How Big is Too Big? The Tipping Point in P&C Insurance

Toronto, ON (May 12, 2021) – The Property and Casualty Insurance Compensation Corporation (PACICC) has released the latest study in its ongoing Why Insurers Fail research series ‒ an update to the Property and Casualty (P&C) Insurance Industry Model ‒ entitled How Big is Too Big? The Tipping Point for Systemic Failure.

The study, authored by PACICC Chief Economist Grant Kelly, examines the threshold above which some form of catastrophic, tail-risk event (e.g. earthquake, grid failure, asteroid strike) would trigger the systemic collapse of Canada’s P&C insurance industry. Using information about the state of the industry in 2019, the report establishes, as accurately as possible, the ‘tipping point’ for systemic failure of the industry.

Alister Campbell, PACICC President and CEO notes the importance of this new study. “Our research makes clear that while the Canadian P&C industry is well-capitalized and prudently reinsured, there remains a definable limit to the capacity of Canada’s private insurance system. The COVID-19 pandemic has powerfully illustrated the merits of having an “in-case-of-emergency-break-glass” plan developed, in advance, for worst-case scenarios. This important research finding amplifies the urgent need for a federal backstop mechanism to protect Canadians from the impact of a particularly severe tail-risk event.”

Says Grant Kelly, “Our modelling shows that Canada’s P&C insurers can readily respond to a large disaster resulting in insurance claims up to $30 billion, with no expected impact on the solvency of well-run, healthy insurance companies. This level of preparedness is seven-times larger than any catastrophe ever experienced in Canada, and likely greater than any other country around the world.” However, the author cautions about the danger beyond this point. “From $30 up to $35 billion of insured losses, we would likely see multiple insurers fail and, if claims exceeded $35 billion ‒ we would reach the ‘tipping point’ and massive losses would completely overwhelm the capacity of the industry to respond.”

Campbell notes, “PACICC was not designed to protect insurance consumers from this magnitude of risk. At this level of catastrophe, the Canadian economy could be permanently damaged.” He adds that “new research from Natural Resources Canada and the Institute for Catastrophic Loss Reduction shows that this danger threshold is closer than we would like. It is time for government action to put a backstop mechanism in place.”

Access the report: How Big is Too Big? The Tipping Point for Systemic Failure.

Executive Summary

In 2013, the Property and Casualty Insurance Compensation Corporation (PACICC) published a study that determined the threshold above which some form of catastrophic event (e.g. earthquake, grid failure, asteroid strike) would trigger the systemic failure of Canada’s property and casualty (P&C) insurance industry – and to establish as accurately as possible, the “tipping point.” The 2013 report used 2011 industry data. This tipping point was updated in a follow-up paper in 2016, which used 2015 industry data. The primary purpose of this paper is to update those earlier estimates using information about the state of the industry in 2019.

PACICC is a consumer protection agency, whose mission is to assist Canadian policyholders in the unlikely event that their insurance company becomes insolvent and is closed by regulators. Both the previous research studies highlighted the threshold above which Canada and Canadian policyholders would be exposed due to systemic failure. This paper shows that, despite strong regulation and the best efforts of highly capitalized and well re-insured private insurers to anticipate a very large event (such as a major earthquake), there are clear and definable limits to the capacity of the private insurance market and a clear and compelling requirement for the creation of a federal backstop mechanism to protect Canadians from the impact of a severe “tail-risk” event.

Key findings

Our modelling indicates that Canada’s P&C insurers are ready to respond (with no impact expected on the solvency of well-run, healthy insurance companies) to a large disaster resulting in insurance claims of up to $30 billion. This level of preparedness is seven-times larger than any catastrophe ever experienced in Canada to date. It is of course possible that at this scale of event, an insurer will prove to have underestimated exposure and accumulated too much risk in a particularly damaged region. However, for a single insurer failure of this nature, the industry backstop – PACICC – would be entirely capable of responding to protect policyholders.

Our study shows that the industry would also likely survive a larger event, resulting in insured losses of up to $35 billion. However, at this scale of event, multiple insurers would become insolvent. PACICC has never previously been required to respond to multiple Member insolvencies as a result of a single event. The majority of insurers would experience significant financial impairment. PACICC’s industry Assessment mechanism has a cap on what can be collected in any 12-month period, so claims settlement for many consumers would almost certainly be delayed. At this level of disaster, Canada’s insurance industry and its policyholders would experience significant problems – as would the Canadian economy.

Our research confirms that a catastrophe resulting in insurance claims exceeding $35 billion would likely overwhelm the capacity of Canada’s insurance industry. This is the tipping point. Multiple insurers would be distressed and could fail, including both smaller regional insurers and large national insurers. These failures would cause contagion in the industry, as PACICC Assessments to address losses from failed insurers would trigger the default of other surviving insurers. Simply put, PACICC was not designed to protect insurance consumers from this magnitude of risk. At this level of catastrophe, the Canadian economy could be permanently damaged without an effective Federal Government backstop.

Importantly, mechanisms exist to manage the risk of loss from unlikely but high-consequence events. They are in place in many, if not most, other developed nations with significant earthquake exposure. Backstop programs can be designed such that the insurance industry is responsible for most catastrophic events, but there exists a role for government in responding to catastrophic losses above a defined threshold. It is a fundamental gap in the public infrastructure of our nation that we do not have such a pre-defined mechanism today – so that we are properly prepared for a rare, but quite certain, peak peril event.

Environment Canada issues more than 10,000 severe weather warnings in Canada each year. None of these extreme weather events have caused an insurer to fail over the past 60 years. Canada’s largest natural catastrophe was a wildfire in Fort McMurray, Alberta in 2016 that resulted in approximately $3.6 billion in insured losses. Many other industrialized nations, however, have experienced very large catastrophes, much worse than anything experienced in Canada, with severe knock-on effects for the insurance industry. Some of these failures occurred in modern, well-functioning societies.

This paper seeks to determine how large a catastrophic event Canada’s insurance industry could handle and what would be the tipping point for systemic failure.

Read more in the full report: How Big is Too Big? The Tipping Point for Systemic Failure.

About PACICC

PACICC is the industry-funded, non-profit resolution authority for Canada’s Property and Casualty (P&C) insurance industry. PACICC’s mission is to protect eligible policyholders from undue financial loss in the event that a Member Insurer becomes insolvent. The Corporation works to minimize the costs of insurer insolvencies and seeks to maintain a high level of consumer and business confidence in Canada’s P&C insurance industry through the financial protection it provides to policyholders. For more information, visit www.pacicc.ca.

SOURCE: The Property and Casualty Insurance Compensation Corporation (PACICC)