate to enable it to deal with insurance industry problems and reduce systemic impacts from severe catastrophes.
- Insurance industry bodies, and the federal and provincial governments, should promote awareness programs to enhance homeowners’ understanding of catastrophe risks. The programs should encourage Canadians to consider disaster insurance coverage, particularly in the Quebec City-Montreal-Ottawa corridor where such insurance penetration is woefully low. The media has a very important role to play in educating homeowners. "In this regard, it is striking that much of the mainstream Canadian media commentary on the earthquake issue focuses on B.C., to the exclusion of other parts of the country,” observes Le Pan.

Paul Kovacs, president and CEO of PACICC, said his corporation’s own research, released in 2013, found that the Canadian insurance industry could manage up to $15 billion for a single catastrophic event (such as a large-magnitude earthquake). Some insurers would become insolvent if an event caused between $25 and $30 billion in insured losses. Beyond $30 billion, the catastrophic losses would exceed the existing capacity of Canada’s insurance industry and would exceed PACICCs ability to meet policyholder claims. (Current insurance industry capacity is between $30 and $35 billion.) 

Earthquake insurance coverage

Some 40% of Canadians live in areas classified as “moderate” or “high” risk for earthquake activity. To better deal with earthquake and other risks, some 600 changes were introduced to Canada's building codes in 2016.

All buildings in Canada will now be designed to take into account earthquake forces regardless of the level of hazard. The revisions, introduced by the Canadian Commission on Building and Fire Codes under the authority of the National Research Council (NRC), apply to the National Building Code of Canada, National Fire Code of Canada, National Plumbing Code of Canada and National Energy Code of Canada for Buildings, and must be adopted by jurisdictions that regulate construction on a local level.

British Columbia is also earmarking millions of dollars for seismic upgrades and construction. More than $2 billion in provincial funding has been spent or committed to upgrade or replace 214 of the 342 schools deemed at risk in an earthquake. Metro Vancouver has seismically upgraded its water reservoirs and is considering a program to bring its sewage system up to date. Hospitals are also being attended to. 

In a joint webinar with the Conference Board in January 2017, IBC director, government relations, Western & Pacific, Aaron Sutherland, said the bureau is still pushing for higher construction standards and improving the building code. “There’s certainly a lot more we can be doing to improve our buildings as technology changes and our understanding of these risks improve,” he explained. He noted the similarities in the older buildings in Victoria, B.C. and Christchurch, New Zealand. “We’re looking at measures to improve those old brick and mortar buildings as well.”

Participants at the Conference Board webinar also noted that the high deductibles continue to be a deterrent for potential buyers. Aftershocks, which frequently attend earthquakes, are also treated as separate events with separate deductibles.

Deductibles on earthquake claims may range up to 15% of the value of the building and contents, but there is insurance for that, with the availability of deductible buy-down cover.

More product innovation required

While most insurers’ policies continue to exclude earthquake insurance, homeowners continue to be in the dark about their exposure. A CADRI Homeowner Property Insurance Survey Report conducted in 2015, found that only 51% of Canadians think, or are certain, that they are covered in the event of an earthquake. Interestingly, the CADRI survey found that Canadians are not overly concerned about property insurance premiums today. Fifty-five percent of Canadians believe their premium to be fair with CADRI inferring from the survey that homeowners are reluctant to reduce coverage especially when faced with the risk for a material loss. This also appears to suggest that in some cases, the lack of earthquake cover for individual homeowners boils down to a lack of knowledge.

A 2016 Canadian Council of Insurance Regulators (CCIR) issues paper reiterated the point that consumer awareness is far from good, adding that the quality of policy wordings and marketing materials provided by insurers to consumers varies widely – “Some provided valuable, plain language explanations of coverage; others provided very little, if any particular information.” More needs to be done to ensure consumers have a good understanding of the coverages in their policies and the onus is on insurers and their intermediaries, the CCIR stressed. For example, to prevent confusion, earthquake deductibles should be shown on the declaration page as a dollar amount instead of as a percentage of the value of the building.

The CCIR also advised that insurers should look at product innovations: "There is no regulation that prohibits the development of products with less coverage, " it noted in the paper.

Policyholders’ misconception about their level of coverage can turn out to be an expensive headache for insurers especially when politicians get involved in the aftermath of a disaster. Indeed, some commentators have suggested that homeowners may turn to their insurers seeking compensation for earthquake-related losses, even if the coverage is not provided by their contracts. For example, after the ice storm in 1998, many insurers were asked to read in coverages that were not in their contracts. After the 2013 flooding in High River, Alberta, insurers were asked to apply sewer back-up coverages to losses caused by flooding, despite the fact that overland flood was an excluded peril in all homeowner policies.

