Why it matters that British Columbians buy earthquake insurance; Washingtonians don’t

Glenn McGillivray, Western University and Mary Kelly, Wilfrid Laurier University

The Pacific Northwest is a region that is both blessed with staggering natural beauty and cursed with extreme risk from powerful earthquakes.

But even though Canadians and Americans living in the region share virtually the same risk from a major quake, the 49th parallel that demarcates the boundary between Canada and the United States also marks another line — more than 60 per cent of homeowners in the lower mainland of British Columbia purchase earthquake insurance protection for their homes and belongings, while less than 14 per cent of those in western Washington State do the same.

In insurance lingo, this means there is a “protection gap” in both B.C. and in Washington State, though the gap appears to be more of a gaping chasm for Americans.

What is the ‘protection gap?’

As losses from natural hazards are on an upward trajectory, both globally and in Canada, the protection gap has been a popular topic in the insurance industry in recent years.

This gap is defined as the portion of total losses generated by an event like a hurricane, flood or earthquake that is not covered by insurance. Globally in U.S. dollars, this gap came in at $171 billion in 2020 for all natural disasters, as only $97 billion of the total $268 billion in damage was insured.

Over the past decade, only $102 billion of $535 billion in losses were covered by insurance for earthquakes alone.

This is problematic because, essentially, the bigger the gap, the greater the disaster-related costs that are borne out-of-pocket by society. According to research, when more people buy insurance, society tends to be more resilient, prompting it to bounce back faster after a catastrophic loss than in places where fewer people buy purchase coverage.

ShakeZone Mobile Earthquake Simulator in Victoria, B.C. Image: City of Victoria

The risk is there, so why not the coverage?

Several theories exist as to why the number of people who buy earthquake insurance in earthquake-prone countries tends to be low considering the significant risk.

Our team (including Steven Bowen, head of catastrophic insight at Aon, a global professional services firm) looked at several potential influences on the decision to purchase earthquake insurance, including socioeconomic factors (such as age, education, income), perceptions of seismic risk and expectation of government bailouts via disaster assistance programs, as well as issues pertaining to the cost of the product and the unattractiveness of the policy design.

Our work finds very little difference in most of these factors in the U.S. and Canada, so these small differences don’t explain the significant variance in take-up rates in B.C. and Washington.

Earthquake damage to Seattle Pioneer Square is seen after the 2001 Nisqually earthquake. Image: Seattle Municipal Archives CC BY-SA

The only significant difference found between the two locales is the broader availability of government disaster assistance in Washington over B.C. While there are numerous aid and grant programs to help uninsured or under-insured people in the U.S., the B.C. government has publicly stated that it will not pay assistance for earthquake damage because of the availability of private insurance.

We believe this and issues centring around national culture are two main reasons why earthquake insurance take-up rates are so low in Washington.

The Canadian Constitution heralds Canada’s “peace, order and good government” while the U.S. Declaration of Independence emphasizes “life, liberty and the pursuit of happiness.” Because Americans tend to be individualistic and less likely to trust information provided by authorities, they are more likely to underestimate the potential risk.

This has resulted not only in low take-up rates for earthquake insurance in western Washington, but also in California, where roughly only 10 per cent of households have proper coverage.

Damage to Washington State Route 302 after 2001 Nisqually earthquake. Image: USGS

Narrowing the gap

Given the worldwide increase in economic losses due to natural catastrophes, it’s essential to narrow the insurance protection gap. When losses are insured, people and institutions don’t need to pay for losses out of pocket. Reducing the protection gap reduces the burden on taxpayers and promotes societal resiliency.

While the protection gap exists for many reasons, potential solutions have been explored worldwide to reduce it. For example, mortgage lenders could require, or governments could mandate, the purchase of insurance.

Changes in product design could also motivate more homeowners to purchase earthquake insurance, from bundling all potential disasters into a basic insurance policy to changing policy duration from the typical one year to multiple years and providing “insurance vouchers” to high-risk but low-income households.

There may also be a role for governments to act as insurers, provide a liquidity or solvency backstop to insurers or offer coverage through property taxes.

Our findings go beyond the issue of earthquake risk and are relevant when considering the impact of climate change, because the phenomenon will increase in the face of extreme weather events around the world.

The increased risk will require both insurers and governments to take steps to ensure that adequate protection against catastrophic losses is in place.The Conversation

Glenn McGillivray, Managing Director, Institute for Catastrophic Loss Reduction, Western University and Mary Kelly, Chair in Insurance and Professor, Finance, Wilfrid Laurier University

Cover/Top image courtesy Seattle Municipal Archives., CC BY-SA.

