Prepping for the Big One, California earthquake insurance agency looks to cut coverage [The Sacramento Bee]

Nov. 13—Some day, a major earthquake causing damage on the scale of Northridge or Loma Prieta, or even worse, is expected to shake California. In the aftermath, anyone who owns or rents a home will be scrambling to see how much insurance they have to cover damages.

It's likely to be far less than they might have wanted.

California's main provider of earthquake insurance is warning that it needs to scale back coverage to stave off a potential financial disaster. The California Earthquake Authority, which was created after the 1994 Northridge earthquake, says it may reduce the payout benefits it provides to the authority's more than 1 million customers. If it doesn't, premiums could double.

The quasi-governmental entity, whose board includes Gov. Gavin Newsom, remains on solid financial footing, according to insurance industry credit ratings. But the authority is, in some respects, a victim of its own success. In recent years it has has taken on so many new customers that it faces a "potentially unsustainable strain on its claim paying capacity," the authority's staff said in a report to the governing board in September.

Unless it changes course and reduces coverage, the staff report says the authority will have to impose substantial rate hikes to bolster its finances. This would mark a reversal after several years of decreases.

The cost of coverage "will likely double over the next five years unless affirmative steps are taken this year," the staff report said. The average policyholder pays $738 a year, although premiums in high-risk areas like the Bay Area and Los Angeles can cost thousands of dollars.

To avoid draconian premium increases, the staff has recommended slashing the amount of insurance someone can buy for their personal belongings, from $200,000 to $5,000. The staff also recommended the elimination of its lowest-deductible policies.

Both moves would reduce the amount of money the authority would have to pay out when a big earthquake strikes.

The authority is looking into reducing benefits "in order to keep rate increases at a minimum," said the authority's spokeswoman Sarah Sol in an email.

Since 2015, the authority's customer base has jumped 28%, according to legislative reports, in part because the authority has been reducing rates and stepping up its advertising. Authority officials believe the appetite for insurance has also been fueled by news about major disasters, including the 2019 Ridgecrest earthquake and California's dismal string of big wildfires.

This growth in customer rolls has dramatically expanded the potential losses the authority would face in a big quake. The total value of the property insured by the authority exceeds $590 billion. In 2016, the figure was just $388 billion, according to a report to the Legislature.

The authority's "exposure has been rapidly accelerating, and maintaining sufficient claim paying capacity is increasingly costly," Sol said.

Northridge disaster changed everything

The Northridge earthquake in 1994 devastated parts of greater Los Angeles — and temporarily made it almost impossible for Californians to buy earthquake insurance. The early-morning, 6.7-magnitude quake killed more than 60 people. Residential damage was estimated at $20 billion, or about $35 billion in today's dollars.

Afterward, most insurers refused to sell earthquake coverage. The Legislature stepped in and created the CEA in late 1996. A not-for-profit "public instrumentality of the state," the authority gets no money from the state budget but is controlled by state officials. It answers to a three-person governing board: Newsom, State Treasurer Fiona Ma and Insurance Commissioner Ricardo Lara.

Buying earthquake coverage is largely an afterthought in seismically-safe areas like Sacramento — even as residents remember the jolt they felt from the 6.0-magnitude quake centered in Mono County four months ago. In 2017, the last year for which figures were available, only about 20,000 homeowners and renters in Sacramento County had earthquake coverage from either the Earthquake Authority or a traditional insurer.

Elsewhere, however, the Earthquake Authority is a well-known entity. It covers one out of every 10 households in the state, a total of about 1.1 million homeowners and renters. It controls about two-thirds of the residential earthquake market in California, which is dominated by Southern California and the Bay Area.

Business has been very good. Selling coverage through 25 participating insurers, the authority took in $845 million in premium last year and recorded an underwriting profit — the basic difference between premiums and claims — of $213 million.

The profits have been rolling in for years. The authority has an A-minus (for excellent) rating from A.M. Best Co., a firm that monitors the financial strength of insurers.

The key to this success: a lack of major claims. "Since the CEA's inception, there has not been a major earthquake," the authority said in its most recent financial statement.

The last significant earthquake in California, the 7.1 quake in the Kern County city of Ridgecrest in 2019, left about $1 billion in damage but barely touched the authority's pocketbook. Insurance claims from Ridgecrest were minimal, and the CEA recorded another big underwriting profit.

California's luck will surely change at some point.

In its annual report to the Legislature, the authority said there's a 48% chance of an earthquake of at least a 7.5 magnitude within the next 30 years. The U.S. Geological Survey says an earthquake as powerful as the 1906 San Francisco quake — at a 7.8 magnitude, one of the strongest ever recorded in North America — isn't likely to occur for several more decades.

Nevertheless, a significant quake isn't that far off.

"The threat of earthquakes extends across the entire San Francisco Bay region," the USGS says, "and a major quake is likely before 2032."

Authority has billions to pay earthquake claims

Earlier this year the authority purchased $9.6 billion worth of reinsurance. That's a type of coverage that insurance companies themselves purchase to help them pay claims that arise from mega-disasters.

It didn't come cheap — the reinsurance cost the authority about $500 million, soaking up more than half of the premium revenue it collected from Californians. But the purchase enabled the authority to dramatically increase its capacity to absorb a big hit.

Along with cash and other assets, the authority now has the ability to pay $19.7 billion worth of claims in the event of a major quake.

That's well short of the $590 billion in property it covers, but "no insurance company maintains claim-paying capacity equal to the total insured value," Sol said. Instead, the authority aims to have enough capacity to handle a 1-in-400-year event — a threshold that it says is established by A.M. Best and other firms that monitor insurers' financial strength.

Meeting that threshold is becoming increasingly difficult. According to the September staff report, reinsurance is becoming more expensive. Meanwhile, thousands of Californians have signed up for earthquake insurance in recent years.

That's no accident; the authority has been aggressive about drumming up new business. After the Ridgecrest earthquake, authority officials conducted media interviews to urge more Californians to buy coverage.

"I like to say that Californians are now in the driver's seat to choose the policy that is right for them, and it's important that they do," authority chief executive Glenn Pomeroy told The Sacramento Bee after Ridgecrest.

Until recently, the authority has been doing what it can to make the coverage more enticing. Since it began operating in 1996, it has raised the maximum amount of coverage available for personal belongings and offered a greater range of policy choices. It has cut premium rates five times by a total of 39%, according to Sol.

Now the authority is beginning to make coverage less attractive for policyholders. According to the staff report, the CEA "halted proactive sales and marketing activity" last year. It also recently secured approval from the Department of Insurance — whose commissioner sits on the authority's board — for a 2.9% rate hike, effective next April.

The board discussed the benefits-reduction plan at its September board meeting but wound up tabling the question. It plans to take up the issue again in December and "further evaluate potential solutions, and to do additional work with stakeholder groups to seek input," Sol said.

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