Glenn McGillivray is managing director of the Institute for Catastrophic Loss Reduction.
There is often a perception that the costs associated with natural disasters are paid out of many pockets, including governments of all levels, insurers, property owners and others.
The reality is that when there is a catastrophe, taxpayers are generally left to cover a substantial portion of the expenses, both directly and indirectly. Not only must they pay the insurance deductible for their own property damage and pay out of pocket for any uninsured damage they experience, but their tax dollars must also go toward paying for first response, evacuation costs, damage to public infrastructure, overtime expenses for government and/or public utility employees, and government-disaster assistance.
Consider the 2013 Alberta flood or last May’s wildfire in Fort McMurray, which prompted the federal government to direct a reported $2.8-billion and $300-million, respectively, to Alberta for disaster assistance. These are substantial unbudgeted amounts that are ultimately funded by all Canadians.
But it needn’t be this way, as there are now many traditional and non-traditional reinsurance products that can be used to transfer all but the very biggest risks off the backs of taxpayers and onto the balance sheets of some of the world’s largest and most capable risk-transfer experts.
What’s more, there are also products that can be used to smooth annually budgeted government expenses that prove to be quite volatile. Imagine an insurance product that kicks in if a city’s snow-removal expenses exceed a certain threshold, or one that reimburses a municipality or public utility if storm-related overtime costs exceed a certain amount? How about a simple stop-loss cover that kicks in if federal Disaster Financial Assistance Arrangements (DFAAs) exceed a certain amount, or what if the DFAAs were laid off to the private reinsurance industry altogether? What about a parametric cover that kicks in if a rainstorm, windstorm or snowstorm of a certain size affects a community?
One of the challenges that has to be overcome is that governments typically do not leverage the many reinsurance and financial instruments that are available to them, possibly because of a reluctance to deal with the up-front costs of implementing the solution (such as having to pay an annual insurance premium for a policy that may not be triggered).
But it may just be a matter of breaking old habits.
While average people tend to be risk averse (and, therefore, purchase insurance to ensure a soft landing if a loss occurs), governments tend to be risk neutral, not insuring their assets (or insuring only certain asset classes) and usually paying for losses directly out of public coffers. This is particularly true as you go up the food chain (municipalities, especially small ones, often at least partially insure their assets while more senior levels of government tend not to).
But governments are showing a desire to get away from this model, as paying for increasingly costlier disaster-related expenses makes it challenging to finance pet projects and/or balance the books. Indeed, likely as a direct result of the 2013 Alberta flood, the federal government altered the DFAAs. Now, provinces and territories affected by a significant loss event have to absorb significantly more of the costs before obtaining disaster assistance from the federal government.
Aside from questions regarding risk aversion vs. risk neutrality, it appears that most governments are not used to thinking in terms of mitigating risk beyond traditional types of insurable losses. It isn’t even clear whether governments know that they can transfer all kinds of risk to reinsurance companies.
On the flipside, some reinsurers are not quite used to approaching certain governments about how they can help manage and temper expenses associated with natural disasters and other expenses related to severe weather. And while there are many examples around the world where private reinsurers work well with governments in the creation of very innovative risk-transfer programs, there just isn’t a long tradition of such collaboration in Canada. But this could easily be changed.
With governments at all levels showing a desire to get out of the business of financing natural-disaster losses and other volatile expenses such as snow removal and wildfire suppression, they need to be open to taking advantage of the reinsurance industry in order to lighten the financial burden that is placed on taxpayers.
This is an imperative, as the frequency and severity of natural disasters is increasing in Canada while the pressure is on for governments to cut taxes while also grow services and invest in public infrastructure.