This article is republished from The Conversation under a Creative Commons license. Read the original article.

The Hurdle of Replacement Cost Value (RCV) to Building Back Better

The Hurdle of Replacement Cost Value (RCV) to Building Back Better

  • Emily Stock, lawyer, Monaghan Reain Lui Taylor LLP

When we discuss the concept of building back better, we all agree that it is great.  Who can oppose making our communities, infrastructure and people more resilient to catastrophes.  We also recognize that there are a multitude of hurdles to consider, and that underlying many of those hurdles is an often inflexible legal regime.

Understanding property insurance coverages is significant to any policy for building back better.  Typically property insurance policies provide for some combination of Actual Cash Value and Replacement Cost Value, depending on a variety of criteria.

Actual Cash Value (ACV) is also sometimes referred to as market value.  It is intended to be the dollar amount you could expect to receive for the item if you sold it in the marketplace.  It thus takes into account depreciation of the property.  An insurance company determines the depreciation based on a combination of objective criteria (a formula considering the category and age) and a subjective assessment in the marketplace.  The result is that if a homeowner receives ACV they technically receive exactly what they lost (i.e. the value of an old house); however they cannot afford to replace their property (i.e. build a new house).

Replacement Cost Value (RCV) is the cost to replace the property.  It insures the depreciation of the property, so that the homeowner receives the cost to build a new house similar to the house they lost.  When we talk about building back better, the homeowner can typically only afford to rebuild if they are able to obtain RCV.

The difficulty in obtaining RCV is that it is typically only available where the rebuild is:

(a)        at the same site or location; and,

(b)        uses materials of “like kind and quality.”

But what if being at the same location, or building the like kind and quality, is not building back better?  Consider if the insured event is a flood in an area that is now prone to flood zones.  We don’t want to encourage that homeowner to rebuild in the same location, despite there being significant financial incentive for them to do so.  Similarly if the event is a fire, we know that we don’t want to require that the rebuild use the same non-fire resistance materials (i.e. siding, roofing materials), or even to rebuild the same type of structure which may have been inappropriate for the location recognizing the changing environment.

Although we recognize that the wording of the policy must define the rights of the homeowner, and the monetary obligation of the insurer, I expect we would also agree that it seems unfair to require the homeowner to rebuild at the same site, or use materials of like kind and quality, where such is contrary to the principles of building back better.

In considering this conundrum, it is helpful to consider the rationale for RCV, as recently articulated by the Ontario Court of Appeal in Carter v. Intact.  After recognizing that replacement cost insurance is justifiable even though it provides the policyholder with greater value than what they lost, the Court explained the following as to why the limitations on RCV are reasonable and required:

… allowing insureds to replace old with new raises a concern for the insurance industry. The concern is moral hazard: the possibility that insureds will intentionally destroy their property in order to profit from their insurance; or the possibility that insureds will be careless about preventing insured losses because they will be better off financially after a loss.

To put a brake on moral hazard, insurers will typically only offer replacement cost coverage if insureds actually repair or replace their damaged or destroyed property. If they do not, they will receive only the actual cash value of their insured property.

It is clear from this reasoning that there is little to no risk of the moral hazard in catastrophic insured events.  There is similarly no risk of the moral hazard where an insured homeowner does not want to comply with one or both of the criteria to receive RCV, same location and/or like kind and quality, because of a desire to build back better.

As an advocate for encouraging the insurance industry to build back better, we therefore advocate thoughtfully reducing the two criteria for building back better.  This could be done proactively by deleting the same location requirement in policies in flood or other risk zones.  The like kind and quality criteria should also be carefully examined for certain types of insured events (i.e. fires), so that more appropriate materials can be agreed upon before the event as acceptable under the policy.

An important step to reducing these types of hurdles is to continue and develop the conversation, which I look forward to doing at the CATIQ Canadian Catastrophe Conference in 2018, and beyond.

IMPROVING WILDFIRE AND FLOOD RISK MITIGATION IN CANADA

Improving Wildfire and Flood Risk Mitigation in Canada

Author: Alan Frith, CPCU, ARe, CEEM

Canadians have suffered an increasing number of natural and man-made disasters that have devastated communities and cost insurers more than CAD 5 billion in 2016 alone. With decentralized regulation and prevention efforts, the growing financial fallout is only likely to worsen. CatIQ’s Canadian Catastrophe Conference, January 31 – February 3, 2018, will bring together industry, academia, and government to discuss Canada’s natural and man-made catastrophes. I will be sitting on a panel discussing the viability of the Alberta property insurance market in light of recent catastrophic events.

