As the water began to drain from New Orleans in 2005, we learned that many of the homeowners in New Orleans did not have flood insurance, as they were supposed to be in “low risk” areas. Over 60% of homeowners will have to rely on their own savings, and limited federal aid, to rebuild New Orleans – at an untold cost to homeowners and taxpayers .
Could that level of disaster, especially that level of uninsured disaster, 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 which do not require coverage. The next big earthquake will result in billions in uninsured damage – but is earthquake insurance really worth the high cost?
How Did We Get There?
The state of California requires all home insurance providers to at least offer earthquake insurance (although, at a high cost). Until 1994, it was widely available – but the high costs of Northridge earthquake damage resulted in 97% of home insurance providers leaving 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 the earthquake policies in California, 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 to pay claims, which it says is enough to pay foreseeable damages (Loma Prieta in 1989 had $6 billion in total damages). If the claims for damages are more than $ 7.2 billion, then each claim is paid a prorated portion of their losses – unlike a regular insurance company, which promises to pay the actual damages under the insurance policy. The state of California cannot help pay claims from general funds.
The policies also have a high deductible – usually 15% of the value of the dwelling. In other words, your home must be damaged more than 15% of its value before the insurance will start paying out. 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 in a neighborhood like yours will catch fire, or a driver like you will have an accident. With data from millions of homes, these probabilities can be calculated with reasonable accuracy. But, no one can reliably predict 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 one or a few dozen homes, as in a fire. As such, the insurer will have to pay either zero claims, or billions of dollars of claims – too much variance to plan reasonably or price accurately.
Are We Really At Risk Here in San Jose?
According to the USGS, there is a 62% probability that there will be an earthquake of 6.7 or greater (like the Northridge earthquake) in the Bay Area in the next 30 years. In my zip code (San Jose 95126), USGS calculates an 80% chance of a 6.0 earthquake and a 20% chance of a 7.0, in the next 30 years. Whether you consider it a high risk depends on your risk tolerance for earthquakes – I would consider it a high risk of a moderate earthquake and a somewhat low risk of a terrible earthquake, over the next 30 years.
But like any matter involving real estate – it’s all local. Where your home is actually located significantly affects your risk – bedrock, reclaimed land from the beach, soil type, nearby streams, actual distance from epicenter – all can affect potential damage.
But of course, many earthquakes occur where the USGS was not 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 afford to pay for your home rebuild from your own savings and investments?
- Can you afford to pay the high cost of insurance, indefinitely?
- Can you make payments on your current mortgage and on a new loan to rebuild?
- Can you mitigate your potential losses by reinforcing your roof to the walls and the walls to the foundation, for example?
- What is your earthquake risk tolerance?
- What are the risks of your home’s current construction (type, age, foundation)?
- What are the risks of your specific location (soil type, distance to known faults)?
Are the Costs worth it?
Let’s assume you have a house that costs $250K to rebuild, you will own the house for the next 30 years, and your earthquake premiums are $1200 a 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, invest the premiums in a diversified mutual fund. With an 8% annual return, you’d have $135,000 (before tax) in year 30.* But of course, you’d only have that total in year 30, not the first year – meaning that if the an earthquake happens tomorrow, you won’t have it. I don’t have the money.
Downsizing is another big turn off for many homeowners. The insurance only pays for major structural damage, not broken dishes or cracked driveways – which means you’re less likely to use it. However, be aware that you won’t need to come up with cash for the deduction – you can either choose not to incur those repair or rebuild costs, or you can apply for an SBA loan to pay for the reduction (assuming a federal disaster). area is declared).
Why Not Just Get Federal Aid, or “Walk Away” and Let the Bank Own the Property?
The federal government will probably provide access to an SBA loan, if the area is declared a federal disaster area (no small business required). However, the maximum $200K SBA loan may not be enough to rebuild your home – and, it’s a loan you 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 non-payment, the bank can also come after the your personal assets and future income in case of default. . So you can’t walk far, especially if you have a good income and some personal assets. The bank can help 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 will stand), it is 75+ years old and not bolted to the foundation, and we have a refinanced mortgage. For my family, insurance premiums are worth the peace of mind in the event of a major earthquake disaster. That’s exactly what insurance is for – the “you never know.”
*calculations ignore inflation
