Small quakes, big impact: lessons learned from

Could a small aftershock in a city not considered an earthquake hotspot trigger one of the largest insurance losses ever? Absolutely, because this is exactly what happened when a 6.3 magnitude earthquake hit Christchurch, , on 22 February 2011. The massive – and unexpected – insurance costs exposed blind spots in current views of financial earthquake risk. And, in the aftermath of the event, both the claims and rebuilding process proved challenging. Given that a similar sized earthquake can occur virtually anywhere, it is vital that we learn from the Christchurch experience. Foreword Two noteworthy features of the This publication is a summary of their Christchurch events – compared to the conclusions and generally seeks to During 2010 to 2011, the world suffered others – were the high contribution of raise awareness of the possible a string of serious earthquakes. the insurance industry towards consequences of earthquakes in city These events were devastating both reconstruction costs and the fact that centres on insurance. in terms of the number of lives lost and the earthquakes affected a city which the destruction of property and was not known as a seismic hot spot. I wish you an enlightening read. infrastructure. I only need mention what happened in Haiti and Chile or later in These features prompted our experts Matthias Weber, Group Chief northeastern Japan and in Turkey. to identify reasons why insurers were Underwriting Officer, Swiss Re During this period, several damaging caught off guard by the scope and earthquakes also struck Christchurch, complexity of the claims process and New Zealand. Seismic events caused the spiralling claims costs as well as to economic losses of over USD 308 billion suggest ways of learning for the future. in these two years and earthquake- After all, other cities around the world insured claims for 2011 are likely to could face similar issues, especially if surpass USD 58 billion, a world record. they are not usually identified as earthquake hot spots.

A small quake in the wrong place For the insurance sector, the cost from The chart below shows the rise of the can have a hefty price tag the Christchurch earthquake is currently total insurance loss estimates made by put at USD 17.2 billion for the February various vendors, brokers and reinsurers Before 2011, Christchurch was not a 2011 event and close to USD 25 billion over time for the February 2011 event. place one readily associated with a high for all three events combined (Swiss Re It shows that the current insurance loss earthquake risk. Unlike the capital Economic Research & Consulting). This estimate of USD 17.2 billion is more than , Christchurch does not sit cost far exceeded the initial, model- twice the upper end of the initial loss near New Zealand‘s main fault lines. It is based forecasts and took the insurance estimates provided by model vendor located on New Zealand‘s , industry by surprise. Over the last companies, which ranged between has a population of 380 000 (total 50 years, the only higher earthquake- USD 1.5 and 8 billion. Part of this country population is 4.2 million) and related insurance losses globally have increase is due to the strengthening of consists of 99 500 houses, 30 000 flats been those from the 9.0 M event in the (NZD) against and 38 000 businesses. Japan in 2011 (USD 37.7 billion indexed the USD since February 2011. However, to 2013) and the 6.7 M event in this only accounts for a 14% increase in Why then was the impact of a Northridge (California) in 1994 the USD-based insurance loss estimate. 6.3 magnitude (M) earthquake so (USD 22.9 billion indexed to 2013). devastating? Estimates for the total economic cost continue to rise. Current estimates stand at USD 21.5 billion for the February 2011 event, or USD 31.6 20 Estimated Insured Loss, USD billion billion if the 7.0 M September 2010 18 and 6.0 M June 2011 earthquakes are 16 also factored in. 14 12 10 8 6

Sources: 4 – AIR news alert, Feb. 23, 2011 2 – EQECAT CatWatch, Feb. 23, 2011 0 – Marsh, Comparing claims from 11 11 12 12 13 13 14 14 catastrophic earthquakes, Feb. 2014 10 20 20 20 20 20 20 1. 2.20 9.20 0. – RMS Cat Update, April 5, 2011 2.20 .1 .1 .0 .0 .04. .06. .08. 27

