Insurance Topics | Earthquake Insurance (2024)

Background

Last Updated: 5/9/2024

Issue:According to theUnited States Geological Survey (USGS), 42 states are at risk of incurring damage from an earthquake. The most active seismic areas in the U.S. are along the West Coast plate boundaries of California, the Pacific Northwest and Alaska. The USGS provides amapping toolto show all magnitude 2.5+ earthquakes to have occurred within the prior 24 hours.

According todata collected by Aon, California has experienced 6 of the top 10 costliest earthquakes in U.S. history and yet only 10% of its residents have earthquake insurance. Similarly, only 11.3% of Washington's residents were covered in 2017. Most people think of large magnitude earthquakes when contemplating earthquake risk, however, earthquakes of smaller magnitude can cause significant damage. According to a study by the USGS, theNew Madrid Seismic Zone (NMSZ)has a 7 to 10 percent chance of experiencing a 7.5 magnitude or greater earthquake over the next 50 years. During the same timeframe, the probability of a magnitude 6 or higher earthquake is 25 to 40 percent. Despite the risk,a reportproduced by the Missouri Department of Insurance shows a 49% decrease in earthquake coverage for MO residents in the New Madrid region, moving from 60.2% in 2000 to 11.4% in 2021.Apoll by the Insurance Information Instituteindicated that only 11% of American homeowners had earthquake insurance.

Overview:There are several key reasons why many people do not obtain earthquake insurance. People may not be aware that standard homeowners coverage does not include coverage for earthquake. The cost of coverage may be prohibitive in high risk areas and coverage may be limited. Earthquake insurance generally includes a percentage deductible, ranging from 2% to 20% of the total insured property value. The higher deductible amount shifts more of the risk onto the insured. Those with the highest perceived risk are also more likely to purchase the coverage—a phenomenon called “adverse selection.” Moreover, people may be unaware of their risk if a major loss event has not taken place in their region for an extended period of time or they may be overly reliant on federal assistance following a catastrophic event.

Earthquake insurance is important because it decreases the post-earthquake loss burden on individuals, businesses and society in general. Insurance serves as an important tool in transferring the risk of earthquake damage and funding recovery efforts. Its function as a pre-disaster funding tool limits the economic impact of post-disaster recovery to individuals, businesses and government. Insurers pay for earthquake losses from funds pooled via insured premiums that are set in proportion to the risk, thus allowing for financial diversification of risk. Insurers protect themselves from the financial instability caused by adverse selection by limiting the amount of risk they will accept from any one region. As a result, risk is spread among many insurers.

Many homeowners believe that earthquake coverage is included in their homeowners insurance policy. For this reason, the NAIC produced theConsumer’s Guide to Purchasing Earthquake Insurance(PDF). The guide explains earthquake insurance, including information on how to obtain coverage and file claims. Earthquake coverage is sold primarily through admitted direct and surplus lines insurers. While it is usually offered as an endorsem*nt to a homeowners or businessowners policy, it can also be sold as a stand-alone policy. However, theCalifornia Earthquake Authority, a publicly-managed, mostly privately-funded entity, sells earthquake insurance in California through participating insurance companies.

The consumer guide also defines common earthquake coverages and exclusions. For example, earthquake insurance typically only covers direct damage to the property resulting from the shaking of an earthquake. Indirect damage, such as fire and water damage from burst gas and water pipes is covered under a homeowners policy. Damage to vehicles would be covered under an auto policy. Earthquake coverage is usually subjected to two separate deductibles, typically 10-15 percent of the cost of rebuilding the home and the home’s contents.

TheNational Earthquake Hazards Reduction Program(NEHRP) leads federal efforts to reduce destruction due to earthquakes by partnering with state and local governments, universities, research centers, professional societies and trade associations to develop research and risk reduction methodologies. In April 2022, FEMA produced,"A Step Forward. Recommendations for Improving Seismic Code Development, Content and Education."

Actions

Status:In 2020, NAIC’s Journal of Insurance Regulation publishedThe Earthquake Insurance Protection Gap: A Tale of Two Countries.The article analyzed why market penetration of earthquake insurance for personal properties is higher in the Lower Mainland of British Columbia (about 60%) versus western Washington state (about 14%), even though both places face similar and significant earthquake risk. The authors offer policy recommendations regarding barriers and considerations for improving market penetration of earthquake insurance.

The NAICCatastrophe Insurance (C) Working Groupunder the Property and Casualty Insurance (C) Committee serves as a forum for discussing issues and solutions related to catastrophic events. They are currently drafting an update to a document regarding catastrophe modeling. In 2018, the USGS One-Year Seismic Hazard Forecast prompted catastrophe vendors to update their models. These model updates allow insurers a better understanding of induced seismic impact to property. Induced earthquakes have been linked to known human activities that are regulated at the state and national levels. For more information and research regarding induced earthquakes, visitusgs.gov.

In 2013, in accordance with Solvency II, the Property and Casualty Risk-Based Capital (E) Working Group adopted a change to the RBC formula to include the 1 in 100 modeled loss for earthquake, net of reinsurance.