Covering earthquakes for Switzerland’s mortgage lenders

2  Swiss Re Covering earthquakes for Switzerland’s mortgage lenders

Despite the country’s exposure  to seismic risk, only few Swiss homeowners take out earthquake insurance. In fact, over three  quarters of private buildings in Switzerland have no earthquake coverage. If an earthquake with a magnitude of 6.2 strikes in central Switzerland, not all homeowners  will be able to absorb the resulting financial loss and some may end  up defaulting on their mortgage.

Swiss Re Covering earthquakes for Switzerland’s mortgage lenders  3

The strongest and most destructive earthquake in Switzerland’s recorded history occurred in Basel in 1356. We estimate that if an earthquake of a similar 6.4 to 6.8 magnitude were to hit Basel today, damage could run as  high as CHF 120 billion, affecting more than two million people and 275 0001 buildings. Basel is not the only region exposed to earthquake risk however. The Valais, the Rhine valley, Central Grisons, the Engadine and central Switzerland have all experienced earthquakes in the past. Seismic risk potentially affects the whole country. 

Assessing earthquake-related loss potential for residential property and mortgage portfolios1

Assuming a magnitude 6.2 earthquake hits central Switzerland, Swiss Re predicts  a total loss of CHF 17.6 billion.2 The total loss amount is equivalent to approximately one third of the local GDP3 and four times the local annual tax revenues. Moreover, it affects 500 000 people and 75 000 buildings. Such a scenario is not only relevant to central Switzerland. In fact, a loss of this magnitude can occur anywhere in the country around every 200 years.

1  This and other estimates in this report are based on Swiss Re‘s proprietary Nat Cat risk assessment tool MultiSNAP and are based on exposure data provided by Perils AG.

2  This includes content and business interruption, in addition to losses to buildings. However, infrastructure losses are not taken into account.

3  Here we include the GDP of the cantons of Lucerne, Uri, Schwyz, Obwalden, Nidwalden and Zug in central Switzerland.

Switzerland

Earthquake

BaselCentral Switzer-land

Magnitude

1 2Scenario Scenario

Economic loss

Affected persons

Affected buildings

6.4 – 6.8 6.2

CHF 17.6 bn

0.5 million

75 000

CHF 120 bn

2 million

275 000

ScenarioScenario

4  Swiss Re Covering earthquakes for Switzerland’s mortgage lenders

In Switzerland, 53% of residential buildings were built before the first earthquake provision came into force in 1970.4 While such provisions have been strengthened over time, most of the existing building structures pre-date the current codes. They might not be resistant to the level prescribed today and thus remain vulnerable to ground tremors. Hence, earthquakes of a similar magnitude will be more destructive in Switzerland in relative terms than in countries with more stringent earthquake resistant design practices.

With an average earthquake insurance penetration of 8.5% in the affected cantons  in central Switzerland (below the national average), the privately insured loss would total CHF 1.5 billion. In addition, CHF 1.9 billion in compensation can be expected through the voluntary earthquake cover of cantonal insurers. This means that  the affected population will have to shoulder much of the financial consequences themselves. And because many of the related mortgages are uninsured, some homeowners may default. Banks can expect defaults in the range of CHF 0.7 to 1.2 billion, of which 80% will be borne by cantonal and local banks operating in central Switzerland.

Earthquake hazard in Switzerland

Switzerland is a country with a medium seismic hazard. The 1356 Basel earthquake is by far the strongest earthquake on record both in Switzerland and north of the Alps. Numerous earthquakes have been recorded since then. Overall, the Swiss Seismological Service expects damaging earthquakes with a magnitude 5 and more to occur every 10–20 years on average. This corresponds to a probability of 5%–10% within a year. Major damaging earthquakes, with magnitudes of 6 and larger, are expected to occur every 50–150 years, which is equivalent to an annual probability of 0.67%–2.0%. The last major earthquake was the 1946 Sierre event, which measured Mw 5.8. A magnitude 6.2 earthquake in central Switzerland, although a severe event, is a rare occurrence. It could, nevertheless, still happen and not just in central Switzerland but anywhere in the country, and at any time.

