When water started flowing from New Orleans in 2005, we learned that most homeowners in New Orleans did not have flood insurance, as they were thought to be in “low risk” areas. More than 60% of homeowners will need to rely on their own savings, and limited federal aid, to rebuild New Orleans – at an unaccounted for cost to homeowners and taxpayers.
Could that level of disaster, especially that level of uninsured catastrophe, occur in California? Less than 15% of California homeowners currently carry earthquake insurance, due to the high cost, the “can’t happen to me or my home” factor, and mortgage providers don’t need coverage. The next big earthquake will cause billions of 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 at least offer earthquake insurance (albeit at a high cost). Until 1994, it was widely available – but the high damage costs of the Northridge earthquake resulted in 97% of homeowners insurance providers pulling out of the state of California. In response, the California Earthquake Authority was created by California legislators 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 policy in California, sold through their member providers, such as Allstate and State Farm. Homeowners buy policies through their regular insurance agents, but the policies are actually CEA policies.
The CEA currently has approximately $7.2 billion to pay claims, which is said to be sufficient to pay for predictable damages (Loma Prieta in 1989 had a total of $6 billion in damages). If the damage claim is more than $7.2 billion, then each claim will be paid in proportion to their loss – unlike ordinary insurance companies, which promise to pay for the actual damage under an insurance policy. The state of California cannot help pay claims from the general fund.
Policies also have high deductibles – usually 15% of the occupancy value. In other words, your home must be damaged at more than 15% of its value before insurance starts paying. So, this insurance is not for cracks in the driveway – it’s for significant structural damage to your home. This policy also pays for limited content (starting at $5K) and lost usage (starting at $1500).
Why is Earthquake Insurance So Expensive?
Insurance policy premiums are calculated based on probability – the probability that a house like yours in a neighborhood like yours will catch fire, or a driver like yours will have an accident. With data from millions of homes, these probabilities can be calculated with reasonable accuracy. However, no one can predict reliably the likelihood that there will be 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 — instead of a house or a few dozen, like a fire. Thus, insurers must pay either zero claims, or billions of dollars in claims – too much variance to reasonably plan or price accurately.
Are We Really At Risk In San Jose?
According to the USGS, there is a 62% chance that there will be an earthquake of 6.7 or greater (such as the Northridge earthquake) in the Bay Area within the next 30 years. In my zip code (San Jose 95126), the USGS calculates an 80% chance of a 6.0 earthquake and a 20% chance of 7.0, in the next 30 years. Whether you consider it a high risk depends on your risk tolerance for earthquakes – I assume that the risk of a moderate earthquake is high and the risk of a terrible earthquake is rather low, over the next 30 years.
But like any issue involving real estate – everything is local. Where your house is actually located significantly affects your risk – bedrock, land reclaimed from the bay, soil type, nearest river, actual distance from the epicenter – can all affect potential damage.
But of course, many earthquakes happen where the USGS isn’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:
- Can you pay to rebuild your home from your own savings & investments?
- Can you afford the high insurance costs, indefinitely?
- Can you make your current mortgage payments and new loans to rebuild?
- Can you reduce your potential losses by attaching the roof to the wall and the wall to the foundation, for example?
- What is your tolerance for earthquake risk?
- What are the current construction risks of your home (type, age, foundation)?
- What is your specific location risk (soil type, distance to known fault)?
Is the Cost Worth it?
Let’s assume that you own a house that costs $250K to rebuild, you will own the house for the next 30 years, and your earthquake premium is $1200 per year. Over the next 30 years, that will be a total of $36,000 in premiums (assuming your premiums don’t increase, to simplify calculations).
Instead of buying insurance, you invest your premiums in a diversified mutual fund. With an 8% annual return, you’ll have $135,000 (before taxes) in year 30.* But of course, you only have that amount in year 30, not in year one – meaning if an earthquake happened tomorrow, you wouldn’t have any money. .
Reduction is another thing that is a turn off for many homeowners. Insurance only pays for major structural damage, not broken plates or cracked driveways – meaning that it’s less likely that you’ll use them. However, be aware that you don’t need to generate cash for deductions – you can choose not to incur those repair or rebuilding costs, or you can apply for an SBA loan to pay for the deductions (assuming a county federal disaster is declared).
Why Not Get Federal Aid, or “Stay Away” and Let the Bank Own the Property?
The federal government may grant access to SBA loans, if the area is declared a federal disaster area (no small business required). However, a maximum SBA loan of $200K may not be enough to rebuild your home – and, it is a loan that you must repay (in addition to your current mortgage).
If you have refinanced your mortgage, you have a recourse mortgage – meaning that not only can the bank foreclose on the property if it doesn’t pay, it can also pursue your personal assets and future income if it doesn’t pay. So you can’t just walk away, especially if you have a good income and some personal assets. The bank can help by delaying payments for a few months, but you will still have to repay the loan.
Last Thoughts
We have earthquake insurance in our house. Our house hadn’t been built in the 1906 earthquake (so who knows if it would last), was 75+ years old and not bolted to the foundation, and we had a refinanced mortgage. For my family, insurance premiums are worth it for peace of mind in the event of a major earthquake disaster. That’s what insurance is for – “you never know”.
*calculation ignores inflation