– Swiss Re sigma 22 .1 18 14 01 26 10 10 06.05. Publication date

Swiss Re Small quakes, big impact 1

How come initial estimates were Such agents are to a large degree blind Liquefaction so far out? spots in the current earthquake models, despite their potential impact on The costs due to liquefaction are Why did initial estimates, which were earthquake risk assessments. They can substantial and all models by far based largely on earthquake model consequently act as claims inflators that underestimated the impact of this outputs, so significantly underestimate significantly increase the ultimate payout. phenomenon in Christchurch – both the the actual loss? Although New Zealand 2010 and the February 2011 events has one of the highest levels of And finally, in the case of residential resulted in widespread . residential and commercial property claims, the specifics of the insurance Liquefaction risk significantly increases insurance penetration, the insurance policy wordings and the interactions of reconstruction costs and often causes sector was taken by surprise in several multiple policies on one claim further total losses to property. It occurs when areas. impacted the adverse loss development. soil substantially loses strength in response to earthquake tremors, causing Firstly, there was the sheer number of it to behave like a liquid. Severe structural claims: As Christchurch was not Aftershocks damage usually results if liquefaction considered an earthquake hotspot, occurs underneath a building or a claims processing procedures were The 22 February 2011 Christchurch highway. Additionally, it also tends to not set up to deal with the well over earthquake was, from a seismological damage underground infrastructure 400 000 claims across all events with point of view, an aftershock of the earlier such as water and sewage pipes. multiple claims lodged per property. For earthquake of 4 September 2010. instance, the Although weaker, the aftershock had In the February 2011 Christchurch of New Zealand (EQC) had to rapidly a far more devastating impact on event, entire neighborhoods were increase staff from 22 core members Christchurch than the earlier main exposed to liquefaction. Many property and 27 assessors in reserve before seismological event, mainly because it owners were not only faced with having the earthquakes, to over 1000 by struck so close to the central business to repair or rebuild their homes, but also February 2011. On certain days, district. It also created higher losses for with restoring the land itself. Liquefaction 13 000 assessments were handled the insurance industry. Although it was often also results in property flooding per day by 350 assessors (equating to well known that large earthquakes are because groundwater is squeezed out of 37 claims per assessor per day). As a followed by multiple aftershocks and the soil. Another outcome, especially for result, detailed assessments were not that this activity often persists for a few large buildings, is a phenomenon called possible. This left them susceptible for years, the New Zealand events are differential settlement. This is where challenge at a later point in time which testing the industry‘s assumption about certain parts of a building settle more prolonged the process and made it the scale of consecutive disasters in the than others during an earthquake, often more costly. Large numbers of claims same region. resulting in total loss because the adjustment experts, brought in building structure was compromised. internationally for a limited time, As aftershock sequences can easily subsequently handed over claims to trigger second event or stop-loss covers, different parties. The resulting lack of they are important to consider when continuity further complicated the assessing earthquake risk. This is claims process. Claims costs have also especially true for second event covers, increased because of protracted which only pay out if the policy is negotiations due to claims advocates affected by two or more loss events. who worked on a contingency basis. If aftershocks are neglected in the This tendency is seen in other regions underwriting process, the risk for claims as well. can be significantly underestimated. The same is true for stop-loss covers, which Secondly, so-called secondary loss trigger when the aggregate of all losses agents contributed significantly to the to a portfolio during the policy contract overall loss resulting from the February period exceed a certain deductible. For 2011 Christchurch earthquake. These these covers as well, the presence of included widespread liquefaction, slope aftershocks strongly increases the instabilities, continued aftershock chance of a payout to the policyholder. activity and the effect of widespread damage in the central business district.

2 Swiss Re Small quakes, big impact Liquefaction: not just an issue in Christchurch

Soil liquefaction is not just an issue in Christchurch. In fact, many past Soil liquefaction can earthquakes such as the 1989 Loma Prieta earthquake affecting the San Francisco Bay Area have resulted in wreak awful damage significant property damage due to soil liquefaction. Many, if not most, large cities around the world would be exposed to significant liquefaction in the event of an earthquake near the city center. The regional liquefaction maps shown here illustrate this risk for four sample cities across the world.

