Thursday, September 18, 2014

Why Californians don’t invest in Earthquake Insurance Part – 2

Rationalizing the reasons to avoid spending on earthquake insurance is easy. Starting with the reason, “It always happens to the other guy” to more complex justifications, there are a huge number of excuses for not buying a policy. Among the most common are:
  • A home survived the last quake without any damage. That may be so, but it is not a good enough reason. Each quake is different and a region that has historically only suffered from mild tremors could have a major quake tomorrow. Just as there is no way to accurately predict where and when an earthquake will happen, there is no way to know how strong the next one will be. Historical precedent means nothing. In addition, new fault lines are being discovered regularly and even if there has never been a quake near a newly discovered fault, it is no guarantee that an earthquake could not happen next week.
  • A home is earthquake proof. New construction techniques can be used to make a structure more earthquake resistant. Retrofitting of older homes to enable them to withstand stronger temblors is possible. But there is no such thing as a completely earthquake proof home. There is no technology available today that can protect a home from a truly massive quake. And even if the techniques that can increase a home’s quake resistance, exist today, these very same techniques need to be properly applied. For example, bolting a home to its foundation, is a popular way in increasing quake resistance. Regardless of these new developments, studies show that while it may be of some help in protecting a one story wood framed building, structures of two or more stories, those with big gaps in the frames and those with big picture windows are more likely to suffer quake damage, if bolted to the foundation. And a strong foundation is of no use if the ground beneath the home crumbles completely, like the earthquake that hit Anchorage Alaska in 1964, when a whole neighborhood was washed out to sea.
  • FEMA will come to the rescue. Homeowners affected by an earthquake may be eligible for low interest FEMA loans to help them rebuild and get back on their feet. Remember however, that these are loans; the money, along with interest, will have to be repaid. Moreover, these loans will be added to a person’s net worth statement as a liability which will offset the equivalent quantum of assets. Another factor to take into account is the growing reluctance in Congress, faced with numerous natural disasters, to hand out money to those who did not bother to get insurance to protect themselves.
  • Let the bank take it. Those with very little equity in their homes, owing to huge mortgages or other reasons like large decline in home prices, may be tempted to hand over the keys of a ruined home to the bank and walk away. Even the little equity available will be lost and perhaps more importantly, their credit rating will suffer, consequently making it very difficult to finance another home for a very long time.
Don’t Set Aside the Odds

Granted many may argue that the odds of an earthquake striking their homes down, are more in their favor. Many may reason that the probability of winning a lottery ticket is much higher than the probability of an earthquake happening in their neighborhood. Stop! Think! Winning a lottery ticket would be awesome, but lack of earthquake insurance, when calamity strikes, would be disastrous. All of the above reasons also would not be of any help, when it is too late, especially when you live in an earthquake prone region. 

Tuesday, September 16, 2014

Why Californians don’t invest in Earthquake Insurance Part – 1

Californians tend to be blasé about earthquakes. They happen; and unless you have been directly affected by one, it’s something you accept as part of living in California. This is one of the reasons why only 17% of homeowners in California have earthquake insurance. The recent Bay Area temblor in August, has made no difference to homeowners. It’s easy to rationalize the apparent lack of or need for earthquake insurance. What are the odds of your home being damaged or destroyed? One way of looking at it is that the odds are very small, so why pay out so much for insurance, when you may never need it? However, the purpose of insuring is to cover against the improbable, which often has devastating financial consequences and therefore, the best approach to take would be, ‘what could happen, if you lose your home and you don’t have insurance’. For example: a healthy man in his 30s buys life insurance because he is safeguarding against an improbable eventuality, thereby averting any financial catastrophes.

The other issue that dissuades people from buying quake insurance is the historically accurate but currently invalid perception that it was not a customer friendly option.

1994 – Northridge and After

Prior to the year 1994, insurance companies that offered homeowners insurance were also required to offer earthquake coverage. Consequent on the Northridge quakes, the $12.5 billion in claims settlement turned out to be higher than all the premiums collected on earthquake insurance in the state. This led to insurers refusing to underwrite either homeowners or earthquake insurance policies – the losses for them were too high. The State Legislature acted to set up a state run insurance pool to provide the needed coverage – the California Earthquake Authority (CEA).

The policies available were basic and not user friendly. CEA policies had a 15% deductible. This meant that a homeowner with a $300,000 policy would have to pay $45,000 before the policy took effect. These policies were limited to only the actual building and did not cover swimming pools, landscaping or other possible areas of loss. Besides, the interiors were covered for only $5,000 worth of assets. Anything else that was destroyed, damaged, ripped out of the walls, etc. that exceeded this amount had to be paid for from the homeowner’s pocket. And until the home was restored, repaired / rebuilt, the family would have to find temporary accommodation elsewhere. While the pre-Northridge policies covered rent and living costs for up to a year during the time the home was being repaired or rebuilt, CEA policies were limited to a $1,500 payout – about enough to pay for a month at a motel.

In addition, the cost of coverage was high in comparison to the pre 1994 quake policies. CEA based its rates on the then current levels of earthquake prediction. This brought places like San Bernardino, which was previously presumed to be fairly safe, into the higher risk zone, resulting in an increase in premiums.

The widespread protests at the cost and limited coverage of quake insurance caused the state to relook the issue and the result was more policy options, increased coverage of contents and lower deductibles. The number of policy holders started to show a steady increase. But even now, 5 out of 6 homeowners in the state still have no earthquake coverage, because:-
  • To the extremely wealthy, the loss of a home is only a minor inconvenience.
  • To the others whose equity in their homes is so low that paying for insurance makes no sense.
Yet, these are a very small minority. For the rest, not having coverage is a huge and potentially catastrophic gamble.

Call Insurance by Allied Brokers (650-328-1000) for all available earthquake options.