Until recently the perils of earthquake and flood seemed to be the flavour of the month and had been hitting the headlines with some regularity. One peril that seemed to be flying under the radar was wildfire. All that has, of course, changed in recent days due to the massive wildfire that has destroyed entire neighborhoods in the city of Fort McMurray.
You can now no longer turn on the television or pick up a newspaper without seeing images of the tragic events unfolding in Alberta. At the time of writing around 88,000 people have been ordered to evacuate and over 1600 structures have been affected.
While the scale of this wildfire is unprecedented, history has shown us that wildfires can be extremely damaging and costly.
You may recall that the Kelowna fires in August 2003 resulted in CAD $200 million in insured damages, and more recently, the Slave Lake fires in May 2011 resulted in insured losses of over CAD $700 million. As we start to feel the effects of climate change more and more we should expect to see a greater frequency and severity of wildfires.
However, what goes unnoticed is that part which is paid by governments in the way of wildfire suppression costs. For example, according to the B.C. Wildfire Service and the 2016/2017 provincial budget, British Columbia has spent anywhere from a high of CAD $382 million to a low of CAD $53 million annually on fighting forest fires over the last decade. This is against a backdrop where the provincial budget for fire suppression was just CAD $63 million in 2015. This has been exceeded in nine out of the last ten years – often by a lot - severely straining the province's resources. These costs are borne by the government and ultimately the taxpayer. Wouldn't it be nice if some of this cost volatility was passed on to the private sector allowing the government to better budget for this peril?
It's apparent the status quo is not sustainable. Besides risk mitigation measures and education programs like Fire Smart in BC, it is important that governments take a serious look at addressing the cost of forest fires. Risk transfer instruments like traditional reinsurance treaties or parametric based reinsurance covers could reduce government emergency outflows and volatility in annual budgets.
A risk transfer solution could be structured whereby we would first simply define the Ultimate Net Loss as the aggregate number of hectares burned multiplied by a certain amount; for example, $400 per hectare. Coverage could then be provided excess of a certain threshold. The threshold could be based on an average over a period of years or the annual provincial fire suppression budget plus a buffer.
Another solution could be based on a predefined parametric trigger. The triggers could be the number of days without precipitation, the number of days where temperatures exceed a certain threshold, humidity levels, wind speeds, soil moisture levels, etc., or a combination thereof. The problem with parametric triggers is basis risk. The loss incurred is not perfectly correlated with the trigger. Therefore, it is possible to receive a payout in a year where wildfires are light and cause very little damage. The opposite is also true whereby you could have a terrible wildfire year and payouts could be low or none at all.
Another approach to addressing this issue is risk pooling amongst several provinces. Ideally, we could have a pool solution that provides cover for those provinces most at risk; for example, British Columbia, Alberta, Saskatchewan, Ontario, and Quebec. The diversification effect will lower the overall cost. Many of the variables mentioned above in the parametric cover section will vary across the country. While conditions that may be ripe for a terrible wildfire season in British Columbia they be moderate to low in Ontario. It is this un-correlation of wildfire risk levels as we move across the country that results in a lower overall cost for participating provinces.
Reinsurance is another tool in managing the volatility of escalating wildfire suppression costs. Governments must continue to use the other tools at their disposal and continue to build on wildfire resiliency. They should continue efforts such as thinning and removing deadfall in high-risk areas. An effort to increase public awareness for those living in high risk areas is also key. They should be uncompromising when it comes to zoning new building developments in, or close to, forested areas. Only then when we take this holistic approach can we achieve our objective of lowering suppression costs and building our resilience to wildfire.
Category: Climate/natural disasters: Climate change, Disaster risk, Resilience
Location: Fort McMurray, AB, Canada