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Flood risks: A Growing Concern and Yet, No Clear Solution

  • Market Insight 3 April 2020 3 April 2020
  • Americas

  • Insurance & Reinsurance

Towards a national strategy to reduce flood risks

Flood risks: A Growing Concern and Yet, No Clear Solution

Storms, power outages, landslides, and road closures; as a result, last year’s floods were identified as the weather event of 2019 in Quebec. Indeed, tens of thousands of residences and businesses were flooded, and an even greater number of citizens were affected.

Floods of varying intensity occur every year in Canada. Historically, the country has been susceptible to flooding across various provinces. Manitoba's Red River Valley is famous for being particularly subject to situational vulnerability – its most severe flood being recorded in 1997, which damaged an estimated 1,000 homes. Similarly, Alberta's flood in 2013 resulted in an approximate $6B in property damage and financial losses, and the evacuation of an estimated 80,000 residents. These majorfloods and many others that cause the forced evacuation of residents, represent the heavy economic burden that threatens the financial situation of the businesses and citizens affected.

How can we protect ourselves against such risk? First, it should be noted that most basic residential insurance policies do not cover damage resulting from floods caused by the overflow of a body of water. Such absence of coverage is explained by the fact that flood zones are clearly identified and that rising water is a foreseeable natural phenomenon, whereas the fundamental principle of insurance is that it covers “unforeseeable” situations.

For several years, however, certain land development has created vulnerable areas leading to inadequate drainage infrastructure. In Ontario, for example, changing levels in the severity of precipitation from one extreme to the other have raised concern for volatility and the increased likelihood of flooding.With the impact of climate change, the damage caused by water will likely continue to increase in frequency and significance.

Insurers' response

Considering the proliferation of claims in this regard, some insurers have developed products to respond to consumer demand for insurance coverage specific to floods. Such coverage is nevertheless quite rare, and, when offered, generally carries high deductibles combined with low coverage limits. While coverage may be available for certain properties, those located in high flood-risk zones are almost never covered. A common misconception has been that residents of high-risk zones can afford higher insurance premiums. However, Craig Stewart, Vice-President of Federal Affairs of the Insurance Bureau of Canada (IBC) has addressed the limited evidence for these claims, suggesting the lack of correlation between high risk activity and income. A flood model developed by the IBC determined that approximately 1.8 million households in Canada are regarded as being at very high risk for flooding.

Typically, flood policies that are available for purchase are subject to a limit; however, several insurers have implemented additional flood endorsements to extend coverage for policyholders. While a benefit to these add-ons is they help to streamline the claims process, the language used to define "flood" has contributed to disputes over application.

The Courts' interpretation

A recent Ontario decision, Le Treport Wedding & Convention Centre Ltd. v. Co-operators General Insurance Company, 2020 ONCA 487, [1] addressed this topic. Following a historic rainstorm event in the Greater Toronto Area on July 8, 2013, the premises owned by Le Treport Wedding & Convention Centre Ltd. was flooded. Water entered the building through the doors, floor drains and ceilings, and caused extensive damage to the premises. A claim was made to Co-operators General Insurance under its "all-risks" insurance policy (the "Policy"). There was a dispute as to whether the Flood Endorsement of the Policy applied to the claim.

The Ontario Superior Court of Justice held that the Flood Endorsement did not apply for two reasons. First, the trial judge concluded that the damage to the insured's property was caused by "surface water," which was defined in the Policy as "water or natural precipitation temporarily diffused over the surface of the ground". Consequently, the "surface water" exclusion contained in the policy operated to exclude coverage. Second, the trial judge found that the event was not caused by a "flood" as defined in the Flood Endorsement. Therefore, the Ontario Superior Court of Justice held that the insured was not entitled to coverage under the Flood Endorsement.

The Court of Appeal reviewed in great detail the wording of the Policy in order to determine whether the event constituted a "flood" within the meaning of the Policy.

The Court of Appeal concluded that the trial judge erred in importing the exclusion of "surface water" flooding into the Flood Endorsement for two reasons. First, the Court of Appeal ruled that an endorsement does not operate independently from the policy, as it does not have "a standalone existence" from the policy; they must be read together. Second, giving effect to the definition of "surface water" when interpreting the Flood Endorsement would effectively nullify or render nugatory the intended coverage. Indeed, flood coverage would be nullified in almost all cases as most buildings are located some distance from water. Accordingly, the Flood Endorsement must be read without giving effect to the surface water exclusion.

