New State Quake Insurance Plan Raises Concerns

The state earthquake insurance bill passed by the Legislature will herald a decline in the percentage of homeowners with coverage because premiums are expected to continue the sharp rise that began following the Northridge earthquake, according to some government and industry experts.

A decline in patronage, the analysts say, also will place new pressures on the federal government to help bear the cost of uninsured losses from catastrophic quakes in the future.

The Senate on Friday gave final legislative approval to a measure creating the $10.5 billion California Earthquake Authority, and Gov. Pete Wilson is expected to sign it, paving the way for its inauguration Dec. 1.

In addition to being more expensive, the coverage being offered is less than half of what it was before the 1994 quake, analysts note. Mini-policies authorized by the Legislature last year cut back the coverage, raising deductibles to 15% of a home’s value and exempting garages and pools. The new earthquake authority will offer only those restricted policies.

“If the price is high [for the state insurance], people won’t want it,” said Howard Kunreuther, co-director of the Risk Management and Decision Resources Center at the Wharton School in Pennsylvania.

“Who will then pay when quakes come?” asked Kunreuther, one of the nation’s foremost experts in catastrophic insurance. “Will it be the government?”

The official charged with implementing the state program, Insurance Commissioner Chuck Quackenbush, said Saturday that he will work to make premiums as reasonable as possible and that small price decreases may occur once the system is functioning.

Quackenbush disputed those who feel that patronage will decline. “Desire for insurance continues to be high because people perceive the hazard,” he said. “Northridge memories are not fading in Southern California, and Loma Prieta memories are not fading in the Bay Area.”

But the premiums are likely to be a shock to many homeowners when they receive renewal notices over the next year. Although coverage has declined, the price of a policy will often be twice what it was before the Northridge quake.

The insurance payout for Northridge residential quake claims was $8.5 billion, according to Insurance Department officials. If the same quake were to occur under the new California Earthquake Authority, officials say, the payout would be less than $4 billion.

This raises the specter that even those with earthquake coverage will be much more exposed than they have been and therefore paying a substantial share of their quake damages.

Under the 15% deductible, the owner of a $200,000 home will have to sustain $30,000 in damage before receiving the first insurance dollar from claims. A $100,000 home would have a $15,000 deductible. Deductibles in the past often were 5% or 10%.

Existing earthquake policies will be transferred automatically by participating insurance companies to the new quake authority, and new prices will not be triggered until individual policies come up for renewal on a staggered basis over the following year.

As policyholders get their bills, “there’s going to be price resistance,” said Richard Roth, chief property casualty actuary for the Department of Insurance.

Because owners of $200,000 homes in most of the state’s urban areas may pay $660 to $1,050 annually for earthquake coverage, Roth and some others say patronage is bound to decrease.

“Particularly, if we go two or three years more without a big quake, you’ll have a lot fewer buying,” said John Wiggins, proprietor of a firm that provides predictive models of quake losses for insurance companies and other businesses.

A decline in patronage, experts say, could signal a return to the situation prevailing in California most of this century, when fewer than 10% of homeowners carried earthquake insurance. In some of the most quake-prone areas in the past few years, that percentage has climbed to 40%.

Before the 1985 law that required all companies providing homeowners insurance to also offer quake insurance, only a very small percentage of Californians had quake coverage, according to state records. This contributed to low damage payouts, and the companies always made a big profit.

In 1971, the year of the Sylmar-San Fernando earthquake, only $4.6 million in quake insurance premiums was collected statewide by the companies, and their payout for damage in that quake amounted that year to less than $1 million.

In 1984, the year before the Legislature linked homeowners and earthquake insurance sales, quake premiums had risen to $79 million.

And they skyrocketed to $208 million by 1987, the year of the Whittier-Narrows quake. The premiums reached $619 million in 1994, the year of the Northridge quake, and $742 million in 1995. This year, they are expected to exceed $1 billion.

The first major loss to the insurance companies occurred with the Northridge quake, and it was spectacular. The payout of $8.5 billion in earthquake coverage amounted to more than twice the amount of the quake premiums collected in the state’s entire history. This generated pressure from many companies to pass the coverage to the state.

The state is relying on capital investments, reinsurance and contributions from the insurance industry during the earthquake authority’s formative years to ensure that it has enough resources to deal with its obligations when quakes occur.

But a mammoth quake would still exhaust the authority’s resources, which are capped at $10.5 billion. So, can California secure additional backing from the federal government?

Jack Weber, head of the industry-supported National Disaster Coalition in Washington, suggested Saturday that approval of the California Earthquake Authority may reshape the thrust of efforts on the national level to reform the nature of federal disaster assistance.

