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How Earthquake Insurance Policies Changed after the Northridge Earthquake

In 1994, Southern California was rocked by a 6.7 magnitude earthquake. The earthquake originated in the San Fernando Valley, with the city of Northridge as the epicenter. It devastated the surrounding areas – turning freeways to rubble, derailing freight trains, crumbling buildings, and sparking fires that covered entire cities with smoke.

The Northridge earthquake was so severe that it knocked out power, electricity, and prompted multiple airport closures. It left hundreds of residents instantly homeless, and many more without transportation when their cars were crushed by collapsing buildings. While most of the physical damage from the Northridge disaster has now been repaired, the event left a permanent impact on the insurance industry.

 

Life before the Northridge Earthquake

Earthquakes have occurred in every state, but Southern California is considered the most at-risk location in the country. SoCal had experienced strong quakes before Northridge, including the 6.5 magnitude earthquake of 1971. The disaster prompted officials to allocate state funding for earthquake-safe improvements to freeways and other structures. Unfortunately, those improvements would be no match for the 6.7 magnitude Northridge earthquake.

According to the Insurance Information Institute, nearly 29% of Californians had earthquake insurance in the years before the Northridge earthquake. The average cost of earthquake protection was roughly $400 per year. (Homeowners seeking a similar policy today will find that the price has quintupled over the last 25 years.)

 

The Immediate Aftermath

After the Northridge earthquake, insurance companies were overwhelmed by the claims they faced. Losses from the quake triggered payouts totaling over $20 billion dollars. (To put this number in perspective, insurers paid more for those repairs than they collected in premiums over the preceding 80 years.)

Following this enormous financial setback, nearly 95% of insurance providers pulled out of California entirely. After decades of underestimating potential losses, the companies didn’t want to risk another disaster. But, why did they leave completely instead of withdrawing only earthquake-specific coverage?

 

The (Temporary) Death of Homeowners Insurance

Unless you were a practicing insurance adjuster in the 1990s, you’re probably unfamiliar with California Insurance Code §10081. The law states:

No policy of residential property insurance may be issued or delivered or, with respect to policies in effect on the effective date of this chapter, initially renewed in this state by any insurer unless the named insured is offered coverage for loss or damage caused by the peril of earthquake as provided in this chapter.  That coverage may be provided in the policy of residential property insurance itself, either by specific policy provision or endorsement, or in a separate policy or certificate of insurance which specifically provides coverage for loss or damage caused by the peril of earthquake alone or in combination with other perils”

We know that legalese can be dense and confusing to read, so we underlined the most important clause of Code §10081. Essentially, it was a law enacted in 1984 which required insurance providers to offer earthquake coverage in addition to homeowners insurance.

After the Northridge earthquake, insurance providers were substantially more risk-averse. In fact, earthquakes were generally deemed ‘uninsurable’. Feeling that they’d been backed into a corner, insurance providers chose not to write any new homeowners’ policies in California, rather than being forced to offer earthquake coverage.

The State’s Solution

With homeowners insurance all but unavailable, the housing market suffered greatly. To address the crisis, new legislation was passed to form the California Earthquake Authority (or CEA). The goal of the agency was to standardize earthquake insurance coverage and assume the majority of the financial risk. By limiting their obligation to cover earthquake damage, the state was able to entice private insurance providers to return to California.

The California Earthquake Authority is a privately funded,  publicly managed nonprofit organization. Their cash reserve is estimated to contain sufficient funds for two Northridge-sized earthquakes. If the reserve is completely emptied, then private insurance companies would be required to fill in the gaps. (To learn more about the CEA, check out our article on the topic!

Modern Earthquake Insurance: Explained

Now that you’ve learned about the history of earthquake insurance, it’s probably a bit easier to understand the state of the industry. Companies now utilize “risk-based” pricing, which has resulted in higher premiums. While some families choose to purchase additional protection, many forgo earthquake insurance altogether. In fact, according to the Insurance Information Institute, less than 10% of Californians have earthquake insurance today.

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