A factory building collapsed in Sukagawa city in northern Japan on March 11, 2011. (FUKUSHIMA MINPO/AFP/Getty Images)

Natural disasters appear to becoming an increasingly more common occurrence. What do these events and their related costs mean to you as a housing provider?

So far in 2011, reports indicate that the earthquakes in Japan and New Zealand, the flooding in Australia and the unrest in the Middle East combine for an estimated cost of $60 billion in direct insured losses to insurers. This does not even include the recent tornadoes and flooding in the United States which are expected to cost upwards of $32B in insured and economic losses. Let’s also not forget the oil spill in the Gulf of Mexico in 2010 ($3.5 billion), the 2004 earthquake and tsunami in Southeast Asia ($4 billion) or Hurricane Katrina in 2005 ($43.6 billion).

Natural disasters are considered catastrophes and insurance companies purchase their own insurance coverage, called reinsurance, to protect themselves against these types of losses. Actuarial studies establish expected losses (both catastrophic and non-catastrophic) which insurers rely on when forecasting how much money they will need to pay for future claims. That number is then used to decide on premiums to charge consumers. When losses exceed these estimations, they deplete the funds set aside by the insurance companies to pay claims. That fund, or claims reserve, must then be replenished to ensure there is enough money available in future years. To increase reserve funds, the insurance companies must in turn increase premiums.

The Effects on the Insurance Company

Not only premiums are affected by unexpected catastrophes – virtually every phase of an insurer’s operations is affected. Insurers must respond, and respond swiftly, to their policyholders and this means more than just paying out claims. Internal and external adjusters are assigned, third party restoration and repairs firms must be retained and policyholders must be reassured that they will be taken care of. Resources in the area of the loss become scarce because of high demand and additional resources must be brought in from far away areas, unaffected by the event, and this costs the insurer more dollars than expected. This also holds true for large, non-catastrophic losses.

VIDEO: Risk Insurance Consultant John Sloan discuss how earthquakes have affected insurance companies, and the need to reinsure following the quakes has driven premiums up nationwide.

When an unexpected large and/or catastrophic loss occurs, which depletes claims reserves and increases administration costs, insurers review their pricing practices – that is, how much premium are they going to charge the client and how that premium is determined. When a large number of these losses occur or when the frequency of claims increases, as we have seen in recent years, pricing methodologies are changed for all clients in the sector experiencing these losses and underwriting standards and premiums are adjusted permanently to reflect the new risk environment. Renewal timing following a large loss becomes longer because insurers require more time to process underwriting information and the time to run their risk models is longer. Insurers wait longer and are reluctant to offer renewal terms too early, in case additional claims occur and they need to make last minute increases to premiums.

Catastrophic incidents contribute to higher insurance premiums for everyone, even when the catastrophes occur in seemingly far away places or when we boast good claims records.  When the claims are closer to home the impact can be even greater.

The Effects Felt in Canada

Catastrophic incidents contribute to higher insurance premiums for everyone, even when the catastrophes occur in seemingly far away places or when we boast good claims records.  When the claims are closer to home the impact can be even greater.

Although the Canadian insurance market is somewhat stronger than other markets because of prudent and conservative regulators, most large insurance companies are international and so the market here will reflect the costs of events that seemingly have no direct impact on our daily lives. Because of this, insurance can be frustrating.

While we cannot control whether there is an earthquake in Japan or a tornado in Joplin, or a wildfire in Slave Lake, there are steps that we can take as homeowners, tenants and housing providers to affect our premiums. And it starts with developing a risk management plan – the subject of my next blog.