Fig 2: Swiss seismic hazard map. 

 

4  Based on data from the Federal Statistical Office

GD

P: 5

8.7

bn

Loss

: 17.

6bn Ta

x In

com

e: 4

.5bn

Insured Loss

Voluntary Cover

1.5bn

1.9bn

Big Banks: 18.1bn

Cantonal andRegionalBanks: 76.2bn

80% of exposureis with cantonal/regional banks

Earthquake-related loss scenario for central Switzerland in CHF

Swiss Re Covering earthquakes for Switzerland’s mortgage lenders  5

Perception of earthquake risk is low

Low insurance penetration attests to a population’s low perception of risk. Because large earthquakes are rare occurrences, their human and economic losses tend  to be forgotten quickly, even in places where there has been deadly and damaging seismic activity, such as was the case in Italy. Consequently, individuals, business owners, domestic regional banks and public entities do not have adequate insurance cover for this peril, compared to other, more frequent risks such as fire and windstorm. When severe earthquakes do strike, however, they often affect a much larger number of people and properties.

Switzerland, with its highly developed insurance culture, is unfortunately no exception. Earthquake insurance penetration among Swiss households is low. As  a result, most residential property is not or insufficiently insured against earthquake risk. In case of a large loss event, many homeowners would be unable to absorb the financial consequences and some may even default on their mortgage. 

Impact on mortgage portfolios

In Switzerland, earthquake insurance is not compulsory, even for mortgage holders. This leaves both the lender and the borrower unprotected in case of a major seismic event. Borrowers could thus find themselves with loans on destroyed homes or with the need to top-up existing mortgages in case of damaged homes. For lenders, this translates into the risk of borrower default and portfolio deterioration. Currently, regulation does not require financial institutions to hold capital to cover such risks.

Mortgage providers will have to absorb some borrowers’ defaults, thus facing diminished equity. At the same time, new credit demand for reconstruction surges. The flow of credit in the first 6-12 months after an event is hampered, as experience from earthquakes around the world shows, and thus protracts reconstruction efforts. 

Local and cantonal banks will be particularly affected by an earthquake, as they are less diversified. Most of their activities are concentrated in one particular region, and a large part of their revenues comes from mortgage business. The mortgage market share of such banks in central Switzerland is 80%. Banks with a large mortgage portfolio geographically concentrated in a single earthquake-prone area carry more risk than their peers. In case of an earthquake, a large percentage of the mortgage portfolio will be affected, thereby impacting the single most important income source for local and cantonal banks. Cantonal and other regional banks play a major role in the economic health of Swiss communities, ensuring stability in the Swiss financial system. However, due to a strong local foothold and focus on mortgage lending, they are more exposed to the financial consequences of earthquakes. 

Instability in the credit market can also aggravate downstream effects on the economy. Affected areas usually suffer from temporary and permanent migration. Following the devastating earthquakes of 2010 and 2011 in Christchurch, New Zealand, the population of the city declined by an estimated 2.4 % in 2011 and a further 1.2% in 20125, even though most of the losses were insured. In the aftermath of an earthquake, people will seek safer places to live while houses are still damaged and aftershocks might take place.

5  As of June 2012, according to the New Zealand Statistical Office http://www.stats.govt.nz/browse_for_stats/population/estimates_and_projections/SubnationalPopulationEstimates_MRYe30Jun12.aspx

GD

P: 5

8.7

bn

Loss

: 17.

