What Canada’s earthquake backstop might look like

After 13 years advocating tirelessly for an earthquake backstop, the Property and Casualty Insurance Compensation Corporation (PACICC) has been asked to help flesh out exactly what the backstop would look like.

“And the deadline was just seven weeks away!” PACICC president and CEO Alister Campbell writes in the corporation’s latest quarterly Solvency Matters report.

Finance Canada launched a consultation on Feb. 24 to hear ideas on what an earthquake insurance cost-sharing arrangement might look like, following a desktop simulation demonstrating the scope and scale of Canadian earthquake exposure in British Columbia and Quebec. The federal government imposed a deadline of Apr. 10.

“As I write this note, we are still developing our full, formal response to the Finance Canada consultation,” Campbell writes. “But the broad strokes are already clear and I am comfortable sharing — at a high level — what we are likely proposing to tell Ottawa.”

One component of the model is that any proposed solution must cover both federally and provincially supervised insurers. “The cost-sharing arrangement needs to be a national mechanism, not just a federal one — in order to fully mitigate systemic writes,” Campbell says. He notes more than 60% of Quebec personal property insurance and 20% of B.C. personal property insurance is currently underwritten by provincial insurers.

Quebec-based Desjardins Group is the largest provincially-regulated insurer. The inclusion of provincially regulated insurers in the cost-sharing arrangement is important, says Evan Stubbings, director of government affairs at Desjardins Group.

“What we are looking for as an industry is a backstop and upfront liquidity to pay for those claims, because there is going to be a huge, huge influx when this happens,” Stubbings said last week at Insurance Institute of Canada’s annual CIP Society symposium in Toronto.

Importance of inclusion

Why does it matter that provincially regulated insurers are included?

“We’re part of Desjardins Group, we have some capital. I think we’ll be okay,” Stubbings says. “But smaller players, if they start to fail because they aren’t part of that liquidity solution, the other carriers, including the federal ones, are just going to assume that risk anyways through their PACICC assessments…

“We really wouldn’t be moving the needle whatsoever if we do not include the entire industry.”

PACICC is also proposing a cost-sharing arrangement modelled on the U.S. terrorism backstop TRIA, the Terrorism Risk Insurance Act. It would be structured with a clear trigger or threshold, an appropriate deductible or net retention for the industry, and an upper bound on total government obligation with some sort of “re-coupment” model, Campbell writes.

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TRIA provides for a transparent system of shared public and private compensation for certain insured losses. The federal backstop applies only if total industry insured losses exceed the statutory program trigger.

“Careful modelling and analysis will be required to set ‘trigger/thresholds’ and the industry ‘deductible’ in the ‘TRIA-like’ structure,” Campbell writes. “To the extent that any successful design will need to allow insurers ‘to fail’ (as antidote for ‘moral hazard’), there will also need to be accurate modelling to estimate how much failure the system can ‘afford.’

“It seems very possible that the PACICC Systemic Risk Model (encompassing both federal and provincial insurers) will prove to be invaluable in supporting this modelling work.”

A recoupment mechanism will likely be a central element of the arrangement. This will enable the industry to repay funds received from the federal government over a period of time after the major earthquake event, Campbell notes.

Lastly, “it is past time for Finance Canada to formally designate PACICC as a ‘compensation association’ under the federal Insurance Companies Act.”

Desktop simulation to formal consultation

The most recent earthquake developments occurred in mid-December in Ottawa after the Office of the Superintendent of Financial Institutions hosted PACICC and the Insurance Bureau of Canada. The industry engaged federal and provincial stakeholders in a desktop simulation demonstrating the scope and scale of earthquakes in B.C. and Quebec.

That exercise provided modelled estimates for two “scientifically credible” events, and the resulting total ground-up losses and insured losses, as well as an evaluation of the likely damage to strategic infrastructure assets such as airports, ports and power plants. Modelling also included fiscal needs and expected impacts to overall GDP and government revenues.

Desktop simulation participants were shown events that would send PACICC member insurers past the ‘tipping point,’ causing them to fail and fuelling systemic contagion. The success of the simulation prompted the formal consultation.

“We anticipate the next few weeks and months to be quite hectic, as we work with all industry and federal/provincial stakeholders to get to the finish line on design of an effective liquidity backstop mechanism,” Campbell writes. “And it is realistic to assume there will be at least a few more bends in the road before we get there.

“But after 13 years of effort, it is clear that we have never been closer to seeing — and perhaps even being part of — a solution to address this glaring gap in the public infrastructure of Canada.”

Jason Contant

Jason has been an award-winning journalist with Canadian Underwriter for more than a decade, including the past three years as associate editor and, before that, as digital editor for seven years.