It’s California’s Fault

It’s California’s Fault

Satyen Paneri

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On a recent plane ride back home from a customer visit, I watched the movie San Andreas. Almost instantly my thoughts went back to few weeks ago when I was awakened around 2:45am by a 4.0 quake. The epicenter was about 8 miles deep but only about 1 mile away on the ground from where I live. Nevertheless it was powerful enough to wake me up. I also remember feeling a minor aftershock a few minutes later. Back home in India a few years ago, I recall the great rumblings of 7.x+ quakes in 2001 and 1993. Not to mention the devastating April 2015 Nepal quake that altered the height of Mount Everest. Guidewire organized an amazing response to this recent natural disaster with fundraising efforts. A few of our brave development colleagues also travelled to Nepal for a month to help with relief efforts on the ground. With a different geology compared to that in California, these quakes are more rare but generally strike with a higher magnitude.

San Andreas is California’s fault. An event of the magnitude shown in the movie would be extremely rare but not impossible. Such an event would be a Black Swan Event, a term and theory coined by Nassim Nicholas Taleb’s bestseller – The Black Swan: The Impact of the Highly Improbable. A Black Swan Event is characterized by three attributes. First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme 'impact'. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable. An example of a Black Swan Event was the financial crisis of 2008. A large-magnitude earthquake would cause extreme damage and possibly split the state of California into two would be classified as a Black Swan Event. I tend to think that such an event happening is not a matter of ‘if,’ but ‘when’.

My home is my primary asset, and following my recent ‘awakening’, I now have earthquake insurance. Of course, prior to purchasing such a policy, I did my research and talked with friends and family. In general, what I found was that less than 20% of homeowners in California have earthquake insurance. There are several well-known reasons for this. First, it’s quite expensive; the cost/benefit analysis does not work out. Second, many people tend to think that an event which would completely destroy their home is impossible, which speaks to precisely the third characteristic of a Black Swan Event. I should also mention that I learned that, in such events, the federal government is not going to help rebuild my home.

I added the earthquake coverage on my homeowner’s policy from California Earthquake Authority (CEA) – a Guidewire customer. CEA has a very nice premium calculator that gives you an immediate quote by providing a few details about your home. You can select a deductible of 10% or 15%; you can increase the building code upgrade coverage; and include (or exclude) personal property and loss-of-use coverage. You can also purchase earthquake insurance from other carriers, and they all have similar parameters to generate a quote. My annual earthquake premium is roughly 1.5 times my annual homeowners premium. It is expensive, comes with a 15% deductible, and I hope I never have to use it. What do you think? Am I making a mistake by purchasing earthquake insurance?

Earthquake insurance is neither mandated nor highly marketed by insurance companies. This could be due to various reasons, but technology has also not yet advanced to a stage where earthquakes can be reliably predicted. In the meantime, are there some options to increase adoption of earthquake insurance for California residents? One thought is what if there were policies offered with different combinations of coverage. People can start with a 90/10 policy where 90% of loss is covered. As a family’s net worth increases, they change to an 80/20, 70/30, or even a 50/50 policy. The lower the coverage, the lower the premium. This works similarly to term life insurance policies. I only need to have term life coverage until my net worth is not sufficient enough to provide for my family in my absence. Once I cross that individually-defined threshold, I no longer need term life insurance. Similarly, as family net worth increases, premiums can go down, eventually reaching a point where earthquake insurance is no longer required.

I am neither an insurance nor a risk management expert and my suggestions above might be completely unrealistic. What are some other options to share this risk and provide better protection for property?

I was quite surprised to learn that less than 20% of California’s residents have earthquake insurance. Until technology improves to accurately predict earthquakes and enable premiums to be cost-effective, it might be prudent to examine alternatives. Living in this beautiful state and not having protection against one of the major hazards should not be California’s fault.