(Source: Swiss Re)

Liquefaction potential in Tianjin Liquefaction potential in Jakarta

Liquefaction potential in Liquefaction potential in Singapore

Nil Low Moderate High

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Business interruption Insurance industry preparedness Loss modelling okay?

Business interruption claims from Primary insurers and their staff may This is a crucial observation in the commercial policyholders increased due themselves be impacted by earthquakes. context of earthquake loss modeling, to the fact that large portions of the So it is important to have effective crisis as loss models assume that a loss on business district response and earthquake preparedness a policy does not exceed the sums (CBD) were cordoned off. Hence, even plans. In Christchurch, staffing was too insured, meaning that the models judge businesses not directly affected by the lean to handle the sheer number of risks too optimistically. Also, the albeit impact of the February 2011 earthquake claims and training of claims adjusters sensible requirement of the authorities were unable to continue operations. That on the job to deal with such an event. that properties be rebuilt according to said, the large scale demolition of the The lack of adjusters was compounded stricter building codes, e.g. with stronger CBD did somewhat reduce the business by the fact that Australian adjusters were foundations, meant that claims on only interruption issue. Furthermore, the still occupied with settling claims from moderately damaged properties could general impact the earthquake had on the floods and Typhoon Yasi. become substantial. This was because the entire region – with many residents insurance also had to cover the work of temporarily relocating, key infrastructure strengthening the foundations. hampered and the worry of subsequent More experts needed aftershocks – activity in the central business district was significantly Engineers were also in short supply and Multiple policies reduced. Additionally, reconstruction facilities were needed for on-site claims has taken several years to get underway staff. This situation highlighed the Another issue was that many residential as authorities work to rebuild the city in importance of cooperation within the properties were covered by two policies: a more resilient way. This has resulted industry to avoid inconsistencies in Firstly, there is the policy issued by the in business interruption claims often in claims adjustment and to consequently EQC, which covers almost all homes in excess of the the full limit. process claims more effectively. Under New Zealand.This policy covers up to such pressure, record-keeping practices NZD 100 000 for building damage and may suffer. NZD 20 000 for content. Then there Government involvement are the additional private policies which were bought to cover the damage not Despite New Zealand having among Policy conditions covered by the EQC policy. The fact the highest take-up rate for earthquake that the two policy wordings were not coverage in the world for both private The high claims costs are partly due to congruent – e.g. the EQC covers land and commercial insurance covers, the the specific nature of residential building damage while most private policies do government became very involved due insurance policies in Christchurch. The not – created much debate between the to the size and impact of the loss. In policies were issued on an uncapped involved insurance companies during Christchurch the government limited full replacement value basis meaning claims settlements. This ultimately access to the central business district, that any damaged property is restated delayed the process and again drove up issued demolition orders, appointed a to an “as new state”. As a result, the the total bill for the insurance business minister of recovery, strengthened cost of repairing heavily damaged building codes and designated red zone properties could significantly exceed areas (where rebuilding is not allowed). the reported value of those buildings. For claims on commercial policies, costs While all these actions were designed were higher due to the absence of a to support citizens and the rebuilding co-insurance clause compounded with process, they also increased insurance the level of underinsurance. Again this claim costs. For instance, as mentioned resulted in claims often far exceding further below, the strengthening of the insured values. building codes resulted in larger insurance claims. Also, the increased number of stakeholders in the settlement process posed extra challenges for claims assessors. So open communication and good relations with government officials are key. Government intervention had far-reaching consequences for insurers

