Earthquake Insurance in California

When the water started draining from New Orleans in 2005, we learned that most New Orleans homeowners didn’t have flood insurance because they were supposedly in “low-risk” areas. The more than 60% of homeowners will have to rely on their own savings and limited federal aid to rebuild New Orleans — at an unprecedented cost to homeowners and taxpayers.

Could that level of disaster, especially that level of uninsured disaster, be happening in California? Less than 15% of homeowners in California currently have earthquake insurance, due to high costs, the “can’t happen to me or my house” factor, and mortgage lenders not requiring coverage. The next big earthquake will result in billions of uninsured damage – but is earthquake insurance really worth the high cost?

How did we get here?

The state of California requires all homeowners insurers to offer at least earthquake insurance (albeit at a high cost). It was widely available until 1994 — but the high cost of damage from the Northridge earthquake caused 97% of homeowners insurers to withdraw from the state of California. In response, the California Earthquake Authority was created 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 California earthquake policy, sold through their affiliated suppliers, such as Allstate and State Farm. A homeowner buys 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 had total damages of $6 billion in 1989). If the insurance claims exceed $7.2 billion, each claim gets a proportional share of their losses – unlike a regular insurance company, which promises to pay the actual damages under the insurance policy. The state of California cannot pay the claims out of general funds.

The policies also have a high deductible – usually 15% of the home’s value. In other words, your home must have more than 15% of its value damage before the insurance starts paying. This insurance is therefore not for cracks in the driveway, but for significant structural damage to your home. The policy also pays for restricted content (starting at $5K) and loss of use (starting at $1500).

Why is earthquake insurance so expensive?

Insurance premiums are calculated based on probabilities — the probability that a house like yours in a neighborhood like yours catches fire, or that 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 probability that there will be an earthquake strong enough to damage your home.

And, as you can imagine, damage from an earthquake, flood, or hurricane is widespread, potentially thousands of square miles — rather than one or a few dozen homes, as in a fire. As such, the insurer would have to pay either zero claims, or billions of dollars in claims — too much variance to plan reasonably or accurately price.

Are we really in danger here in San Jose?

According to the USGS, there is a 62% chance that a 6.7 or greater earthquake (such as the Northridge earthquake) will occur 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 that a high risk depends on your risk tolerance for earthquakes – I consider that a high risk of a moderate earthquake and a somewhat low risk of a terrible earthquake, over the next 30 years.

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But as with any real estate problem, it’s all local. Where your home is actually located has a significant impact on your risk — bedrock, reclaimed bay land, soil type, nearby streams, actual distance from the epicenter — anything 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.

Do I need to take out earthquake insurance?

Factors to consider:

  • Can you pay for the renovation of your house with your own savings and investments?
  • Can you afford to pay the high insurance costs indefinitely?
  • Can you pay off your current mortgage and a new loan to rebuild?
  • Can you limit your potential losses by, for example, screwing your roof to the walls and the walls to the foundation?
  • What is your tolerance for the risk of an earthquake?
  • What are the risks of your current housing construction (type, age, foundation)?
  • What are the risks of your specific location (soil type, distance to known fractures)?

Is the cost worth it?

Let’s assume you have a house that would cost $250K to rebuild, that you will own the house for the next 30 years, and that your earthquake premiums are $1,200 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 taking out insurance, invest the premiums in a diversified mutual fund. With an 8% annual return, you’d have $135,000 (before taxes) in year 30.* But, of course, you’ll only have that total in year 30, not year one — meaning if the earthquake happens tomorrow, you won’t don’t have the money.

The deductible is another big turn-off for many homeowners. Insurance will only pay for major structural damage, not broken signs or cracked driveways — meaning you’re less likely to use it. However, keep in mind that you don’t have to pay the deductible – you can choose not to have those repair or remodeling costs, or you can apply for an SBA loan to pay the deductible (assuming a federal disaster area is indicated).

Why not just get federal aid or “Walk Away” and let the bank own the property?

The federal government would likely grant access to SBA loans if the area is declared a federal disaster area (no small business required). However, the $200,000 maximum SBA loan may not be enough to rebuild your home — and it’s a loan you’ll have to pay back (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, the bank can also find out about your personal assets and future income in the event of non-payment. payment . So you can’t just walk away, especially if you have a good income and some equity. The bank can help by delaying payments for a few months, but you still have to repay the loan.

final thoughts

We have earthquake insurance on our house. Our house wasn’t built in the 1906 earthquake (so who knows if it would hold up), it’s 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 disaster. That’s exactly what insurance is for – the ‘you never know’.

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*calculations ignore inflation