For insurers, an accurate and objective view of risk, reinforced by an up-to-date insight into the exposure, is crucial to maintaining financial stability. Managing catastrophe risk through historical losses alone is unreliable and volatile. Organizations must seek out the most comprehensive information available to understand how rapidly changing environmental characteristics alter their risk profiles.

Let’s examine two of the perils that have recently caused significant losses in Canada to understand how risk assessment tools can be used to quantify the impact of these kinds of events.

Wildfire

High-resolution satellite imagery enables us to develop an in-depth understanding of land use/land cover and is a critical piece of the risk mitigation framework. Using this imagery, risk modelers can construct an accurate map of potential fuel sources, a fundamental requirement for effectively modeling wildfire spread. Dense or dry vegetation, for instance, allows a fire to spread easily, while roads, rivers, or even mountains serve as natural firebreaks. Depending on the local distribution of fuel sources, the interaction between different types of fuels, and the gradual evolution of the surrounding landscape, your portfolio’s exposure may very well outpace your organization’s risk appetite over time.

It’s also important to monitor the effect of population movement. Rapid residential and commercial/industrial growth deeper into areas of combustible fuel, the Wildland Urban Interface (WUI),  exposes properties to greater wildfire risk. For organizations underwriting property risk in Canada, one fire in recent memory certainly stands out from the rest, demonstrating well the dangers of increased development in the WUI.

In 2016, the Fort McMurray fire blazed through the surrounding areas of northeastern Alberta, causing unprecedented devastation and destroying up to 80% of homes in some neighborhoods. A hub of oil production in Canada, the town had experienced a 30% population boom between 2006 and 2011 as people moved to the area to take advantage of job opportunities at the many mines and oil sands refineries in the area. The increased presence of residential structures among dense forest helped the flames spread quickly and resulted in insured losses of nearly CAD 4 billion – making it the costliest natural disaster in Canadian history. Although the oil facilities and pipelines themselves avoided damage, oil companies suffered significant business interruption losses as firefighters struggled for months to contain and extinguish the fires.

Flood

Detailed satellite imagery, coupled with high-resolution elevation data in the form of digital terrain maps (DTMs), is also used to build floodplain maps, which play an important role in evaluating flood risk. Reliable model output for this peril is highly dependent on precise exposure locations, as small changes to a location’s elevation or proximity to floodplains can have a significant impact on potential losses. The development of risk mitigation strategies, such as strict building codes and zoning laws, can help prevent these losses, so long as these codes are followed and the laws are enforced. Government agencies must consider the effect that unchecked commercial development—and the associated infrastructure of roads, sidewalks, and parking lots—can have on the larger ecosystem, especially during a natural disaster. The consequences of unregulated urban sprawl were recently seen in Houston, Texas, during Hurricane Harvey: Severe flooding was caused in part by floodwater that had inadequate access to natural drainage, such as undeveloped prairie and marshland areas.

Although flood is by far the most frequent natural disaster in Canada, preventive efforts are largely decentralized. For residential structures, overland flood damage has only recently been included as a covered peril by private insurance. In many cases, it’s a common exclusion from homeowners’ policies, with catastrophic losses ultimately falling in taxpayers’ laps via government emergency funds. With multiple catastrophic flood events in the past seven years, each causing billions of dollars of losses, it’s imperative to mitigate risk through preventive measures. This includes building flood defense systems as well as encouraging homeowners in and around potential flood zones to purchase policies that protect them against flood loss.

What’s Next?

Governments, insurers, and homeowners need to work together to reduce losses caused by natural disasters. It’s encouraging to see mitigation efforts gaining momentum, but there is much more work to be done. While government can manage building codes and zoning laws, it’s also up to insurers to carefully evaluate their risk profiles and exposures to ensure that they continue to maintain adequate reserves in the event of a catastrophe.

A useful first step in risk assessment is a detailed hazard map. These maps indicate the associated risks for perils such as wildfire and inland flood for a range of return periods, such as 100, 250, and 500 years. The logical next step to advance your risk evaluation strategy is to use a probabilistic model.  These models use advanced simulation methods to provide valuable metrics such as Average Annual Loss (AAL), Tail Value at Risk (TVaR) and a full Exceedance Probability (EP) Curve, from portfolio level down to individual exposures.