4 Swiss Re Small quakes, big impact “Neighboritis” Lessons learned rebuilding of downtown Christchurch is far from complete more than four years Another reason for the rise in claims as There are many lessons to be learned after the earthquakes. Furthermore, as time went on had to do with so-called from the Christchurch experience, but an industry, we have to take a serious “neighboritis”. Policyholders who may the most profound one is that a small look at the way earthquake risk is have accepted a settlement at the magnitude earthquake could hit virtually assessed for city scenarios. Is the beginning witnessed how some of anywhere and trigger unexpectedly potential for business interruption, their neighbors who initially rejected large losses. Another basic lesson is that including wide area damage fully to settle were receiving more generous earthquake models, which are built to understood and taken into account? Are payouts. This may have prompted predict losses due to well-established there policy wordings that leave liability them to reconsider and also demand loss patterns, must be updated to uncapped or open to interpretation higher payouts. ensure accuracy by addressing key with regard to reinstatement values? model blind spots. These should include If so, is the impact on the claims process the cascading effect of earthquake properly reflected in the way earthquake aftershock sequences, the significant models predict financial losses? The impact of the claims handling process Christchurch experience suggests that on the ultimate payout, the potentially this is not the case. It is possible that widespread effect of liquefaction in Christchurch is not an exception but urban areas, and the paralyzing effect that similar loss developments beyond that slow reconstruction efforts in a city current risk perceptions could also center can have. Witness the fact that happen in other cities.

Impact of soil liquefaction beneath a highway

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Case studies There are a number of reasons why Sydney is a city not deemed an Sydney is prone to extremely high Small earthquakes, such as the earthquake quake hotspot. However, as insurance payouts in the case of a 22 February 2011 event in Christchurch, the 25th anniversary of the Newcastle Christchurch-like earthquake. The city can strike virtually anywhere. The earthquake reminds us, it is located in a has a higher population density than consequences to society, the local geographical area that has experienced Christchurch and the economic value economy and the insurance industry damaging earthquakes in the past. per square meter can be as much as could be as severe as in Christchurch. Approximately 120 kms from the five times higher. The risk of building What can other cities around the world Sydney central business district, damage is higher in Sydney than learn from the Christchurch event, Newcastle was hit by a 5.6 magnitude Christchurch as many of Sydney‘s older including those which are typically not earthquake in 1989. According to the buildings have unreinforced masonry on the radar of earthquake risk studies? Australian Insurance Council at the time, walls. The latter is a type of construction We have selected three cities to serve this triggered an insurance loss of that most of the over 35 500 buildings as templates for many others around the AUD 862 million (USD 805 million) damaged in Newcastle had. world to illustrate how a Christchurch- despite its small magnitude. It should be like earthquake would impact other borne in mind that if it happened today, Like Christchurch, the majority of Sydney locations. Needless to say, each city is insurance costs would be in the range property owners (an estimated 80% of unique. However, the effects which of AUD 4.3 billion (Risk Frontiers, residential property and 90% of resulted in very high insurance payouts Australian and New Zealand Institute of commercial property) buy earthquake in Christchurch, could also play out in Insurance and Finance Journal in 2007) insurance written on a full replacement other cities such as Sydney or Singapore. to AUD 6.2 billion (AIR, Flyer on value basis, albeit in most cases with a Earthquake Model for Australia in 2012) policy limit. Challenges in the claims The likelihood is low that a magnitude or USD 3.8 to 5.4 billion. process and the ensuing delays and 6.3 earthquake would occur beneath inflation of cost would almost be any of the cities listed below. If such costs could arise from an inevitable. This would be due to the Nonetheless, as the Christchurch earthquake in Newcastle, what would sheer number of claims and also to the event showed, because such an be the impact of a small earthquake in policy wordings which are similar in earthquake can happen even in places the much larger and more built-up city many ways to those in Christchurch. In not considered a high seismic risk, it is of Sydney? It should be noted that the addition, claims handlers in Sydney are worthwhile considering the associated likelihood of such an event is low with a not experienced in settling earthquake loss scenarios. return period of several thousand years. claims. Such lack of knowledge would That said, a Christchurch-like event pose additional challenges. A further could result in total damages of complicating factor could be the USD 120 billion (Swiss Re estimate), increasing practice of offshoring claims even without accounting for the effect adjustment, meaning that the claims of potential aftershocks. The bulk of this handlers are often unaware of local loss would be covered by insurance. practices. The only Christchurch factor which Sydney would likely be spared is soil liquefaction. With only few exceptions, such as certain areas around Botany Bay, Sydney is largely built on strong sub soil and is expected to have little to fear from soil liquefaction.

