We discovered that flood insurance was not available to most homeowners in New Orleans, even though they lived in low-risk areas. To rebuild New Orleans, the over 60% homeowners will have to rely on their savings and limited federal assistance. This is at a cost that homeowners and taxpayers cannot afford.
Is it possible that California could be hit with such a disaster? California’s earthquake insurance is only 15%. This is due to the high cost of earthquake insurance, the “cannot happen to me” factor, and the fact that mortgage providers do not require coverage. But is earthquake insurance worth the high price?
How did we get here?
California’s state requires all homeowners to have earthquake insurance. However, it is expensive. It was available until 1994. However, the Northridge earthquake caused high damage costs and 97% of California’s homeowner’s insurance providers to leave the state. California’s legislator created the California Earthquake Authority to provide earthquake insurance.
What is the California Earthquake Authority and how does it work?
California Earthquake Authority is responsible for two-thirds (or more) of earthquake policies in California. These policies are sold through their member providers like Allstate or State Farm. The policy is not a CEA policy, although homeowners can purchase it through their regular insurance agent.
According to the CEA, it currently has $7.2 billion available to pay claims. This is sufficient to cover foreseeable damages. Loma Prieta had $6 billion in total damages in 1989. Each claim for damages exceeding $7.2 billion would be paid a proportion of the losses. This is in contrast to regular insurance companies, which promise to compensate the actual damage. California is unable to pay claims from general funds.
Also, the policies have a high-deductible policy that usually covers 15% of the property’s value. Your home must be worth more than 15% before insurance will pay. This insurance does not cover cracks in your driveway, but for serious structural damage to your house. The policy covers limited contents starting at $5K and loss of use starting at $1500.
Why is Earthquake Insurance so expensive?
Insurance premiums are determined based on probabilities. This means that there is a chance that your house in a similar neighborhood will catch fire or that you will be involved in an accident. These probabilities can be calculated using data from millions of homes. However, it is impossible to predict when an earthquake will strike your home.
As you can see, damage from an earthquake, flood or hurricane is widespread and could affect thousands of miles. Instead of just a few homes as in a fire, there are many. The insurer would be required to cover either zero or billions in claims. This is too large a variance to price or plan for.
Are We Really at Risk in San Jose?
The USGS estimates that 62% of earthquakes (like the Northridge quake), will occur in the Bay Area within the next 30 year. USGS estimates that there is a 80% chance for a 6.0 earthquake in my San Jose zip code. There is a 20% chance for a 7.7 earthquake within the next 30 year. It depends on how you view earthquakes. I believe that there is a high chance of a moderate earthquake and a low risk of a devastating earthquake over the next 30 year.
It is local, as with any real estate issue. Your risk is greatly affected by where your home is located – soil type, bedrock, reclaimed bay land, and distance from epicenter.
However, earthquakes can occur in places where the USGS wasn’t aware of fault lines – and until it happens, we don’t know when or where.
Do I need Earthquake insurance?
Factors to Be Considered:
- Are you able to afford the cost of rebuilding your house using your savings and investments?
- Are you able to afford the high price of insurance indefinitely?
- Could you make your mortgage payments and get a loan to rebuild?
- You can reduce your losses by bolting your roof on the walls and walls to the foundation.
- How much do you accept the possibility of an earthquake?
- What are the potential risks associated with your home’s current construction? (Type, Age, Foundation)
- What are the potential risks in your particular location (soil type, distance from known faults)
Are the costs worth it?
Let’s say you own a $250K home to rebuild. Your earthquake premiums are $1200 each year. To simplify calculations, this would amount to $36,000 in premiums over the next 30 year.
Instead of buying insurance, you can invest your premiums in a diversified mutual fund. You would be able to make $135,000 in 30 years if you get an 8% annual yield. * However, this total is only available in year 30 and not in year 1. This means that you won’t have enough money if an earthquake occurs tomorrow.
Many homeowners find the deductible to be a major turnoff. Insurance does not cover large structural damages, such as cracked driveways or broken dishes. This makes it less likely that you will ever use it. You don’t have to make the deductible payment. However, you can either choose to forgo the repair or rebuilding costs or apply for an SBA loan.
You can get federal aid or you can “walk away” and let the bank have the property.
If the area is declared a federal catastrophe area, the federal government will likely provide SBA loans. The maximum SBA loan amount of $200K may not be sufficient to rebuild your home. You will also need to repay it (in addition to your existing mortgage).
Refinance your mortgage to get a recourse mortgage. This means that the bank can foreclose on your property in the event of non-payment. The bank can also take your future income and personal assets. Even if you have assets and a high income, you can’t just walk away. Although the bank might defer payments for a few more months, you still have to repay the loan.
Last Thoughts
Our home is covered by earthquake insurance. We have an earthquake insurance policy on our home. Our home wasn’t built during the 1906 earthquake. It is 75+ years old, has not been bolted to the foundation and has a refinanced mortgage. My family considers the insurance premiums worth it for peace of mind in the event of a major earthquake. Insurance is exactly for that purpose – you never know what the future holds.