The Geospatial Analytics Module in AIR’s Touchstone® platform lets you seamlessly integrate exposure information with location-specific hazard maps, including wildfire fuel layers and flood inundation footprints for Canada. In addition, AIR offers probabilistic models for earthquake, crop hail, severe thunderstorm, winter storm, and tropical cyclone in Canada; models for wildfire and flood are being developed. As the insurance industry in Canada continues to cope with recent losses, the development of risk maps and probabilistic models as well as a deeper understanding of underlying hazards can help provide more effective risk management.

AIR models give you the information you need to support your entire risk-decision chain. Learn about the AIR Model Advantage!

About AIR Worldwide

AIR Worldwide (AIR) provides risk modeling solutions that make individuals, businesses, and society more resilient to extreme events. In 1987, AIR Worldwide founded the catastrophe modeling industry and today models the risk from natural catastrophes, terrorism, pandemics, casualty catastrophes, and cyber attacks, globally. Insurance, reinsurance, financial, corporate, and government clients rely on AIR’s advanced science, software, and consulting services for catastrophe risk management, insurance-linked securities, site-specific engineering analyses, and agricultural risk management. AIR Worldwide, a Verisk (Nasdaq:VRSK) business, is headquartered in Boston with additional offices in North America, Europe, and Asia. For more information, please visit www.air-worldwide.com.

IMPROVING SAFETY THROUGH SIMULATING WILDFIRE RESPONSE

Improving Safety Through Simulating Wildfire Response

Steven Gwynne, Ph.D., Research Officer, NRC Construction – Fire Safety, National Research Council Canada

Wildland fires represent an important safety issue in many regions of the world – including Canada. This is complicated by the current location and possible future expansion of wildland-urban interfaces (WUI) posing severe challenges from a community evacuation perspective. Large WUI fires, like the recent Fort McMurray fire, are associated with severe negative consequences including massive community evacuation, property losses, social disruption, short- and long-term damage to infrastructure, injuries, and in some instances fatalities of evacuees and responders. Tools to assist planning and response are essential to provide evidence to planners, evacuees and responders to better address these challenges.

As we go forward, it is expected that droughts will get more severe and prolonged, thunderstorms more frequent, wind patterns will change and harsh hot seasons will affect new regions. Current trends in community planning show that more people are inhabiting areas that are now or soon to be vulnerable to WUI incidents. Housing developments in WUI areas are particularly appealing given their low cost, access to recreational pursuits, and the aesthetic benefits of being closer to nature. Therefore, WUI incidents are likely to become more severe and affect new areas and those areas already susceptible to wildfires.

The social and physical geography associated with WUI communities present a special challenge that needs to be addressed when ensuring life safety. In order to successfully respond to a wildfire incident, those involved must have an understanding of current and future events enabling them to reach safety or facilitating others to do so. Decisions made during community planning, property upkeep, emergency planning, public education, responder training, and during the evacuation itself are all heavily reliant on the information available. To ensure that this preparation and response is adequate, the effectiveness of the pre-incident decisions and decisions taken during the incident needs to be understood to allow assessment of these decisions before they are finalised and executed; i.e. before they are put into practice in the real-world. This effectiveness is reliant on the accuracy and completeness of the information available.

Very often, the wisdom derived from previous wildfire disasters is the only available source to identify current scenarios of interest and plan the response of a given community. However, there is no guarantee that these past experiences correlate well with the next disaster to be faced or with the conditions that might contribute to the outcome of the incident in the current context – especially given the expected evolution of WUI incidents. In this context, a simulation framework that can establish evacuation performance ahead of time, and that is capable of examining different designs and response scenarios would be very useful. Such a computational framework might be used to predict how the evacuation develops based on different fire scenarios (different origin, speed, development, etc.) and according to different evacuation decisions (e.g., staggered evacuation by neighbourhoods, the arrangement of traffic flow on highways, or the appearance of congestion). Moreover, current resources do not allow for the impact of procedural decisions to be assessed (and quantified) before they are executed; i.e. how conditions might evolve and might affect and be affected by an evacuating community. This is an important limitation in current approaches – that cater to understanding the current situation but cannot provide numerical evidence to support procedural decisions given forecasted changes in conditions. To do this, simulation tools are needed to explore the development of a wildfire, and the impact that it has on the response (e.g. evacuation using vehicles or on foot) – to identify current and future vulnerabilities and inform ways of addressing it. This might then provide an additional tool for planners and responders in their attempts to address WUI life-safety issues as we go forward.