2005
Insurance Reference Manual
Personal Insurance Federation of California Insurance Reference Book
A FACTUAL GUIDE TO:
THE CALIFORNIA EARTHQUAKE AUTHORITY
for
CALIFORNIA LEGISLATORS
January 26, 2005
Prepared by:
The Personal Insurance Federation of California
980 Ninth Street, Suite 2030
Sacramento , California 95814
Phone: 916-442-6646
www.pifc.org
WHY WAS THE CALIFORNIA EARTHQUAKE AUTHORITY (CEA) FORMED?
In an era of finite resources, when both consumer and businesses are limited in their ability to pay for the transfer of earthquake risks, we must come to grips with the reality of just how to deal with the economic challenges associated with earthquakes.
In January 1994, the California property and casualty insurance industry suffered the second largest insured loss in U.S. history when an earthquake struck Northridge, California causing $15.6 billion in commercial and residential insured losses.
It measured 6.7 on the Richter scale, killed 60 people, destroyed thousands of homes, businesses and apartment complexes, and left a wake of destruction that directly affected the lives of millions of people.
The insured loss in Northridge was more than four times the $3.5 billion in earthquake premiums collected by all earthquake insurers from 1969 through 1994. Excluding the Northridge earthquake, insurers paid out more than $2.6 billion in losses during 1969-1994, including $1.7 billion in insured losses paid as a result of the Loma Prieta earthquake that struck in 1989.
The much higher than anticipated damages from Northridge were a painful lesson for insurance companies in California and throughout the nation. Northridge taught insurers that they had dramatically underestimated the potential damage caused by moderate earthquakes and as a result many companies found themselves dangerously overexposed to earthquake risk. Insurance rating agencies also took note of this increased exposure and downgraded the financial ratings of many companies.
It is not a matter of if, but when, the next quake will strike. The probability of a quake with a magnitude of 7.0 or more on the Richter scale hitting the greater Los Angeles area within the next 5 to 7 years is 47 percent. It is better than a 70 percent probability that it will happen within the next 30 years.
Two major earthquakes within a short time could wipe out the entire net worth of all 180-plus insurance companies that carry homeowners insurance policies in California -- and leave millions of Californians totally destitute.
Because California law requires insurers that sell homeowners insurance to also offer earthquake insurance, the only way for an insurance company to reduce its earthquake exposure following the Northridge quake was to seriously restrict the sale of new homeowners policies or to stop writing homeowners insurance altogether. That is exactly what happened after Northridge. At the height of the unavailability crisis, insurers representing over 93 percent of the homeowners market had severely restricted the sale of new policies or had stopped writing entirely. To further reduce their exposure many insurers also planned to non-renew thousands of their existing policyholders.
THE LEGISLATURE'S RESPONSE TO THE AVAILABILITY CRISIS
The California Legislature responded to the availability crisis by enacting two major earthquake insurance measures. The first, in 1995, was the creation of a reduced coverage catastrophic earthquake insurance policy designed to protect a policyholder's dwelling while excluding coverage for costly non-essential items such as swimming pools, patios, and other appurtenant structures. This new policy, called the "mini-policy," was supported by a wide range of groups including insurers, insurance agents and consumer organizations such as Consumers Union. The creation of the mini-policy reflected the realization that it was no longer feasible to provide the broad coverage for earthquakes that existed prior to Northridge. The policy carries a 15 percent deductible, $5,000 in contents coverage, and $1,500 in additional living expenses. Currently, the mini-policy is being offered by 96 percent of the homeowners insurance market.
The creation of the mini-policy helped to stop the hemorrhaging of the homeowners insurance market, but availability of new policies was still very limited. In 1996, the Legislature responded by establishing the CEA. The CEA is a privately funded, publicly managed entity which provides earthquake coverage to residential property owners, condominium owners, mobilehome owners and renters. Participation in the CEA by insurers is voluntary and since its creation, property and casualty insurers who write over two-thirds of the California market have joined.
Creation of the CEA had a dramatic impact on the availability of homeowners and earthquake insurance in California. A Department of Insurance study found that as of October 1997 almost 90 percent of the market was freely writing new policies. For the first time in many years, residential earthquake insurance is readily available to all Californians.
HOW WILL THE CEA PAY CLAIMS WHEN THE NEXT EARTHQUAKE STRIKES?
STRUCTURE OF THE CEA
The CEA is funded by a voluntary assessment of participating insurance companies upon joining the CEA and by consumers paying annual premiums. Participating insurers receive 2.8 percent of the premiums from CEA policies to pay for billing and policy processing, agents receive a 10 percent commission, and no more than three percent may be used by the CEA for administrative purposes.
