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The federal government needs to take action to shore up systemic risks in Canada’s insurance industry that could leave the sector vulnerable to collapse in the event of a mega-catastrophe, says the co-author of the latest research into potential fallout from major disasters such as earthquakes.
“Canada is the only G7 nation that doesn’t have any type of federal involvement to help the insurance industry as a whole deal with mega catastrophes,” said Anne Kleffner, a professor at the University of Calgary’s Haskayne School of Business.
“Without some type of intervention, such an event will result in serious economic consequences for Canadians,” she said.
Her report follows at least two others with similar dire warnings, one of them penned three years ago by a former head of Canada’s top banking and insurance regulator, the Office of the Superintendent of Financial Institutions (OSFI).
Since 2017, there have been “lots of conversations” with government officials but “no action,” Kleffner told the Financial Post.
Private insurers in this country are backed only by an industry-funded compensation body — the Property and Casualty Insurance Compensation Corporation — and a major earthquake in what scientists regard as hot zones around Vancouver and Montreal could lead to a domino-like financial collapse of Canada’s entire insurance industry, Kleffner and her co-authors warn in their study, which was published in August in the Geneva Papers on Risk and Insurance – Issues and Practice.
A mega-disaster in which total insured losses of policyholders exceeded $35 billion would cause small regional property and casualty insurers to fail, pushing their obligations onto larger insurers through payouts required under the industry-funded compensation body, according to study, which was co-authored by Mary Kelly, a professor and chair in insurance at Wilfrid Laurier University, and Grant Kelly, chief economist at PACICC. The levies would be so huge that they would cause the larger insurers to fail as well.
The impact of such a scenario would spread beyond the insurance sector to industries that rely on insurance to operate, such as transportation and manufacturing, Kleffner said in an interview.
In an isolated real-world example of this phenomenon, the collapse of a single major insurer in Australia in 2001 caused medical services to be temporarily curtailed due to uncertainty over coverage.
At a minimum, a major catastrophic earthquake in Canada would lead to months of dislocation and disruption as businesses scrambled to find insurance from other sources, Kleffner said.
Previous research pointing to significant risks to Canada’s insurance industry from a major catastrophe includes a report from the Conference Board of Canada in 2016, which estimated the country’s rate of economic growth would be halved in the short term. That report further warned of the potential for nearly $100 billion in cumulative losses in real Gross Domestic Product (GDP) in the long term.
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A 2016 report from the C.D. Howe Institute, authored by Nick Le Pan, former head of the Office of the Superintendent of Financial Institutions (OSFI), recommended the adoption of a federal emergency backstop arrangement to minimize systemic financial impact on the economy at large. That report noted that policymakers’ focus on the buildup of risk in the banking system since the 2008 financial crisis had not been mirrored in the insurance industry when it came to the impact of natural disasters.
The issue of catastrophic earthquake risk made it on to a 2017 list of issues the Department of Finance planned to address, but the impact on the insurance industry was subsequently put on a longer-term track to be addressed by around 2024, according to Kleffner.
Also in 2017, the industry-funded Property and Casualty Insurance Compensation Corporation and the Insurance Bureau of Canada made a joint submission to the federal finance department proposing to expand the compensation body’s toolkit by allowing it to borrow money from the government in the event of a catastrophic earthquake. That idea remains at the proposal stage, Kleffner said.
A spokesperson for the Department of Finance confirmed the government’s pledge in a 2017 consultation paper to consider ways to limit system-wide risks that an extreme earthquake could pose to property and casualty insurers.
“This work is underway,” Anna Arneson, manager of media relations and consultation, said in an email.
She added that OSFI, the federal banking and insurance regulator, imposes stringent standards on federally regulated insurers that require them to have sufficient “resources to withstand a 1-in-500-year earthquake.”
Kleffner said it would be much more efficient to have a government backstop arrangement set up ahead of time than to try to bail out the insurance industry if necessary once a catastrophe struck. But she acknowledged the difficulty of trying to spur action with no way to predict how soon the arrangement would be needed.
“It isn’t perceived to be an urgent risk because there hasn’t been a recent major earthquake to remind people, and most elected governments don’t have a long planning horizon,” she said.
If the government were to act to mitigate the risks to the insurance industry and economy, Kleffner said she thinks Canada would do well to adopt a model put in place in Japan. In that public-private model, the government provides reinsurance to backstop private insurance liabilities stemming from massive earthquakes, and the amount to be paid by government is determined by pre-set triggers and limits.