Policy Documents

Research & Commentary: California Earthquake Insurance and the California Earthquake Authority

Matthew Glans –
November 22, 2010

Earthquakes present unique challenges for homeowners and insurers. They are not as easy to predict or forecast as major storms, and writing earthquake insurance policies is a costly and risky endeavor that many insurance companies are not willing to undertake.

After the 1994 Northridge earthquake, the costliest in U.S. history, the state of California began requiring all companies writing homeowners insurance to offer earthquake coverage. Rather than abide by that costly mandate, property and casualty insurers stopped written new policies in the state. Seeing this as a threat that might destabilize the state’s housing market, in 1995 the California legislature offered an alternative, the earthquake “mini-policy.” The mini-policy allows insurers to comply with the law by offering a less-comprehensive and less-costly policy.

Mini-policies are required to cover only losses due to structural damage, and they can have a 15 percent deductible. In addition, the policies limit taxpayer risk by limiting claims on personal property losses and “loss of use.”

To encourage the issue of mini-policies, the legislature created a quasi-governmental, privately funded agency to provide earthquake coverage. The California Earthquake Authority (CEA) is publicly run but receives no public funds. Participation is voluntary for insurers, offering another option for them to satisfy the mandatory offer law by selling a CEA mini-policy. Roughly two-thirds of California insurers take part in CEA.

The CEA imposes no formal risk on California taxpayers, because it is required to purchase reinsurance (insurance for insurance companies) from private entities for all the risk it takes on. Most Californians, however, do not buy what the CEA offers. Only about 15 percent of California homeowners have CEA coverage, and for most it is relatively limited.

The following articles examine earthquake insurance and the California Earthquake Authority from multiple perspectives.

New Strategies for Dealing with Earthquake Hazard
This paper by Howard Kunreuther of the University of Pennsylvania examines the challenges facing society in reducing losses from future severe earthquakes.

Federal Reserve Bank of St. Louis Review: Why Do Private Markets for Catastrophic Risks Fail?
This article from the St. Louis Federal Reserve Bank asks two questions: Why do private markets for catastrophic risks fail, and should the government pick up the slack? It includes a discussion of the California Earthquake Authority.

Funding the Inevitable: The California Earthquake Authority Appears Ready for the Big One
This article from Best’s Review examines both the CEA and the Florida Hurricane Catastrophe Fund and finds the CEA to be better run and more fiscally sound.

Government Catastrophe Funds: An Idea That’s Bad for America’s Insureds
This policy paper from the RAA argues against all government catastrophe funds, including the CEA. The RAA also contends the CEA is not working to provide consumer coverage, with fewer homes being covered after its founding than before.

Catastrophe Insurance, Dynamic Premium Strategies, and the Market for Capital
This paper by Thomas Russell of Santa Clara University and Dwight Jaffee of the University of California-Berkeley examines non-insurability of catastrophe risk, with a special focus on questions surrounding the insurability of earthquake risks in California.

Should Society Deal with the Earthquake Problem?
This article from the Cato Institute’s Regulation magazine examines possible roles for government in responding to the potential damages from earthquakes.

III Overview: The California Earthquake Authority
This overview from the Insurance Information Institute examines the California Earthquake Authority, how it works, how it is funded, and the industry’s assessment of the authority.