Who's Paying for the Big One?

An old joke about California is that homeowner's insurance is cheap there. After all, once the "Big One" hits, the insurance companies reckon that there won't be anyone left to make any claims.

This old joke takes on a new meaning because of recent, increased seismic activity off the California coast. The joke ceases to be funny when it's revealed that the vast majority of Californians do not have earthquake insurance.

Prior to 1994, the state of California required that insurers offer supplemental earthquake protection for all homeowner's policies. After the 1994 Northridge quake, which caused $15 billion in insurable damages ($50 billion in total damages), insurance companies reacted by refusing to underwrite new policies.

In response, earthquake insurance changed dramatically. "Mini-policies" were developed to cover catastrophic damages: 15% deductible for the structure of the home, $5,000 in property losses, $1,500 for living expenses. (Supplementals are available raising property loss and living expense coverage, and/or lowering the deductible to 10%, but few opt for the supplements.)

The legislature further established the California Earthquake Authority, which would pool earthquake premiums/risks from participating private insurers, though the state has made it very clear that it will not underwrite earthquake insurance. (The CEA is not funded by state government, and the State of California will not cover any private insurance losses.)

In spite of these changes, only 13% of Californians have earthquake insurance for about 1.2 million homes. In comparison, about 30% had insurance prior to Northridge, which in 15 seconds destroyed in excess of 30 years of earthquake insurance premiums. This is particularly appalling given the potential for financial havoc: FEMA has a risk calculation called the Annualized Earthquake Loss, essentially a tool that allows for "budgeting" of seismic event damage on a yearly basis, even if earthquakes don't happen yearly. For Los Angeles County alone, the figure is $1 billion per year... and L.A. County hasn't experienced a damaging earthquake since 1994.

That means that the next large seismic event will be carried, in some way, by Uncle Sam.

The federal government already underwrites $640 billion in property through the flood insurance program. This is coverage for homes that would be difficult or impossible to insure against flood. This allows people to live in flood-prone areas (often expensive coastal regions) for relatively little premium, at taxpayer expense. If a large earthquake hit California, the rest of America would be too caught up in the drama to notice that Californians may get insurance coverage for free (FEMA emergency aid typically comes in the form of loans; however, it's easy to imagine a series of events where loans magically turn into grant aid.)

Pete Moraga, Spokesperson for the Insurance Information Network of California, says the farther we get from an earthquake, the fewer the homeowners who have earthquake insurance. Further, many of them use psychological rationalizations: "I rode out the last one, I'll be fine for the next one." And last but not least, "a lot of people think the federal government will bail them out."

In effect, Americans are underwriting the reckless behavior of those who choose to live in risky areas. It's particularly maddening that mortgage lenders have not only encouraged the California housing bubble, but also the risk of major property losses by not requiring earthquake insurance. Even if FEMA only hands out emergency loans, the potential financial losses are on a national scale. (Uncle Sam does, incidentally, reimburse local government 75% of post-disaster costs, such as debris removal and infrastructure repair.)

This is not to say that California is the only seismically dangerous area. The infamous New Madrid fault is a disaster waiting to happen. Worse than California, because the ground under the area is geologically better at transmitting energy, and many homes in the area are not built to the same earthquake standards that are found in California. A significant New Madrid earthquake can cause damage for hundreds of miles.

It would be remiss to leave Florida out of this article, which could become a potential insurance problem. Many climatologists believe that the last 30-50 years of "quiet" hurricane activity were unusual, and that years like 2004 (where hurricanes caused $20 billion in damages in Florida alone) are more the norm, and the norm is returning.

After the 2004 hurricane season, insurance companies applied to the Florida insurance regulator asking for significant increases. It is possible that insurance companies will stop underwriting hurricane insurance, or premium rates will drive people out of Florida.

Scientists estimate a 70% chance of a 6.7 earthquake to hit San Francisco in 30 years. Conservative predictions include at least 2 major hurricanes for Florida yearly. Skin cancer is the least of their worries.


Posted 08-02-2005 1:07 PM by Doug Casey