Maybe now, Weber said, Congress will authorize the federal government to sell reinsurance or offer a line of credit at the time of quakes to state agencies.

Weber also suggested that lending institutions require homeowners in quake-prone states such as California to purchase the earthquake insurance, thus keeping insurance at a high level.

But the bill creating the earthquake authority has a stipulation in it that would disband the authority if lending institutions ever made the insurance mandatory, and Quackenbush reiterated Saturday that he believes the insurance should be fully voluntary.

“I’m not in favor of forcing people to buy those policies,” he said.

Meanwhile, the private insurance companies remain, in at least two ways, heavily involved in providing quake coverage.

First, fires caused by earthquakes will continue to be covered by the private companies under regular homeowners policies, as John Drennan, the actuary who drafted plans for earthquake authority pricing, points out.

Because homeowner policies often have quite low deductibles, such policyholders who do experience fires after quakes will receive massive help for repairing that damage, even though they do not have earthquake coverage.

Fire was not much of a factor in the Northridge quake, but caused a substantial loss in the Kobe, Japan, quake in 1995 and more than 80% of the losses in the San Francisco quake in 1906.

Second, as the Insurance Department’s Roth noted, some private companies that choose not to adhere to the earthquake authority may be able to undercut its prices.

The reason for this, Roth said, is that the costs of securing reinsurance and interest paid to capital investors in the new authority will be added to its prices.

Under the legislation, companies holding at least 70% of the residential quake insurance market in the state must agree to participate in the quake authority before it can be established.

The state is expected to meet this requirement because the three largest sellers--State Farm, Allstate and Farmers, with a 53% market share among them--are committed to the authority, along with a few mid-sized carriers.

But many small carriers with 1% or 2% of the market will stay out of the authority, and may not only undercut its prices, but be able to offer better deductibles and wider coverage than the authority, Roth said.

* SECESSION DEFEATED

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Earthquake Insurance

The state would offer homeowners earthquake insurance policies through private insurance companies under a bill that saw final action Friday by the Legislature.

* Covered: Structural damage to residences, regardless of value, and $5,000 in contents.

* Not covered: Swimming pools, fences, driveways, outbuildings and landscaping.

* Deductible: 15% of structure’s value.

* Living expenses: Up to $1,500 in first year; $2,500 in the second year; $3,000 in the third year.

* Price: Initial average statewide: $3.29 per $1,000 of coverage, varying by seismic risk.

* Claims: Processed by insurance firms and paid by the state.

* Limits: If the state authority’s money runs short, policyholders would only get partial payment of claims.

* Surcharge: Policyholders could be charged up to a 20% surcharge if claims from an earthquake exceed $6 billion.

Source: California Department of Insurance

Quake Coverage History

During most of the state’s history, only a tiny percentage of homeowners have purchased earthquake insurance. The number started growing after the Sylmar earthquake of 1971, and rose dramatically after 1985 when the Legislature required insurance companies to offer quake coverage. It was profitable for the companies until 1994, when the Northridge earthquake produced their first major losses and inspired a drive to turn quake insurance over to the state government.

Earthquake Premiums and Claims Payments Year by Year (All companies)

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Year Premiums Claims-Payments Comment 1971 $4,617,916 $803,220 Sylmar quake 1972 $8,954,000 $2,076,000 Sylmar aftermath 1973 $10,957,000 $67,000 1974 $12,966,000 $444,000 1975 $13,842,000 0 1976 $17,130,000 $78,000 1977 $19,760,000 $141,000 1978 $23,159,000 $357,000 1979 $28,968,000 $629,000 1980 $38,540,000 $3,548,000 1981 $50,208,000 $464,000 1982 $58,877,000 0 1983 $70,488,000 $2,043,000 1984 $79,452,000 $3,951,000 1985 $132,871,000 $1,666,000 Quake insurance offering required 1986 $180,034,000 $16,699,000 1987 $208,376,000 $47,609,000 Whittier Narrows quake 1988 $277,817,000 $31,815,000 1989 $333,598,000 $433,047,000 Loma Prieta quake 1990 $384,642,000 $180,915,000 Loma Prieta aftermath 1991 $427,399,000 $73,679,000 Sierra Madre quake 1992 $479,969,000 $67,663,000 Landers-Big Bear quakes 1993 $520,960,000 $13,181,000 1994 $619,382,000 $7,414,000,000 Northridge quake 1995 $742,932,000 $1,085,000,000 Northridge aftermath

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Source: California Department of Insurance