Major disaster could pose 'systemic' problem for insurance industry, warns OSFI head

Canada alone among G7 in lacking mechanism for government to stabilize the insurance industry if disaster strikes

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Canada’s insurance industry is ahead of the pack when it comes to recognizing the risks from climate change but is still vulnerable to a massive disaster on the scale of the one that struck Japan in 2011, this country’s top financial watchdog said Tuesday.

Peter Routledge, head of the Office of the Superintendent of Financial Institutions, told an industry conference in Toronto on Feb. 6 that Canadian insurers have “experienced financially the consequences of climate change,” but that the industry remains at risk as the annual cost of weather-related wildfires, floods and storms climbs.

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“The problem we have, and it’s a really big one where I was raised in Vancouver, (is that if there’s a major earthquake there it) has a $35- or $40-billion damage price tag attached to it,” Routledge said. “We could have and most likely would have very serious problems, systemic problems, in terms of capital to absorb the aftermath of such an event.”

Routledge later referred to research that suggests British Columbia faces a 30 per cent chance of a significant earthquake in the next 50 years.

Canada lacks mechanism

Canada stands alone among G7 countries in lacking a built-in mechanism for government and financial regulators to intercede and stabilize the insurance industry in such a situation. The industry-funded Property and Casualty Insurance Compensation Corporation — the existing back-up fund — would only go so far.

Routledge has been pushing to avoid the financial ripple effect that would occur without a more extensive support mechanism, comparing the worst-case scenario to a plot point in a classic 1947 movie starring James Stewart.

“You have … the It’s a Wonderful Life risk, when one institution gets in trouble and it spreads to a whole bunch of institutions that are otherwise fine (and they) get hurt,” he said, following a discussion on stage at the conference with Celyeste Power, chief executive of the Insurance Bureau of Canada.

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Routledge proposed creating something akin to the Canada Deposit Insurance Corp., in which banks contribute to an industry fund capable of absorbing small bank failures by making depositors whole. If a larger problem arises, the federal government steps in to provide bridge funding and then bills back the cost to the industry over time so taxpayers don’t bear the burden.

“I’ve tried to use CDIC as just a framework, not impose or replicate, but as a framework that conforms to basic principles,” Routledge said. “That’s where the sovereign being there as an ultimate backstop … on a temporary basis, that reality creates confidence in our financial banking system that is an asset for all players. And, surely, we could find, maybe not that exact model, but something that conforms with the principles in that model in that way.”

During their conversation on stage, Power said adding levies would be a burden for insurers, noting that Canada’s property and casualty industry is about one-tenth the size of the country’s banking sector and brings in only about half the annual profit of the country’s largest bank, Royal Bank of Canada.

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“Even if you put a levy on the industry to do this bail-in CDIC model of one per cent, it would take about 150 years to capitalize for the significant tail risk of an earthquake, and for contagion,” she said.

No burden on taxpayers

Routledge pointed out that the CDIC model, where temporary government intervention is built in, doesn’t require upfront funding to cover the entire banking industry. About $7.5 or $8 billion in insurance covers well over a trillion dollars in assets, he said.

Talks aimed at closing the gap in Canada’s insurance resolution framework have spanned more than a dozen years — involving industry players, OSFI and the federal Department of Finance. The insurance industry now favours a public-private mechanism along the lines of low-cost flood insurance announced in the 2023 federal budget for areas that are difficult to insure. The government has already earmarked $31.7-million for that effort and is expected by industry players to be directly involved, with reinsurance provided through a Crown corporation, once the program is rolled out.

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Speaking to media after his talk at the conference, Routledge said he is urging insurers to be mindful of anything that puts a burden on the taxpayer.

“What I’ve asked the industry and encouraged them to think about is … for Canadians to have confidence in that process, I think they don’t want to feel like they’re subsidizing the industry’s exposure to the costs of the downside,” he said.

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Routledge said he doesn’t think the ongoing debate against a backdrop of escalating climate-related events, including last summer’s extensive Canadian wildfires, is the result of intransigence by any industry organization, regulatory body or government department at the table. Rather, he suggested, it comes down to human nature.

“It’s a hard problem to solve … where you’re dealing with a hypothetical,” he said, adding that he doesn’t view it that way but understands others who do. “The earthquake hasn’t happened. It happened in Japan, it happened in New Zealand, but it hasn’t happened in Canada.”

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