The Opening Bell

Articles from The Opening Bell

Earthquake Insurance

by Forrest Bell, CFP®, President, Financial Planner & Senior Investment Advisor

January 2019

Over the past two years, the number of homes destroyed by wildfires in California has prompted many homeowners to reconsider their homeowners insurance policies and for good reason. Homeowners policies that are written to insure a home from damage affecting a single home might not provide coverage for damage that results from a larger disaster. Take the loss of use provision found in homeowners policies, for example. Loss of use provisions—sometimes called additional living expense provisions—pay for reasonable costs of living over normal household expenses so homeowners can live elsewhere while their damaged home is being repaired or rebuilt. If a home burns down because of a kitchen fire, a full year of loss of use coverage is often sufficient. But what if the cause of home damage is not limited to a single home? What if the cause has impacted an entire community?

Rebuilding after a disaster that has impacted an entire community always takes longer. It takes more time to get permits because they require architecture and engineering plans, which are in short supply as the city is overwhelmed with similar requests from so many homeowners. The rebuilding itself takes longer because there isn’t enough available labor to do all of the work. Ideally in a homeowners policy that anticipates larger disasters, the loss of use provision is unlimited and includes a cash-out option so the homeowner can opt out of rebuilding altogether.

However, even homeowners policies written with larger disasters in mind do not ensure against damage from an earthquake. For that, you need earthquake insurance. In our past article about homeowners insurance, we mentioned that California homes tend to cost well above the national average. For that reason, home equity often plays a major role in the retirement plans of Californians. If you’re counting on your home’s equity to realize your retirement goals but your home is vulnerable to earthquakes, then earthquake insurance can be very important.

When the next large earthquake will hit California is unknown, but it’s certain that it will happen. That certainty makes earthquake insurance a relatively expensive kind of insurance, which is a big reason why so few Californians own it. Only 13% of California homes and fewer than 10% of the state’s commercial structures are covered by earthquake insurance. Many of the homeowners who do not own earthquake insurance now did own it at one time but decided to drop it due to its high cost. But because the cost of earthquake insurance can vary significantly depending on the carrier and market conditions, it is worth exploring, or reexploring, whether you need earthquake insurance. So other than a large amount of equity in your home, what other factors make earthquake insurance worth buying?

The features of a home help determine how vulnerable it is to earthquake damage. What type of construction was used? How close is the home to a fault line? What is the quality of soil the home is built on? Bedrock is more secure than a hillside rich in clay. Does the home have multiple stories? Single-story homes generally perform well in an earthquake, while homes with three or more stories are the most vulnerable.

Then there is the quality of the foundation. A foundation built to current code is the most cost-effective defense against home damage due to an earthquake. California building codes as they relate to foundations have changed a lot in the past 80 years. Starting in 1940, the code changed to require that frames be bolted to the foundation. By 1997, the code not only required that frames be bolted to the foundation but also that the bolting include mudsill bolts and transfer ties. Additionally, the cement used in the past was much weaker than the cement required for foundations today. These and a slew of other important seismic improvements were added to the code in the 1990s, so if your home was built later than that, you likely have a good foundation. Still, even the foundations of newer homes are worth taking a look at as the bolting can rust and deteriorate over time.

Homeowners shopping for earthquake insurance also need to consider which insurance company to use. Homeowners insurance providers in the state of California are required to offer residents earthquake insurance every two years. After the Northridge earthquake of 1994 in Los Angeles, many private insurance companies decided that earthquake insurance was too risky. Because of this, California created the California Earthquake Authority (CEA) to fill the void insurance companies had left behind. Private insurance companies can partner with the CEA to offer earthquake policies while reducing their financial risk. Since the Northridge earthquake, the CEA has had more than 20 years to build its reserves, allowing it to accrue $15 billion in available funds. There are some questions about what will happen if the total liabilities from successive earthquakes exceed those available funds. Private insurers, on the other hand, boast that they’re in an even better financial position and are able to offer a cash-out option in their policies. However, not all homes will qualify for private insurance, and it may be more expensive. So homeowners have to decide whether a private insurer or a policy through the CEA is better for them. It’s crucial to use a professional insurance broker to help you decide what’s best.

A key consideration as you begin thinking about earthquake insurance is to understand your home’s equity and the extent to which your financial plan depends on that equity. Once you have that in mind, you should think about the specific features of your home that might make it especially vulnerable to an earthquake such as the quality of its foundation, the type of soil on which your home is built, its proximity to a fault line and the number of stories. If these point to a need for earthquake insurance, then gather quotes from different insurance providers including the California Earthquake Authority. You can visit the CEA’s website (https://www.earthquakeauthority.com) to get a premium estimate and then work with a professional insurance broker to choose the policy that best aligns with your concerns and needs.

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