Only Christchurch factor Sydney would be spared is soil liquefaction

6 Swiss Re Small quakes, big impact Singapore Vancouver Vancouver has several areas which are The probability of the Singapore area We chose Vancouver as the final case prone to widespread liquefaction as the being directly exposed to a devastating study to highlight that Christchurch-like liquefaction map shows. The areas earthquake is low. However, a number of effects are also relevant for cities outside around the Fraser River, especially in relatively close tectonic features such as of the Asia-Pacific region. Vancouver has Richmond, Delta and around Vancouver the Sumatra Subduction zone and the not experienced a substantial earthquake International Airport are located on Sumatra Fault could create losses in in recorded history. However, Vancouver liquefiable soils. The impact of wide-area Singapore if they generated substantial is located close to the so called Cascadia damage and business interruption on events in proximity to Singapore. subduction zone, which runs along the the economy in Vancouver would likely Earthquakes on these tectonic features US-Canadian roughly 75 km off be substantial as well. This is accentuated have been repeatedly felt in Singapore the coast of Vancouver Island and by the reliance of the transport network (e.g. M 7.2 in 1909 at a distance of 300 km from the Vancouver City Centre. on the numerous bridges crossing the 470 km, M 7.5 in 1914 at a distance of Paleoseismic studies indicate that the Fraser River. Many of the bridges are 650 km, M 7.1 in 1971 at a distance of Cascadia subduction zone has located on poor subsoil and would likely 550 km among others). Distant but large generated very large earthquakes on have to be closed for some time earthquakes produce “slow shaking” average every 500 years. The last event following an earthquake. that travels relatively large distances and happened roughly 300 years ago. can impact tall buildings in Singapore. The earthquake insurance take-up rate in Compared to Christchurch, the Vancouver is smaller than in Christchurch, As in Christchurch, many parts of population density and economic value so insurance would only be liable for a Singapore, such as Changi airport or per square meter are significantly fraction of the economic damage. Jurong petrochemical complex, are higher in Vancouver, especially in the Nonetheless, due to the larger value located on potentially liquefiable soils. downtown area. By simply comparing accumulation, the insurance loss would At close to 100%, the earthquake Vancouver’s economic exposure in the be on a similar scale to the Christchurch insurance take-up rate is also very high downtown area to that of Christchurch, loss. The burden on claims adjustors, and insurance would carry the bulk of it is clear that should a Christchurch-like most not being experienced in settling the financial burden, except for the M 6.3 earthquake happen beneath earthquake claims, would be significant. impact on infrastructure. Being a Vancouver, it would result in substantially Like in Christchurch, residential policies relatively aseismic country, Singapore‘s larger economic losses estimated at are issued on a full replacement value building codes are less focused on USD 40 billion (Swiss Re estimate). basis and are often uncapped, which earthquake resilience, although some For a large earthquake on the Cascadia would make these policies prone to seismic code provisions exist for tall new subduction zone, the total economic loss inflated claims. Therefore, delays and buildings, which are built on weak soil. is estimated by an AIR study in 2013 complications in the claims process, as At the same time, many of the newer at CAD 75 billion (USD 66 billion) with experienced in Christchurch, would buildings are characterised by special an insurance loss of CAD 20 billion likely also occur. architectural features, which introduce (USD 18 billion). This estimate is higher irregularities in the buildings‘ shapes. since such an earthquake would create Another complicating factor in While architecturally interesting, such more widespread damage in the larger Vancouver are the so called “loss buildings are inherently weaker in Vancouver area and would also include assessment covers”, which are sold to earthquakes than simpler and more Victoria on Vancouver Island. condominium owners. The loss conventional shapes. assessment covers are intended to pay for the part of the building damage Singapore therefore is exposed to the which is not covered by the same factors which contributed to a condominium association’s building large insurance loss in Christchurch. insurance, or which falls within the These include the potential for deductible of that cover. With the liquefaction in many newly-built up substantial deductibles on the building areas, a very high earthquake insurance insurance sold to the condominium take-up rate, and an insurance industry associations, the loss assessment covers that is relatively unaware of these risks. are susceptible to substantial payouts. Additionally, Singapore‘s older buildings However, this loss assessment cover were not built with earthquake safety as exposure is often not systematically a primary objective. And, as in Sydney, tracked and the corresponding claims Singapore has a much higher economic might offer a further surprise. value per square meter than Christchurch. Consequently, an earthquake similar in magnitude and area affected might trigger a total economic loss of USD 65 billion (Swiss Re estimate).Insurance would be liable for a large portion of this economic loss.