PACIFIC QUAKE ‘16

Despite British Columbia's vulnerability to earthquakes, B.C.'s provincial government was recently criticized by auditor general, Russ Jones, for not being ready to handle a catastrophic earthquake 17 years after the first earthquake preparedness report raised the issue. In the auditor general's updated 2014 Catastrophic Earthquake Preparedness report (which concluded that "the province is still at a significant risk if a catastrophic earthquake were to occur today"), nine recommendations were put forth, covering issues like long-term planning and annual public reporting.

Stung by the report, B.C. quickly invested over $1-million to support its first-ever provincially led, full-scale earthquake response exercise that would test elements of the new B.C. Earthquake Immediate Response Plan (IRP).

The exercise, called Pacific Quake ’16, was held between June 7 and 10, and involved the real-time deployment of the Provincial Coordination Team (PCT), a cross-government group that can be activated to bring support to a local authority in an emergency, and the Heavy Urban Search and Rescue (HUSAR) team from Vancouver. The U.S.'s Federal Emergency Management Agency (FEMA), created an imaginary scenario of a morning quake on June 7 that was followed by aftershocks and a tsunami.

Pacific Quake ‘16 aimed to gauge how effectively governments could respond to a magnitude 9.0 earthquake off the southwestern coast of British Columbia and Portland, Oregon, and involved over 20,000 people on both sides of the border.

While Public Safety Canada has been commended for the effort, the exercise revealed many concerns. Internal documents obtained by CBC found that the plan was marred by bad communication and shoddy protocols — including the lack of any plan to respond to a destructive tsunami triggered by a quake, despite the imaginary scenario specifically including one.

Fracking and induced seismicity

A survey by Dr. Gail Atkinson at Western University, and published in the journal, Seismological Research Letters, has confirmed the link between fracking in the oil and gas fields of Western Canada and the earthquakes that have been occurring there.

Fracking refers to the process of injecting fluids deep underground to shatter rock and release trapped oil and natural gas. Most of the resulting earthquakes are small and might never have been detected without the use of new kinds of recording devices.

Dr. Atkinson and her colleagues investigated 12,289 fracking wells and 1,236 waste-water wells in an area of 454,000 square kilometres along the B.C.-Alberta border. The study linked 39 fracking wells and 17 wastewater disposal wells directly to several earthquakes of magnitude 3 or larger. The study confirmed that in the last few years nearly all of the region’s overall seismicity of magnitude 3 or larger has been induced by human activity, with only 5 to 10% of the earthquakes having a “natural” origin.

The Canadian Association of Petroleum Producers has put forth voluntary guidelines that encourage companies to assess the risk of seismic activity before drilling, and to make pressure and water volumes adjustments in the fracking operation to reduce risks. Critics argue that this is not enough, and that provinces must do more to prevent fracking-related earthquakes.

In Oklahoma, which has experienced a significant amount of earthquakes caused by fracking, regulators have stepped up their requirements on oil and gas companies. Producers wanting a drilling permit must now submit geological evidence that assesses seismic conditions. For quake-prone parts of Oklahoma, the state mandated a 40% reduction in injections of saltwater that have been linked to earthquakes.

Before the new rules came into effect on May 28, 2016, Oklahoma experienced about 2.3 quakes a day. Since then the figure has dropped to 1.3 a day. But the danger is not over. An Associated Press article states that some of those fewer post-regulatory quakes have been large and damaging, with “more magnitude 5s.” A September 3, 2016 quake of magnitude 5.6 was felt in parts of Nebraska and Iowa, and triggered the shutting down of dozens of oil and gas disposal wells.

Not surprisingly, there has also been an insurance sector fallout. A Reuters report in May 2016 notes that as the number of earthquakes in Oklahoma has risen, nearly a dozen insurance companies moved to limit their exposure: six insurers hiked premiums by up to 260%; three increased deductibles; and three companies stopped writing new earthquake insurance altogether. Reuters also reported that insurers have revealed that they would consider suing oil and gas companies for reimbursement in instances where they would have to pay damages to homeowners.

In acknowledgement of these new seismic risks, in 2015, the US Geological Survey released its first ever map identifying human-induced seismic hazards in the heartland of the US, which until very recently, was not considered “earthquake country.”

A similarly updated survey might also be needed for Canada’s vulnerable regions. Dr. Atkinson points out that the Western Canada Sedimentary Basin, which hosts one of the world’s largest oil and gas reserves, has “thousands of hydraulic fracturing wells being drilled every year.”

Dr. Atkinson said recalculating the seismic hazard for the region could impact everything from building codes to safety assessments of critical infrastructure such as dams and bridges. "Everything has been designed and assessed in terms of earthquake hazard in the past, considering the natural hazard," she said. "And now we've fundamentally changed that, and so our seismic hazard picture has changed."