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When water began receding from New Orleans in 2005, we learned that most New Orleans homeowners did not have flood insurance, as they were allegedly in “low-risk” areas. Rebuilding New Orleans will require more than 60% of homeowners to rely on their own savings and limited federal aid – at an incalculable cost to homeowners and taxpayers.
Could a disaster of that scale, especially an uninsured disaster of that scale, happen in California? Less than 15% of California homeowners currently carry earthquake insurance, due to its high cost, the “couldn’t happen to me or my house” factor, and mortgage providers not requiring coverage. The next big earthquake will result in billions in damage – but is earthquake insurance really worth the high cost?
How did we get here?
The state of California requires that all homeowner insurance providers offer at least earthquake insurance (albeit at a higher cost). By 1994, it was widely available – but the high damage costs of the Northridge earthquake resulted in 97% of homeowner’s insurance providers pulling out of the state of California. In response, the California Earthquake Authority was formed by the California legislature to provide earthquake insurance.
What is the California Earthquake Authority and how does it work?
The California Earthquake Authority provides two-thirds of earthquake policies in California, which are sold through their member providers, such as Allstate and State Farm. A homeowner purchases the policy through their regular insurance agent, but the policy is actually a CEA policy.
The CEA currently has about $7.2 billion in claims to pay, which suggests it has enough to pay for the estimated damages (Loma Prieta had $6 billion in total damages in 1989). If damage claims exceed $7.2 billion, each claim will be paid a proportionate share of their losses – unlike a regular insurance company, which promises to pay actual losses under an insurance policy. The State of California cannot assist in paying claims from general funds.
The policies also have a high deductible – typically 15% of the value of the dwelling. In other words, your home must be damaged by more than 15% of its value before insurance will start paying. So, this insurance isn’t for cracks in the driveway – it’s for significant structural damage to your home. The policy also pays for limited contents (starting at $5K) and loss of use (starting at $1500).
Why is earthquake insurance so expensive?
Insurance policy premiums are calculated based on probabilities – the likelihood that a house like yours will catch fire in your neighborhood, or a driver like you will get into an accident. With data on millions of households, these probabilities can be calculated with reasonable accuracy. But, no one can reliably predict the likelihood that an earthquake will be powerful enough to damage your home.
And, as you can imagine, damage from an earthquake, flood, or hurricane is widespread, potentially over thousands of square miles—instead of one or a few dozen homes, as in a fire. Thus, the insurer must either pay zero claims, or billions of dollars in claims—a variation too vast to reasonably plan or price.
Are we really at risk here in San Jose?
According to USGS, there is a 62% chance that an earthquake of magnitude 6.7 or greater (like the Northridge earthquake) will hit the Bay Area in 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 a 7.0 in the next 30 years. Do you believe the high risk depends on your risk tolerance for earthquakes – I agree that there is a high risk of moderate earthquakes and a somewhat low risk of severe earthquakes over the next 30 years.
But like any issue involving real estate – it’s all local. Where your home is actually located affects your risk significantly – bedrock, reclaimed land from the creek, soil type, nearby streams, actual distance from the epicenter – can all affect potential damage.
But of course, there are plenty of earthquakes where USGS didn’t even know the fault line was there – and we’ll never know when or where it will be until it happens.
Should I Get Earthquake Insurance?
Factors to consider:
- Can you pay for your home renovation with your savings and investments?
- Can you afford to pay the high cost of insurance indefinitely?
- Can You Afford Your Current Mortgage and Rebuild on the New Loan?
- For example, can you reduce your potential damage by anchoring your roof to the walls and the walls to the foundation?
- What is your tolerance for earthquake risk?
- What are the risks of your current home construction (type, age, foundation)?
- What are the risks in your specific location (soil type, distance to known faults)?
Is the cost worth it?
Let’s say you have a home that will cost $250K to rebuild, you will own the home for the next 30 years, and your earthquake premium is $1200 per year. Over the next 30 years, that would total $36,000 in premiums (assuming your premiums don’t increase, to simplify the calculations).
Instead of buying insurance, you invest the premiums in diversified mutual funds. With an 8% annual return, you’ll have $135,000 (pre-tax) in year 30. I don’t have money.
The deductible is another big turn off for many homeowners. Insurance only pays for major structural damage, not broken pots or a cracked driveway—which means you’re less likely to use it. Keep in mind, however, that you won’t need to come up with the cash to pay for the deductible—you can either choose not to incur those repair or rebuilding costs, or you can apply for an SBA loan to pay for the deductible. (Assuming a federal disaster area has been declared.)
Why not just get federal aid, or “walk away” and give the property to the bank?
The federal government will probably provide access to SBA loans if the area is declared a federal disaster area (not a small business requirement). However, the $200K maximum SBA loan may not be enough to rebuild your home – and, it’s a loan you’ll need to pay back (in addition to your current mortgage).
If you refinanced your mortgage, you have a recourse mortgage – which means that not only can the bank foreclose on the property in the event of nonpayment, the bank can protect your personal property and future property rights in the event of nonpayment. Can come even after income. , So you can’t easily walk away, especially if you have a good income and some personal assets. The bank may help by deferring the payment for a few months, but you will still have to repay the loan.
final thoughts
We have earthquake insurance on our house. Our house was not yet built in the 1906 earthquake (so who knows if it will stand), it is 75+ years old and not connected to the foundation, and we have a refinanced mortgage. For my family, the insurance premium is worth the peace of mind in case of a major earthquake disaster. That’s exactly what insurance is for – “you never know.”
*Calculation ignores inflation
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