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When catastrophe happens: Are we ready?

Glen Hodgson
Senior Fellow

This article was originally published in The Globe and Mail on July 12, 2017.

The tragic rail accident in Lac-Mégantic, Que., terrible fires last year in Fort McMurray, Alta., and extensive flooding this spring in Eastern Canada have again driven home the message that bad things can happen with little warning—with huge financial, economic, environmental and human costs. Do Canadians have the right policies and practices in place to manage catastrophic events?

Risk-taking and risk management is part of daily life for businesses, governments and individuals, but catastrophic events go well beyond normal risk preparation. Some places are more exposed than others. Japan represents an extreme case, as it sits in a major earthquake zone, has active volcanoes and is still struggling to manage the aftermath of the earthquake and tsunami in 2011. It should not be forgotten that Pacific Canada rests on the same Ring of Fire seismic belt.

How destructive could a catastrophic event be? Last year, the Conference Board of Canada examined the macroeconomic impacts and systemic financial risks of a major earthquake off the coast of British Columbia. The analysis set out to stress test the resiliency of Canada’s economy to an earthquake. The scenario projected total economic losses of $127.5-billion, of which just $42-billion were insured. Insured losses of this massive scale would wipe out the capital base and reserves of one or more insurance companies. Business failures would be inevitable, and the entire property-insurance industry in Canada could be at risk.

Financial-sector contagion would ripple into many other sectors. The availability of credit- and risk-management services across the economy would be disrupted, and private investment and consumption would be impaired for many years. The overall economic impact of a major earthquake in the Conference Board analysis was to reduce Canadian GDP by $100-billion over 10 years, and to cut employment by nearly 44,000 jobs annually on average for 10 years.

Since the events are rare, there is often limited public awareness of, and agreement on, the need to plan ahead thoroughly. A combination of individual and collective responsibility is required.

Adequate insurance is the most basic layer of risk management to cover individual assets—residences, commercial buildings, public institutions and vehicles. Data from global insurer Swiss Re indicate that 65 per cent of households in affected areas of British Columbia have residential earthquake coverage, compared with 12 per cent of Californians. Only 3.4 per cent of Quebec households have earthquake insurance, even though there are heightened earthquake risks in the corridor from east of Ottawa, through Montreal, to the Charlevoix region near Quebec City.

The risk of earthquakes, fires and flooding should prompt governments to define fully the conditions for public assistance. Moral hazard (or conditions that actually heighten risk) is created if individuals and firms in affected areas assume the state will bail them out. Is consumer awareness and education sufficient to change behaviour, or should households be “nudged” to acquire earthquake and other coverage voluntarily in affected areas, such as through tax credits or different property coverage options? What is the role of financial institutions holding mortgages on at-risk properties? In an era of extreme weather owing at least in part to climate change, should development on floodplains be restricted?

The next layer of risk management is the policies and practices of firms, public-sector organizations and insurers. The design and refit of private and public buildings and infrastructure can help mitigate the impact of catastrophic events. Issues such as capital adequacy and disaster-recovery planning for events such as floods, major fires and large-scale accidents would be included in this layer, as would improved co-ordination among three levels of government. However, these measures may not be able to withstand the systemic impacts of a massive catastrophic event such as an earthquake, no matter how well designed.

The final layer is the role of governments in managing collective risks and impacts to the economy and society. Wise public policy would involve the pre-design and public communication of ultimate government backstops for communities and industries. For example, governments may be required to help recapitalize the property insurance industry after a catastrophe, if the industry’s capital base is exhausted. If financial contagion spreads, governments should have a plan to backstop the national credit system, similar to the actions taken during the 2008–09 financial crisis.

Catastrophic events, such as a major earthquake, are rare. But disasters, both natural and human-caused, happen often enough that there is no reason to be unprepared. It makes good sense to think through the consequences of various scenarios, prepare and co-ordinate thoroughly, and communicate with the public well in advance.

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