The Court of Appeal further concluded that the Event was a "flood" within the meaning of the Flood Endorsement. The ordinary meaning of the word "flood" included "the massive, forceful, and fast-moving flow of water" into the property. Further, the Flood Endorsement did not require a body of water to have a permanent existence. In other words, a creek or a drainage ditch constituted a "body of water" even though they may have been dry for several hours before an overflow.  Finally, the Court of Appeal reiterated that the provisions granting coverage, such as the Flood Endorsement, must be construed broadly. Construing the Flood Endorsement otherwise would nullify coverage for the "obvious risks" identified in the endorsement and defeat the legitimate expectations of the insured as to the coverage purchased. Accordingly, the Flood Endorsement applied to the loss suffered by the Insured and caused by the flood.

However, coverage has not always been granted in favour of the insureds. In an earlier decision, Parker Pad & Printing Ltd. v. Gore Mutual Insurance Company, 2017 ONSC 3894, the Court dismissed the plaintiff's claim for coverage under its flood endorsement, citing lack of evidence that the damaged premises surrounded a "body of water."

Alternatives to traditional insurance

In addition to insurance, alternate opportunities may exist to receive compensation for losses sustained due to flooding. However, it is important to note these alternatives are also subject to limitations. In Quebec, for example, citizens may be eligible for the province's public safety department’s general indemnity and financial assistance program. The program was enacted by Order in Council on April 10, 2019, and aid may be granted, in particular, to compensate for the additional costs of accommodation and food during evacuation, for repairing or replacing essential personal property that was damaged, and for repairing damage to the main residence.

Even so, the program is now more restrictive than it was previously and includes several limits to the amounts that may be granted.

Nevertheless, when floods of the magnitude that affected Quebec in the spring of 2019 occur, thousands of citizens seek support from their government, which is then faced with a significant economic burden. Aid is therefore also available through the federal Disaster Financial Assistance Arrangements (DFAA), administered by Public Safety Canada, to compensate those who have experienced losses and to finance recovery.

Flood-related issues continue to be an ongoing concern across the country. The federal government recently considered creating a low-cost national flood insurance program to protect homeowners at high risk of flooding who are without adequate insurance protection. When asked about developments for the program, Public Safety Canada did not offer a direct response, simply expressing "full consideration" for recommendations proposed by IBC in its June 2019 report, titled Options for Managing Flood Costs of Canada's Highest Risk Residential Properties.After reviewing international experience, IBC analyzed three potential schemes that could be implemented:

  • Option I: a pure market solution pursuant to which private properties would no longer be eligible for government financial assistance and the risk would be borne by homeowners. Homeowners would therefore have to move, self-insure, or transfer their flood contingent liability to the private insurance market. Since premiums are risk-based, a portion of high-risk homeowners would opt out of the insurance market, and the government could invest in adaptive infrastructure.
  • Option II: an evolved status quo in which the risk would be borne by a combination of homeowners and governments. As this option is the closest to the current state of affairs, the private insurance market would continue to provide insurance coverage in accordance with its risk appetite, and government aid would be provided in cases where premiums are too high. The government’s exposure could also be reduced by transferring some of the risk to the global reinsurance market.
  • Option III: create a high-risk flood insurance pool. A high-risk flood pool of properties would be separated from what is considered normally insurable risk. The group would be managed by a public-private partnership, administered by the insurance industry but governed and guaranteed by the government/global reinsurance market. The pool would need pre-capitalization to get up and running as well as ongoing capitalization that would be supported by premiums paid into the pool and levies assessed on all homeowners or municipal ratepayers and financed by levies or through government contributions.

The governments of other countries have already implemented similar measures to address the issue of the insurability of flood risk. The United Kingdom has launched Flood Re, a reinsurer subsidized by a levy imposed on all insurers that offer home insurance. The United States created the National Flood Insurance Program (NFIP) in 1968. To benefit from NFIP flood insurance, the property must be located in a community that participates in the program and that agrees to apply sound floodplain management standards. In some cases, NFIP premiums may be subsidized.

The complete withdrawal of government aid would allow the government to focus on mitigation rather than disaster management, an area in which insurers are generally more efficient, but could also lead to avoidance by homeowners, who may simply choose not to purchase insurance and risk financial ruin in the event of a loss. Conversely, placing too much emphasis on the availability of insurance (by subsidizing premiums, for example), creates the possibility that the premium rate paid will not reflect the full risk of loss and that the funds available in the event of a loss will prove insufficient.

In short, regardless of the perspective from which the issue is addressed, the allocation of costs among citizens, their insurers, and both levels of government after a flood is a significant challenge. For that reason, all participants must increase their efforts to implement measures that are preventive, rather than corrective. Whether that consists of elevating critical equipment (heating, ventilation, electrical transformers, communication systems, etc.) in commercial buildings above expected flood levels or even using technology that allows buildings to float above water during a flood, there is no doubt that improving infrastructure and implementing preventive measures will contribute to reducing the risk and, in so doing, make it somewhat more insurable.

 


[1] 2020 ONCA 487 reversing in part 2019 ONSC 3041.

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