Participating insurers also agree to pay an additional $3.584 billion in assessments if needed for earthquake claims for a minimum of 12 years. The insurers will be assessed in direct proportion to their share of the California homeowners insurance market. Their total liability assessment commitment is capped at $6 billion.
Reinsurance has been purchased for the CEA pool. The contracts with reinsurers and private investors are delicately balanced to assure full payment when the next earthquake strikes.
Special assessments may be placed on CEA earthquake policyholders if a mega-earthquake occurs. This was done at the request of the IRS which has granted tax exemption to the CEA, thus allowing the CEA to pay more in claims to policyholders when the next quake strikes.
In December of 2002, CEA received a financial strength rating of A- (Excellent) from A.M. Best Company, the world's most authoritative insurance rating agency. This financial strength rating was reaffirmed in December of 2004.
THE CEA POLICIES
CEA offers a base-limits policy that provides the same basic coverage that is available from most private insurance carriers. The base-limits CEA policy is designed to provide basic protection against earthquake damage. The policy will pay to repair or replace the dwelling, subject to deductible, but it excludes some items from coverage including pools, patios, fences, driveways and detached garages. Only covered, structural damage counts toward meeting your deductible. The base-limits CEA policy pays up to $5,000 to repair or replace personal property and provides $1,500 for any additional, higher living expenses you incur if your home is uninhabitable while it is being repaired.
The Condominium Policy
Individual condominium owners receive coverage that includes $25,000 for real property damage, $5,000 in personal property losses, and up to $50,000 in loss assessment coverage. Loss assessment coverage helps to pay assessments levied by condominium associations on individual owners and the CEA is one of the only insurers in California offering this type of coverage.
The Renter's Policy
Renter's policies are offered with $5,000 contents coverage, $1,500 additional living expense (ALE), and a $750 deductible.
Supplemental Coverages
Many CEA participating insurers are now offering CEA's new, higher coverage limits to their policyholders. For an additional premium, up to $100,000 in Contents coverage and $15,000 for Loss of Use are available. Homeowners and mobilehome owners have an additional option: lower the deductible from 15% to 10%. (Condominium owners and renters are not eligible for a lower deductible but can purchase the higher limits for Contents and Loss of Use coverages.)
Policyholders must purchase a base-limits CEA policy to be eligible to buy higher limits. The supplemental limits policy is available to CEA base-limits policyholders whose homeowners insurer offers that coverage. Like a CEA base-limits policy, a policyholder can purchase supplemental limits earthquake coverage only from the insurer that provides their policy of residential insurance.
THE RATES CHARGED BY THE CEA
Probably the most controversial issue surrounding the CEA has been how rates are determined. Policies can range from $.80 per thousand dollars of coverage to $5.70 per thousand dollars of coverage. The average statewide rate is $ 2.79 per thousand, while the average rate of the largest companies outside of the CEA is $2.92 per thousand.
The CEA has been a catalyst of sorts for some important advances in earthquake modeling and science. Prior to the creation of the Authority, little structural engineering or seismic science had been focused on residential structures. Since the CEA was formed, with a mandate to base rates on the best available science, several private and government agencies have started to generate new science on earthquakes and homes. Partly as a result of these efforts, the CEA has been able to adjust rates twice since its creation. Although some parts of the state have seen rate increases since the CEA was established, others have seen significant decreases. Overall, CEA rates have decreased an average of 15 percent since the Authority was created.
CURRENT STATUS OF THE CEA
Today, the CEA has the claims paying capacity to pay more than $7 billion in residential earthquake claims. If the Northridge earthquake were to strike today, CEA losses would be approximately $1.55 billion. Thus, the CEA is financially sound enough to pay off MORE than three Northridge earthquakes.
To date, the CEA has approximately 730,000 policies in force, making it the largest earthquake insurer in the world. In addition, thousands of supplemental policies have been written since the CEA began offering those options in June of 1999. The in-force policies represent about $160 billion in exposure.
THE CEA AND THE FUTURE
Having successfully restored the homeowners market and completed its ramp up, the CEA just finalized its five-year strategic plan. Some highlights of the proposed plan are to increase basic policy sales by 10 percent, increasing supplemental policy sales to 100,000 policies in-force, and raising consumer awareness about earthquake risk in California.
The CEA recently completed a pilot retrofit program in 8 counties in the San Francisco Bay area. The program provided free seismic safety assessments by engineering firms, and access to low-interest financing for improvements. The CEA is evaluating that program and developing plans to expand retrofit services throughout the state.
The CEA is growing financially stronger each day. Its existence helps create a solid marketplace that offers availability, affordability and accessibility to homeowners and earthquake insurance throughout the state.
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