Seismologists know that a major earthquake will someday occur in British Columbia or the Ottawa/Montreal/Quebec City corridor. This is not a question of if, but rather a question of when. These same experts have developed models that can estimate how many billions of dollars in damage this quake will cause. OSFI and provincial insurance regulators have established regulatory requirements for insurers writing property insurance in quake-prone areas, to demonstrate that they have adequate capital and reinsurance to withstand the losses from a very large earthquake with a “return period of one-in-500 years. However, they also acknowledge that there is significant model-risk in these estimations. Even assuming that the models are right, a quake with insured losses greater than those estimates could and likely would, cause a series of P&C insurers to fail. Almost all other developed nations with significant quake exposure have some form of pre-planned mechanism to “backstop” the industry in such circumstances. Canada is a significant and troubling outlier in this regard. In the absence of a federal plan, Canada’s Property and Casualty Insurance Compensation Corporation (PACICC), which is Assuris’ peer organization for P&C insurers, is forced to function as the default earthquake insurer of last resort. This is not a role that PACICC was designed to play. Beyond a certain size of quake event, our policyholder protection model will simply fail. Canada desperately needs a better solution.
Why will the PACICC model fail? A catastrophic earthquake that damages thousands of homes will essentially act as a massive “cash call” on P&C insurers. Above a certain size of event, that cash call will exceed the capital base and reinsurance protections of multiple PACICC Member Insurers – rendering them insolvent. The resulting PACICC Assessment required to return unearned premiums to policyholders, pay any non-earthquake claims on the books at the failed insurer, and fund payment of their policyholders’ earthquake claims, will act as a secondary shock on all the other “surviving” P&C insurers – and cause even more insurers to fail.
PACICC has published a series of Systemic Risk studies to identify the potential threshold in total insured losses (the “Tipping Point”) above which PACICC would fail in its mission to protect Canadian policyholders. The first study was published back in 2013. An updated version of our Systemic Risk Model was prepared in 2016, with the most recent publication in 2021. The 2021 study pegged the “Tipping Point” at approximately $35B in insured losses. There is much good news in this study finding. The threshold is very high, as the industry is highly capitalized and well reinsured. Even better news, the study also noted that there were very few perils which could cause such extensive insured losses (e.g., asteroid strike, space weather, or a mega-earthquake in British Columbia or the Quebec City/Montreal/Ottawa corridor). Of these, the one that we can be certain will happen in due course is quake.
Canadian policymakers agree that this is a problem. In its 2017 Budget, the Federal Government made an explicit commitment to address the systemic risks associated with a major quake. Since then, PACICC has participated in ongoing dialogue with key stakeholders. Tangible progress on implementation of solutions, however, has unfortunately been quite limited. PACICC’s Board consequently established “Mitigating Systemic Risk” as a “Permanent Priority Issue,” until such time as some form of federal, backstop mechanism is finally put in place.
In the most recent Federal Budget, Finance Minister Chrystia Freeland affirmed her Government’s commitment to addressing this issue. The industry is actively engaged in discussions around how to implement public-private partnerships to address multiple perils, including flood and quake. Given the complexity of these public policy files, we recognize that additional time may be needed for this dialogue with Finance Canada to reach a successful conclusion.
However, after waiting more than a decade, and in the absence of long-overdue policy action by the Federal Government, PACICC has begun to move forward with a series of incremental measures designed to mitigate systemic risk. In May 2024, regulators approved an amendment to PACICC’s Memorandum of Operation to remove the obligation for PACICC to establish a “maximum exposure” when calculating any Special Assessment. This has been replaced with a requirement for a modernized, actuary-established “best estimate” that will help to mitigate systemic risk following a catastrophic earthquake.
PACICC is also engaging in other incremental activities to mitigate systemic risk for the P&C insurance industry, including:
- Changes to capital tests to change the treatment of PACICC Special Assessments – PACICC is seeking a change to the Minimum Capital Test (MCT) formula which would more readily enable regulatory discretion regarding the capital treatment of multi-year PACICC Assessment obligations
- Desktop Insolvency Simulation Exercises – In July 2024, PACICC partnered with the British Columbia Financial Services Authority (BCFSA) and other stakeholders (including OSFI, CCIR, Finance Canada, IBC) to conduct a desktop insolvency simulation exercise examining the impact of a major earthquake and subsequent aftershock on the financial services sector in B.C., and the efficiency and effectiveness of response protocols at “the Tipping Point” and beyond
- Expanding financial capacity – PACICC is exploring if it would be able to access capital markets to secure debt financing, in circumstances where additional liquidity may be required beyond what is available via PACICC’s General Assessment mechanism. Both the Louisiana Insurance Guaranty Association (LIGA) and the Florida Insurance Guaranty Association (FIGA) have recently taken this alternative approach to secure immediate funding to address large numbers of claims caused by a cluster of insurer member failures, triggered by a series of devastating hurricanes
These incremental measures are in addition to efforts that PACICC has already undertaken to enhance its financial capacity and expand its “resolution toolkit” to make effective use of resolution powers granted to the Corporation upon its founding. These initiatives have included: adoption of a Resolution Protocol in 2021; Member-approved changes to PACICC’s Memorandum of Operation (enabling us to use the Compensation Fund and other resources to fund resolution alternatives); and the addition of rapid liquidity via a Standby Line of Credit facility of $250 million supported by a subscription list comprising all six of Canada’s largest domestic banks.
PACICC continues to work diligently on incremental measures to be better prepared for worst-case scenarios. However, it is essential to appreciate that an earthquake that causes greater than $35 billion in insured losses will be a national tragedy for Canadians, and all of our current initiatives will likely prove inadequate. We, as a nation, are simply not ready for “the big one.” It is incumbent upon the Federal Government to work with provincial authorities and the insurance industry of Canada to develop and implement solutions, before the inevitable actually happens.
