The earthquake in Japan could be one of the most expensive ever, but the insurance sector's losses are capped by a government-backstopped system that insurers would like to see adopted in Canada.
The magnitude 8.9 earthquake off the northeast coast of Honshu is one of the strongest ever recorded, and experts say the costs will inevitably stretch into the billions. That will hit the global insurance industry, which is still adjusting to the extraordinary cost of quakes and catastrophes that have occurred in the past two years.
Japanese insurers will bear the brunt of the pain. But strict building codes - and a highly regulated earthquake insurance system in which the government acts as an ultimate reinsurer - will mitigate potential losses. Japan is more prepared for earthquakes than any other country in the world, including Canada, where experts say it's only a matter of time before a significant earthquake will hit.
"Whenever you're not prepared for an event, it gets worse," said Glenn McGillivray, managing director of the Institute for Catastrophic Loss Reduction, a think tank created by the insurance industry that is affiliated with the University of Western Ontario. "Businesses remain offline longer, business interruption losses go up, more people try to lean on government for assistance, and if infrastructure is in a total mess then a simple thing like a lack of power would just exacerbate problems even more."
The most expensive earthquake for the insurance industry in recent decades occurred in California in 1994, when a 6.9 magnitude quake killed 61 people, according to data from Swiss Re. More than $44-billion (U.S.) worth of losses were inflicted and the insurance industry picked up the tab for $20.6-billion of that.
The next most expensive were last year's quake in Concepcion, Chile, which cost the insurance industry $8-billion, followed by last year's quake in Darfield, New Zealand, which cost about $4.4-billion, and the quake that occurred in Kobe, Japan in 1995. The Kobe quake killed 6,425 people and caused a whopping $117.9-billion in total damage, but cost insurers only $3.5-billion.
That's partly because very few people in that region of Japan held earthquake insurance, and also because of strict loss limits imposed by the Japanese government. For instance, residential buildings and furniture can be covered, but very expensive jewellery and artwork cannot, and there are rules that ban people from taking out insurance once an earthquake warning has been issued.
Mr. McGillivray said the Japanese government protected domestic insurers by limiting foreign participation in the system and, to keep the risks manageable, limited the payouts.
The Kobe quake in 1995 prompted an increase in demand for earthquake insurance and also caused the government to increase coverage limits, making it harder to determine what the impact on the industry from Friday's quake will be. But the loss-sharing agreement remains in place and if the damage stretches into the billions, the Japanese government will be on the hook for much of the bill.
Some of the losses from Friday's quake will be absorbed by reinsurance and by catastrophe bonds that are sold to investors. Desjardins analyst Michael Goldberg said Manulife Financial Corp. might have exposure through its property and casualty reinsurance business that could result in a noticeable quarterly earnings hit.
Toronto-based Fairfax Financial Holdings Ltd., one of the companies that has suffered from higher catastrophe losses of late, said Friday it was too early to assess the impact of the quake.
Fairfax had an underwriting loss of $236.6-million last year, partly because of catastrophe losses of $331.4-million, up from $165.6-million the prior year. The Chilean earthquake had a particularly large impact on the firm.
Fairfax chief executive officer Prem Watsa is one of the industry executives who has been warning Canadian officials that he doesn't think the country is sufficiently prepared for an earthquake. He wants Ottawa to partner with the industry to create a program that ensures the country, and the insurance industry, are prepared for a major quake.
The risk has never been front and centre in this country like it is in Japan, but experts say it is real. "An earthquake disaster will happen to a Canadian city," said John Adams, a seismologist with Natural Resources Canada.
The country is better prepared than it was a decade ago, but more needs to be done, he said. "We do have a cohort of buildings that are not very good. Buildings built before World War II out of brick masonry are really not earthquake proof."
Insurers are raising alarms over old buildings, but also infrastructure. They say more needs to be done to ensure that power lines and water systems can continue to function after a quake.
Mr. Adams said there's more the industry could do to protect Canadians. "I don't think the insurers have got their product right," he said. "I don't think it's very well priced. You have something like a 5-per-cent deductible. I think if the insurers got their product right, that would go a long way to making it more accessible and more used."