6bn Ta

x In

com

e: 4

.5bn

Insured Loss

Voluntary Cover

1.5bn

1.9bn

Big Banks: 18.1bn

Cantonal andRegionalBanks: 76.2bn

80% of exposureis with cantonal/regional banks

Banks’ mortgage exposure in central Switzerland in CHF

6  Swiss Re Covering earthquakes for Switzerland’s mortgage lenders

In Switzerland too, some people may never return and thus aggravate current depopulation trends in the mountain regions. More importantly, uninsured households that suffered large losses on their property are financially strapped  for long periods. To rebuild their homes, they need to use their savings or  if possible take on more credit. Since buildings are damaged, loan-to-value ratios would increase, in some cases exceeding 100%. Under such circumstances,  taking on more debt is difficult.

Borrowing more can result in over-indebtedness, reducing disposable income to a minimum. Shrinking disposable income affects consumer spending, which in turn can impact on small businesses in the region. Experience has shown increasing default ratios among small businesses two to three years after an earthquake.  The default ratio on the disaster relief loans paid out by the US Small Business Administration (SBA) after the Northridge Earthquake in 1994 is a prominent example of this. The Northridge earthquake caused total economic losses of USD 70 billion. In the aftermath of the event, the SBA granted a total of USD 4.1 billion in loans to help companies finance their reconstruction efforts. Over the years, a total of USD 370 million of these loans defaulted, putting the default ratio at 9%.6 

Affected communities may not recover for many years. Homeownership rates may drop significantly as people tend to rent instead of owning property. It can take years for homeownership rates to return to normal levels.  After the Northridge earthquake, the homeownership rate dropped by 11% in the Los Angeles County and took six years to recover.7 Events are usually followed by a shift of economic activity away from affected areas. Some sectors will also find it difficult to recover at all (eg tourism). Employment also tends to suffer after an event due to a mismatch between required skills (construction) and available skills (mostly services). 

Making local communities in Switzerland more resilient

Prevention policies, such as enforcement of adequate building codes, can significantly reduce the losses arising from disastrous events. However, no community or country can fully insulate itself from major natural catastrophes. Re/insurance can provide the funding needed for post-disaster reconstruction and timely recovery, alleviating the financial impact on the local communities. Homeowners could rebuild their homes and not default on their mortgages. Equally, local banks would benefit from insurance payouts in the case of an earthquake if the borrower defaults. This would allow banks to maintain a strong capital position to absorb defaults while continuing to provide credit.

Comparisons with other major natural disasters suggest that high rates of insurance protection, particularly accompanied by international reinsurance, have helped  to mitigate the longer-term adverse economic effects of earthquakes.8 Switzerland’s mortgage market has grown by an annual average of 6.6% since the early 1970s.  Credit growth has outpaced GDP growth by approximately three percentage points per year in the same period. Even though a very comfortable household net worth situation backs this, bank equity-to-mortgage ratios have nevertheless declined for  a number of years, stabilising only recently. A globally diversified insurance market can add an additional layer of protection against credit default, allowing the cantonal and local banks to continue functioning after an event and provide the necessary new credit for reconstruction. 

6  Petak, William J., and Shirin Elahi, The Northridge Earthquake, USA and its Economic and Social Impacts, Euroconference on Global Change and Catastrophe Risk Management: Earthquake Risks in Europe, Luxemburg, Austria: International Institute for Applied Systems Analysis, July 2000, p. 8

7  Catastrophic Risk and Credit Markets, Mark J. Garmaise and Tobias J. Moskowitz; The Journal of Finance, 2009, 64(2), pp. 657-707 

8  The economic impact of the Canterbury earthquakes, Reserve Bank of New Zealand,  Bulletin Vol. 75 No. 3, September 2012 

© 2016 Swiss Re. All rights reserved.

Title: Covering earthquakes for Switzerland’s  mortgage lenders

Authors: Clemens Schmale, Oliver Kübler, Lucia Bevere, Sabrina Schönholzer

Editing and realisation: Bernd Wilke, Liz Kelly

Managing Editor: Urs Leimbacher 

Graphic design and production: Swiss Re Corporate Real Estate & Logistics/ Media Production, Zurich

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