This month’s big earthquake in Eureka, followed by the far more devastating one in Haiti, should focus attention on the staggering uninsured losses that will result from the next big shaker in California unless something is done soon.
Statewide, only 12 percent of homeowners with insurance also have quake coverage. About 70 percent of that is underwritten by the California Earthquake Authority, a state-sponsored entity that sells quake insurance through commercial insurance companies.
The CEA admits that even with its insurance, homeowners could suffer "substantial uninsured loss." Its policies pay nothing until structural damage alone exceeds 15 percent of the home’s insured value. After that, they pay for damage to structure and household goods up to the policy limit. The basic policy pays only $1,500 in living expenses if you can’t stay in your home.
If a large quake erupted on the Hayward Fault, only 6 to 10 percent of total residential losses and 15 to 20 percent of commercial losses would be covered by insurance, according to Risk Management Solutions, a firm that predicts damage from catastrophes.
By comparison, about 53 percent of the economic losses to homes and businesses following Hurricane Katrina were covered by insurance, including payouts from the National Flood Insurance Program.
Katrina looks like "a well-covered event" compared with a potential earthquake in California, says Doug Heller, executive director of Consumer Watchdog.
Even if you have earthquake insurance, if most of your neighbors don’t, your property value and quality of life could plummet if their homes are abandoned or fall into disrepair.
One way to minimize damage is to encourage home and building owners to retrofit their property, says Mary Lou Zoback, a vice president with Risk Management Solutions. Another is to sell more quake insurance.
Lower premiums
Spreading risk should give insurers more capital from which to pay claims and lead to lower premiums for consumers – the same way group health insurance costs less than an individual policy. It also helps offset adverse selection, which happens when the only people who buy insurance are those most likely to have claims.
But here’s the conundrum: Premiums won’t come down until more people buy policies, and sales won’t pick up until premiums come down.
The average CEA premium in California is $707, but prices vary greatly depending on the home’s location and type of construction.
The CEA, along with similar agencies in hurricane-prone states, is pushing a bill that it says would dramatically lower its costs by substituting reinsurance with a federal guarantee on bonds sold following a major disaster. If the legislation passes, the CEA says, it could lower its premiums by 30 to 40 percent. Or it could lower them by a smaller percentage but also reduce the deductible, or make other policy improvements.
In California, companies that sell homeowners insurance are required to offer earthquake coverage. After the 1994 Northridge earthquake, many companies stopped or threatened to stop selling new homeowners policies rather than continue offering quake coverage. In response, the state created the CEA, which offers bare-bones policies that firms can offer as an alternative to their own.
Insurers representing 70 percent of the residential market offer CEA policies. CEA pays these companies a fee but keeps the premiums and takes the risk itself.
Today, if a major quake occurred, the CEA would pay claims first from its own capital, then from proceeds of revenue bonds it has sold, then from reinsurance and finally, if needed, by hitting insurance companies that do business in the state with a special assessment.
Insurance companies buy reinsurance to pay claims that they can’t. The CEA says it is spending about 40 cents of every premium dollar on reinsurance.
Under the proposal in Congress – called the Catastrophe Obligation Guarantee Act – the CEA would cut way back on its reinsurance. Then, if a major quake occurred and it exhausted all of its other resources – including the special industry assessment – the authority would sell bonds guaranteed by the federal government.
To repay the bonds, the CEA would raise premiums, but not as high as they are today. The bonds would not be an obligation of the state, and the federal government would step in only if the CEA defaulted.
Limited guarantee
The government could guarantee a total of $5 billion worth of bonds for all earthquake damage and $20 billion for hurricanes.
"Our modeling is that there is only 1/2 to 1 percent chance we would need to borrow," says Glenn Pomeroy, the CEA’s chief executive.
Heller, the consumer advocate, supports the bill. He believes the CEA, as a nonprofit state-sponsored entity, would pass along savings to policyholders.
"The risk for the federal government is that the earthquake authority can’t bring in enough money to pay back the bonds," he says. "But it’s something they would kind of be on the hook for anyway. If California is falling into the ocean, the federal government will have to do something about it. If they can shore up private or state coverage of disasters, the federal government doesn’t have to step in as much."
The downside is that homeowners won’t directly benefit if their insurance company doesn’t offer a CEA policy. "A flaw in the law" doesn’t let consumers buy a stand-alone policy from CEA, Heller says.
Robert Hunter, director of insurance with the Consumer Federation of America, says "the concept is good, but the devil is in the details."
If they couldn’t compete on price, private companies might have to stop selling their own quake insurance and offer CEA coverage, which could impact competition.
"It could have an adverse effect on competition," Hunter says, although hardly anyone is buying quake insurance in the first place.
The Senate version of the bill, S886, was introduced in April. The House version, introduced in November, is HR4014. The concept is also included in a larger bill dealing with catastrophes, HR2555.
Sen. Dianne Feinstein, a co-sponsor of the Senate bill, says it would "save Californians up to $150 million per year at a time when family budgets are stretched thin."
The American Insurance Association, a trade group, opposes it.
Risk potential
"Any time you are setting up a federal backstop for a state-run insurance mechanism, you are potentially creating a disincentive for the state to charge risk-based rates and to manage their portfolio of risk to an appropriate level," says Eric Goldberg, the group’s associate general counsel. In other words, "If you know the government is there to bail you out, you might take on more risk than is prudent and keep prices artificially low because it is politically expedient to do so."
Goldberg doesn’t see any benefit to U.S. taxpayers. "Post-Katrina, the vast majority of federal dollars spent were not covering uninsured homeowners. Everyone who wanted flood or windstorm coverage could have bought it. What you saw in terms of federal expenditures was way more on infrastructure and temporary housing. That’s something the federal government would do anyway, regardless of insurance."
The two bills have had little action, which is understandable given the focus on health care and financial regulation.
"What’s going on in Haiti is not comparable, but it brings some awareness that we have disaster issues in America," Heller says. The problem for the bills’ sponsors "is not convincing people it’s right, it’s convincing people it’s relevant. I’m hopeful this will break through the consciousness in Washington to give elected officials a chance to actually get something done."
