Earthquake insurance in California

When water began draining from New Orleans in 2005, we learned that most New Orleans homeowners did not have flood insurance, since they were supposedly in “low risk” areas. More than 60% of homeowners will need to rely on their own savings and limited federal assistance to rebuild New Orleans, at an uncalculated cost to homeowners and taxpayers.

Could that level of disaster, especially that level of uninsured disaster, happen in California? Less than 15% of California homeowners currently have earthquake insurance, due to its high cost, “it can’t happen to me or my house” factor, and coverage is not required by mortgage providers. The next big earthquake will result in billions in uninsured damage, but is earthquake insurance really worth the high cost?

How did we get here?

The state of California requires all homeowners insurance providers to offer at least one earthquake insurance (albeit at a high cost). Until 1994, it was widely available, but the high costs of damage from the Northridge earthquake caused 97% of homeowners insurance providers to withdraw from the state of California. In response, the California legislator formed the California Earthquake Authority to provide earthquake insurance.

What is the California Earthquake Authority and how does it work?

The California Earthquake Authority provides two-thirds of the earthquake policies in California, sold through its member providers such as Allstate and State Farm. An owner buys the policy through his regular insurance agent, but the policy is actually a CEA policy.

The CEA currently has about $7.2 billion to pay claims, which it says is enough to pay for foreseeable damages (Loma Prieta in 1989 had $6 billion in total damages). If damage claims exceed $7.2 billion, then each claim would receive a pro-rated share of their losses, unlike a regular insurance company, which promises to pay actual damages under the insurance policy. The State of California cannot help pay claims from general funds.

The policies also have a high deductible, typically 15% of the home’s value. In other words, your home must be damaged by more than 15% of its value before the insurance will start to pay out. Therefore, this insurance is not for cracks in the driveway, it is for significant structural damage to your home. The policy also pays for limited content ($5K and up) and loss of use ($1500 and up).

Why is earthquake insurance so expensive?

Insurance policy premiums are calculated based on probabilities: the probability that a house like yours in a neighborhood like yours will catch fire or that a driver like you will be in an accident. With data from millions of households, these probabilities can be calculated with reasonable precision. But no one can reliably predict the probability of an earthquake strong enough to damage your home.

And, as you can imagine, the damage from an earthquake, flood, or hurricane is widespread, potentially over thousands of square miles, rather than one or a few dozen houses, as in a fire. As such, the insurer would have to pay out zero claims or billions of dollars in claims – too much variance to reasonably plan or accurately quote.

Are we really at risk here in San José?

According to the USGS, there is a 62% chance of an earthquake measuring 6.7 or greater (such as the Northridge earthquake) in the Bay Area in the next 30 years. In my ZIP code (San Jose 95126), the USGS estimates an 80% chance of a 6.0 earthquake and a 20% chance of a 7.0 earthquake in the next 30 years. Whether you consider it a high risk depends on your tolerance for earthquake risk: I consider a high risk of a moderate earthquake and a somewhat low risk of a terrible earthquake, in the next 30 years.

But like any real estate related problem, everything is local. The actual location of your home significantly affects your risk: bedrock, reclaimed bay land, soil type, nearby creeks, actual distance from the epicenter can all affect potential damage.

But of course many earthquakes occur where the USGS wasn’t even aware of a fault line, and we never know when or where it will happen, until it does.

Should I get earthquake insurance?

Factors to consider:

• Could you afford to rebuild your home with your own savings and investments?
• Can you afford to pay the high cost of insurance, indefinitely?
• Could you make the payments on your current mortgage and a new rebuild loan?
• Can you mitigate your potential losses by bolting your roof to the walls and the walls to the foundation, for example?
• What is your tolerance for earthquake risk?
• What are the risks of the current construction of your house (type, age, foundation)?
• What are the risks of your specific location (soil type, distance to known faults)?

Are they worth the costs?

Let’s say you have a house that would cost $250,000 to rebuild, you will own the house for the next 30 years, and your earthquake premiums are $1,200 per year. Over the next 30 years, that would be a total of $36,000 in premiums (assuming your premiums don’t increase, to keep things simple).

Instead of buying insurance, invest the premiums in a diversified mutual fund. With an 8% annual return, you would have $135,000 (before taxes) in year 30.* But, of course, you will only have that total in year 30, not year one, which means that if the earthquake hits tomorrow, you won’t have I don’t have the money.

The deductible is another big drawback for many homeowners. Insurance pays only for major structural damage, not broken dishes or cracked driveways, which means you’re less likely to use it. Keep in mind, however, that you won’t need to come up with the cash for the deductible; You can choose not to bear those repair or rebuild costs, or you can apply for an SBA loan to pay the deductible (assuming a federal disaster occurs). area is declared).

Why not just get federal help or “walk out” and let the bank take the property?

The federal government would likely provide access to SBA loans, if the area is declared a federal disaster area (no small business required). However, the maximum loan of $200,000 from the SBA may not be enough to rebuild your home, and it is a loan you must pay back (in addition to your existing mortgage).

If you have refinanced your mortgage, you have a recourse mortgage, which means that not only can the bank foreclose on the property in case of default, but the bank can also go after your personal assets and future income in case of default. non-payment. . Therefore, you cannot just leave, especially if you have a good income and some personal assets. The bank can help you by deferring payments for a few months, but you still have to pay off the loan.

last thoughts

We have earthquake insurance on our house. Our house wasn’t built yet in the 1906 earthquake (so who knows if it would hold up), it’s over 75 years old and not bolted to the foundation, and we have a refinanced mortgage. For my family, the insurance premiums are worth the peace of mind in the event of a major earthquake. That’s exactly what insurance is for: “you never know.”

*calculations ignore inflation