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Some (Bad) Reasons to Skip Quake Insurance


Last week I wrote about Californians' reluctance to face their earthquake risk and the many wrongheaded reasons people use for not buying earthquake insurance. Several readers wrote in to defend their decision to go "bare"--inadvertently providing even more examples of less-than-stellar thinking.

One woman said she dropped her earthquake insurance after her company delayed paying her 1994 Northridge claim. Although most claims were paid without incident, many consumers did indeed have trouble with their carriers after that massive quake, and the state wound up ordering several insurers to pay a total $11 million to settle consumer complaints that the companies improperly handled their claims.

That is definitely a reason to be a careful consumer, to know your rights and to stay on top of your claim; that may even be a reason to hire a lawyer to get the company's attention. It's not a reason to put at risk your entire financial investment in a house.

The excuse cited most often for forgoing coverage, however, was the structure of the California Earthquake Authority itself--particularly the provisions that could require policyholders to pay an additional assessment or accept less coverage if the state-run insurance pool runs out of money.

It's true that current CEA policyholders could be assessed as much as 20% of their yearly premium if a huge disaster or string of disasters depletes the CEA's front line of coverage: the $500 million in cash the agency has on hand plus the $2.15 billion that would be contributed by the CEA's member companies, which include most of the state's insurers; plus the $1.43 billion in reinsurance--insurance the pool has purchased from companies that specialize in covering such risks.

To trigger the assessment, we would have to experience two Northridge-size earthquakes in a row, or one quake that does twice the damage, said Mark Leonard, CEA spokesman.

Northridge's $12.5 billion in insured damage included about $8.5 billion in residential claims--the only type the CEA handles. The CEA's exposure is far less now than insurance companies faced then, largely because most CEA policies are much more restrictive than private policies available in the past. (And yes, that's another point of contention, even though the CEA recently began offering enhanced policies with better coverage.) If another 6.7 earthquake like Northridge happened today, the CEA would end up paying about $2 billion--half the level required for a policyholder assessment.

The assessment was not something the CEA originally wanted, Leonard said. Lawmakers had hoped to avoid it through reinsurance. But in order to get the CEA tax-exempt status, the IRS requires that it have taxing authority, and the assessment was the only way to create that, he said.

The assessment is, it's true, kind of stinky. Surely the burden should be distributed to all homeowners instead of confined to those responsible enough to get coverage in the first place. But it's not a reason to forgo insurance. (Homeowners who want to avoid the assessment after a major disaster can simply drop their coverage, although they would have to pay up if they ever wanted an earthquake policy in the future.)

A pro rata reduction of policyholder's benefits would require an even bigger disaster.

After the policyholder assessment, the CEA would have to run through two more layers of reinsurance ($1.075 billion) and industry assessments ($1.434 billion) before cutting back the amount paid policyholders.

Some homeowners pine for the good old days when private insurers offered earthquake policies that were backed up by the California Insurance Guaranty Assn. What they might not understand is that CIGA is far from an ironclad guarantee to pay.

CIGA is not like the Federal Deposit Insurance Corp., which insures the nation's bank accounts. If a bank goes under, the government-backed FDIC will pay back its depositors, up to certain limits. If a CIGA insurer goes under, the other member insurers will be assessed, but they could go under as well in a big enough disaster. Unlike the FDIC, the federal government doesn't stand behind CIGA.

Could the CEA and the rest of the insurance industry face a disaster that big? Oh, absolutely, especially if a massive earthquake hit populous Los Angeles or Orange county. The CEA estimates that a 7.8 quake like the 1906 San Francisco tremor would cause $4 billion in insured losses in the Bay Area; it won't even guess what such a rocker would cost Los Angeles, but it's bound to be much, much more. Some experts have estimated that a quake that large could cause $250 billion in total damages (although a much smaller amount in insured damages).

Earthquakes of that magnitude would cause financial losses and chaos that we can barely imagine; no one really knows who would pick up which bills in that case.

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