California earthquake insurance

When water started flowing out of New Orleans in 2005, we learned that most New Orleans homeowners didn’t have flood insurance because they were supposedly in “low risk” areas. More than 60% of homeowners will have to rely on their own savings and limited federal assistance to rebuild New Orleans – at uncalculated cost to homeowners and taxpayers.

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

How did we come here?

The State of California requires all home insurance providers to carry at least earthquake insurance (albeit at a high cost). Until 1994, it was widely available – but high damage costs from the Northridge earthquake caused 97% of home insurers to withdraw from the state of California. In response, the California Earthquake Authority was created by California lawmakers to provide earthquake insurance.

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

The California Earthquake Authority supplies two-thirds of earthquake-resistant fonts in California, sold through their member vendors, 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 to pay claims, which it says is enough to pay foreseeable damages (Loma Prieta in 1989 had $6 billion in total damages). If damage claims amount to more than $7.2 billion, each claim would receive a proportional share of its losses – unlike a regular insurance company, which promises to pay actual damages under the insurance policy. ‘assurance. The State of California cannot help pay general fund claims.

The policies also have a high deductible – typically 15% of the home value. In other words, your home must be damaged by more than 15% of its value before the insurance will start paying. So this insurance isn’t for cracks in the driveway – it’s for major structural damage to your home. The policy also pays for limited content (starting at $5,000) and loss of use (starting at $1,500).

Why is earthquake insurance so expensive?

Insurance premiums are calculated on the basis of probabilities – the probability that a house like yours in a neighborhood like yours will catch fire or that a driver like you will have an accident. With data from millions of households, these probabilities can be calculated with reasonable accuracy. But no one can reliably predict the likelihood 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 covering thousands of square miles – instead of one or a few dozen homes, as in the case of a fire. As such, the insurer would have to pay out either zero claims or billions of dollars in claims – too much of a spread to plan reasonably or assess accurately.

Are we really in danger here in San Jose?

According to the USGS, there is a 62% chance that there will be a 6.7 or greater earthquake (like the Northridge earthquake) in the Bay Area within the next 30 years. In my zip code (San Jose 95126), the USGS calculates an 80% probability of a 6.0 earthquake and a 20% probability of a 7.0 earthquake, over the course of 30 coming years. Whether you consider this a high risk depends on your risk tolerance for earthquakes – I consider this to be high risk of a moderate earthquake and rather low risk of a terrible earthquake, over the next 30 years.

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

But of course, many earthquakes happen 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 take out earthquake insurance?

Factors to consider:

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

Are the costs worth it?

Suppose 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 simplify the math).

Instead of buying insurance, you invest the premiums in a diversified mutual fund. With an 8% annual return, you’d have $135,000 (pre-tax) in year 30.* But of course, you only have that total in year 30, not year one – which means if the earthquake earth happens tomorrow, you don’t have the money.

Another big annoyance for many homeowners is the deductible. Insurance only pays for major structural damage, not broken dishes or cracked driveways – meaning you’re less likely to use it. However, be aware that you won’t need money for the deductible – you can choose not to undertake these repair or rebuild costs, or you can apply for an SBA loan to pay the deductible (assuming a disaster federal zone is declared).

Why not just get federal help or “walk away” and let the bank own 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 SBA loan of $200,000 may not be enough to rebuild your home – and it’s a loan you need to pay off (in addition to your current mortgage).

If you have refinanced your mortgage, you have a recourse mortgage – which means that not only can the bank seize the property in the event of non-payment, but also the bank can come after your personal assets and your future income in case of non-payment. So you can’t walk away, especially if you have a good income and some personal property. The bank can help you by deferring payments for a few months, but you 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 would hold), 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. This is exactly what insurance is for – the “you never know”.

*calculations ignore inflation

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