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.

With the 2009-2010 insurance renewal term finally completed, I thought I would talk about the things affecting insurance premiums: losses, economic environment, legislation and the size of an organization.

The first item to consider is loss history.  An organization with a high loss ratio (Ratio = Losses/Premium) is more likely to see a premium increase than one with a low loss ratio.  Generally, your premium will not increase if you incur one loss because you are purchasing insurance for that one catastrophic loss.  This is one reason having a sound risk management program is essential to any organization, not just non-profits.  A successful risk management program will result in a reduction of your overall insurance premiums.  However, insurance premiums are based on a number of other criteria, not just on one’s loss history.

This brings me to my second point, which is economic environment.  You may have heard of “soft” and “hard” markets.  Insurance companies make most of their money from their investments and public investments into their companies, so a soft market is dependent on the buoyancy of the stock market.  During a soft market, insurers are eager to write new business and so they compete to write new accounts, they offer relatively low premiums and they are inspired to identify new coverages and products to meet the needs of our sector.  By contrast, when the economic cycle is on a downturn, generally we move into a harder market.  A hard market brings higher premiums, more restrictive coverages and lower limits.  To generate revenue lost on their investments, insurers increase premiums to make up for the shortfall.  Some coverages may cease to be available or they are severely restricted, limits are reduced and exclusions are imposed.  It is not uncommon for some types of businesses to be unable to find reasonable insurance arrangements.

Legislation is another factor in considering insurance premiums.  Insurance is highly regulated in Canada, with each province and territory having its own insurance legislation.  Insurers are restricted to certain types of investments only and must adhere to strict government regulations when operating their businesses.  For example, insurers in Ontario are not allowed to invest in stock that is deemed to be too risky.  They must maintain cash reserves equal to the amount of business they write at any given time so that they are able to pay for any and all claims to which they may be exposed.  Legislation in Ontario is constantly changing as claims that are brought before the courts are decided and become precedents.  Auto insurers are legislated to provide a minimum amount of liability insurance for all vehicle owners in Ontario in addition to minimum accident benefits.  As precedents are set and reforms to existing legislation are made, insurance rates are affected both positively and negatively.

My final point is about the size of one’s organization.  Insurers consider the physical size of the organization’s structure, the number of employees, the scope of the organization’s business and the number of locations and the environment surrounding these locations. The larger the organization, the larger the spread of risk which helps reduce the rate of insurance and in turn reduces the insurance premium.  That is why group programs are effective when obtaining terms from insurance companies.  The volatility of the marketplace is one of several reasons why purchasing insurance as a group affords a certain level of protection during uncertain times.  A group such as SHSC allows us to consider alternatives to the normal insurance marketplace to meet the needs of our sector.

This is basic summary of a much more complex process. Hopefully, it will give you a basic understanding of how the insurance industry works.  Remember you can access valuable insurance and risk management information in our newsletter, Risky Business.  Check it out under Useful Forms & Newsletters in the Insurance section of our website.