The Truth About Earthquake Losses
Underwriting fire risk is relatively routine for property underwriters. We’re comfortable setting an estimated maximum loss for fire damage, and we’re confident that we have enough data to determine reasonable loss costs. We can also set claims reserves with a degree of accuracy.
Earthquakes (EQ), however, have the power to make redundant all of our assumptions to do with risk-taking, loss distribution and claims settlement – in a shake. When providing EQ cover, it pays to dispense with fire-based thinking.
Firstly, after an earthquake there will be widespread disruption across a region. Access roads, suppliers and local governments may all be affected. Competition for loss adjustors, engineers and contractors will be intense and demand surge will magnify claims.
A year of Business Interruption (BI) insurance coverage can easily be exhausted before any restoration gets underway. When whole communities are massively disrupted and there’s loss of life, recovery is inevitably going to take a while.
Next, we must remember the limitations of the models. Models are helpful when it comes to risk pricing and measuring aggregate loss expectancies across a portfolio. But models are only as good as the data that goes in and a simple import of a spreadsheet ignores other aspects of the deal such as coverage extensions for example.
Models predict shake damage fairly well, but no model explicitly accounts for aftershocks, nor does any model adequately deal with damage caused by settlement following liquefaction, which can be huge. Models can’t take account of undiscovered fault lines. Remember, the Christchurch event in New Zealand was on a previously unknown fault line.
There are big challenges around reserving for EQ claims, including early loss estimates that are usually unreliable because damage is largely hidden beneath ground and behind internal finishings. In any case, expert loss adjusters can be difficult to get hold of after a major event.
New definitions of damage brought forward by claimants are another feature of EQ losses. That’s because insureds often look for a total loss payout that will allow them to set up fresh in a new location. Questions to do with what reasonably constitutes actual damage are still being played out in the New Zealand courts, with structural engineers and lawyers arguing on either side.
In the end you have to ask the question, are we underwriting or simply modelling earthquake?
At Gen Re we have first-hand experience of the incredible tail exposure in an earthquake portfolio, beyond the Average Annual Loss that a model will predict. I think we have learned from these lessons, and we are ready to share that experience with our partners around the globe.
Read my article in Property Matters for more on managing earthquake risk.