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Conclusion Furthermore, we recommend that insurers conduct “what-if” scenarios As the Christchurch events and the case based on the Christchurch experience. studies of Sydney, Singapore and These exercises need to address Vancouver highlight, the impact of a questions such as: Do the policy Christchurch-like earthquake on a city wordings offer the necessary clarity? center can be immense. There are many What potential exposures could be such cities around the world which are covered which are not currently taken not usually associated with high into account? Would sufficient claims earthquake risk. But when such an event adjusters be available? Is a process in does occur, losses can nonetheless be place to deploy and coordinate claims substantial. The consequences seen in adjusters? How will the settlement of Christchurch are most probably the claims work? Could damage to key norm as opposed to the exception. It is infrastructure hamper reconstruction true that the probability of a efforts? During the process of Christchurch-type event in any specific reconstruction how will the city is very low. Nevertheless, there is a communication and coordination substantial probability that one or other between insurers, authorities, and the city somewhere in the world will be public be handled ? Addressing these affected in the coming years and will questions will help us benefit from the show similar claims-inflating effects. costly lessons from the Christchurch experience. Relying on potentially outdated models which may not fully reflect the factors described in this publication, could potentially lead to the situation where the insurance industry is not taking the risk of potential earthquakes in city centres fully into account. We have focused on three cities as examples. However, many other cities around the globe meet similar criteria and would be equally prone to devastating earthquake damage.

Seismic risk in city centres underestimated by insurance industry

8 Swiss Re Small quakes, big impact © 2014 Swiss Re. All rights reserved. Title: Small quakes, big impact: lessons learned from Christchurch Author: Balz Grollimund Editing and realisation: Sarah Davies De Paola, Richard Heard Managing Editor: Urs Leimbacher Graphic design and production: Swiss Re Corporate Real Estate & Logistics/ Media Production, Zürich Photographs: Getty Images The front cover image shows the devastation caused by the 2011 Christchurch earthquake and the subsequent rebuilding process. The content of this brochure is subject to copyright with all rights reserved. The information may be used for private or internal purposes, provided that any copyright or other proprietary notices are not removed. Electronic re-use of the content of this brochure is prohibited. Reproduction in whole or in part or use for any public purpose is only permitted with the prior written approval of Swiss Re, and if the source reference is indicated. Courtesy copies are appreciated. The information provided and forward-looking statements made are for informational purposes only. They do not constitute any recommendation, advice, solicitation, offer or commitment to effect any transaction or to conclude any legal act of any kind whatsoever. Although all the information used was taken from reliable sources, Swiss Re does not accept any responsibility for the accuracy or comprehensiveness of the details given. All liability for the accuracy and completeness thereof or for any damage resulting from the use of the information contained in this brochure is expressly excluded and readers are cautioned not to place undue reliance on forward-looking statements. Under no circumstances shall Swiss Re or its Group companies be liable for any financial and/or consequential loss relating to this brochure. Visit www.swissre.com to download or to order additional copies of Swiss Re publications. Order no: 1505985_14_en 11/14, 300 en Swiss Reinsurance Company Ltd Mythenquai 50/60 P.O. Box 8022 Zurich Switzerland

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