Understanding California Earthquake Insurance Essay, Research Paper
Understanding California Earthquake Insurance
How many people remember where they were and what they were doing when the 1994 Northridge earthquake hit? I know I do. I was slipping out of work early that day. It took me three hours to drive the ten miles to my home. All the way I was wondering what was I going home to. I was lucky; I only lost a few items that tumbled from shelves and countertops. Many people were not so lucky. They came home only to find that they no longer had a home. They, unlike me, had lost everything. Buying a home is an investment milestone in life. People work hard to keep and protect that investment. Today earthquake insurance is at a premium in California; no pun intended. It is difficult to answer the question; What will the insurance cover, how does it work and finally how much is it going to cost?
Looking around for earthquake insurance is getting easier and more difficult, all at the same time. After the 1994 Northridge earthquake, 90% of the insurance companies threatened to quit issuing new policies for homes. In an attempt to protect residence of the state of California, a new state agency, the California Earthquake Authority was created. It was estimated that insurance companies spent nearly $12.5 billion dollars covering damage and losses as a result of the 1994 quake. “Had the California Earthquake Authority been around at the time of the 1994 Northridge quake, state insurance commissioner Chuck Quakenbush estimates losses would have been closer to about $4 billion”. (”California Earthquake Insurance: What does it cover?”). How can that be? That is a difference of over $8 billion. Are people cheating the insurance companies? Are the insurance companies that poorly managed? No, the truth is the CEA (California Earthquake Authority) does not cover as much as most traditional insurance policies. They will not cover pools, fences, driveways, detached garages or plants and landscaping. A CEA policy will cover the home and its contents. The amount is capped by the liability limit declared on the owner’s homeowner’s policy. In addition, there is a 15% deductible. The CEA is mostly concerned with the structural repair. Getting people back into their home is the primary goal and objective. Basically the CEA only covers repair on the structure of homes, personal property, and living expenses during the repairs. In regards to personal property the CEA will cover only $5,000. There are restrictions on what is considered reimbursable personal property. Also, the policy only allows for $1,500 in living expenses while the home is being repaired. One company, USAA, is asking for approval to offer a wraparound policy. This policy would only extend additional coverage for personal property and living expenses. The USAA would only offer policies to past and present Armed Forces officers and their families.
So, just how does the CEA work?
As the result of the creation of the CEA, how earthquake insurance works has changed dramatically. Gone are the days when claims were filed with the insurance company and people were reimbursed for damage and loss. Now, in the event of a major earthquake, insurance companies will cover the first $700 million in claims. If claims go beyond the $700 million mark the insurance companies have agreed to pay an additional $2.148 billion. The CEA has a $1.432 billion reinsurance policy, as well as the ability to borrow an additional $716 million to make further reimbursements on claims. In the event that this is still not enough to cover outstanding claims, investors will contribute $1.074 billion. To get to this point, claims would have to have reached over $700 billion. If additional funds are still needed to pay claims, each insurance company has agreed to pay an additional $1.432 billion. Through the CEA and its structure of support through insurance companies, investors, reinsurance policies, and loan capabilities, there is a total of $7.5 billion in coverage for the state of California. If claims were to exceed the $7.5 billion mark the CEA would effectively be bankrupt. Analysts feel it is unlikely that California would suffer an earthquake of this magnitude to cause that kind damage. In order to raise additional funds, the CEA is enticing other insurance companies to join in the program.
Lastly, how much is this coverage going to cost the average homeowner? That may still be difficult to say. Recently the state insurance commissioner announced that CEA rates would be cut by an average of 11%. The reduction in earthquake insurance will not affect the cost of homeowners insurance. These are two different kinds of policies. In fact, when trying to obtain CEA insurance, the homeowner’s insurance must be through a participating CEA insurer. When calculating insurance rates the CEA primarily looks at zip codes. The CEA went through a long and involved process to set up rating bands. A majority of the rate investigation work was done by a San Francisco company, EQE International, as well as John Drennan from Chicago and Greg Butler, a former political aide. In determining rate bands EQE International looked at soil types from bedrock, considered to be the safest, to alluvia soils, which are soft and considered to be less stable. In addition, the age of homes and the building codes they were built under help to determine the damage potential. Many of the homes in California were built before 1960. Since codes were not as strict as they are now, they are considered more vulnerable to damage. This is where the zip codes come into play. Each zip code was examined for an estimated cost in damages in conjunction with fault lines and previous earthquakes. Pooling this information together gives an idea of what areas would be hit hardest and would need the most financial compensation; therefore posing the highest risk. John Drennan then took the thousands of zip codes in California and split them in to 19 rating bands. Prior to this, there were only two rate bands, high and low. During their initial work there was consideration of up to 2000 bands, with prices ranging from forty-five cents per thousand dollars in coverage to as much as fifteen dollars per thousand dollars in coverage. Now the risk is spread between the 19 rate bands. Currently costs are varying from approximately one dollar per thousand dollars of coverage to five dollars and twenty-five cents per thousand dollars of coverage, working through a participating CEA insurer is the only way to obtain a fixed cost.
In closing, it is hard to say if earthquake insurance is worth the investment for everyone. For some homeowner’s investing funds in a financial institution, money market or other alternative investment plan may better prepare them for “the big one”. A home is a major investment but the CEA may not be the way for everyone to protect it. When looking for earthquake insurance ask questions and get answers before deciding. Be sure the coverage is suitable to personal needs. Do not be afraid to shop around, there are several companies working with the CEA, and pricing may vary from company to company. With the possibility of new insurers entering the market, pricing is destined to change. Do not be afraid to ask agents questions periodically to see how things are improving in the market. The bottom-line; stay informed, ask questions and evaluate insurance needs often.
Blumberg, Peter. “A Rocky Beginning.” California Journal Sept. (1997): 38-43
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11 pars. Online. Internet. 8 Oct. 1997. Available FTP: insure.com/states/ca/home/cea1.html.
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19 pars. Online. Internet. 8 Oct. 1997. Available FTP: insure.com/states/ca/home/cea4.html.
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62 pars. Online. Internet. 8 Oct. 1997. Available FTP: insure.com/states/ca/home/cea2.html.
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31 pars. Online. Internet. 8 Oct. 1997