(Backdated 14 January 2010)—After the 6.5-magnitude earthquake that struck Eureka, CA over the weekend, California Insurance Commissioner Poinzer requested that California residents purchase earthquake insurance. Coincidentally, 70% of earthquake insurance in the state of California is provided by the California Earthquake Authority (CEA), a state-sponsored, private-public partnership. But the state’s $20 billion budget gap provokes the question, is a state-sponsored earthquake-insurer to be relied upon in time of need?
How is it “state-sponsored” and “private-public?”
What it means to be state-sponsored in this case is not that the CEA receives tax dollars but that the organization is a state inception and continues to be regulated by the state government (beyond the regulation of ordinary insurance laws). As a perk of state sponsorship, the CEA enjoys exemption from federal income tax.
The CEA is not structured like an ordinary insurance company. It’s a state-run club of 16 private member companies, who conduct their business according to CEA standards. It sounds a bit like a guild, but whereas guilds were historically guilty of artificially driving prices up by controlling an industry, the CEA rather presents the danger of making prices too low.
How are low premiums and deductibles a danger?
The usual danger is that government-sponsored businesses tend to undercut their citizen-owned competitors (because government sponsorship often entails special funding or tax exemptions). Thus, private enterprises are driven to bankruptcy, and the industry becomes socialized de facto.
The matter of more immediate concern to the California earthquake insurance shopper, however, is that if insurance products are too affordable, the insurer may ruin its ability to pay claims when they’re really needed. The insurer sells too many policies and takes in too few premiums. Is the CEA in any danger of overreaching its capital base? Indeed it appears unlikely that it will be able to meet its financial obligations if a large earthquake strikes a highly populated area:
An illustration
The CEA currently holds $8 billion in claims-paying capacity to support 750,000 earthquake insurance policy owners. The densely-populated Bay area holds about 138,594 of them. In the event of a major earthquake there, an average of only $58k per claimant would be available—a scant payment in an area whose average home value lies between $500k and $750k.
The CEA is not permitted to declare bankruptcy, but this protective regulation will not put money into the hands of policy owners in the event of a major disaster.
Cheaper earthquake insurance in the future
The CEA is currently pressing for legislation to allow it to further reduce its premiums and deductibles.
The efforts of a government-sponsored business to make its products outlandishly affordable recalls to mind Congressman Barney Frank’s vision of making US housing affordable for even the most profligate in Fannie Mae and Freddie Mac’s subprime loans to high-risk applicants.
News you can use
Homeowner’s insurance does not cover earthquake damage. If you can’t afford to rebuild your home right now, and if you live in an earthquake-prone zone (like much of California) consider obtaining earthquake insurance.
The chance of a large earthquake hitting CA in the next 30 years is over 99 percent, the chance of one hitting the Bay area in such a time frame is estimated between about 65 and 70 percent.
