I'm not clear how a CEA policy makes financial sense for a standard single-family, owner-occupied house. The only affordable plans have massive deductibles and only partial cost coverage. If "the big one" hits, it's likely that:
(a) CEA will quickly run out of money and I won't be covered anyway.
(b) The whole community will be ruined so assuming all of my family is still alive we'd best move somewhere else anyway (and a rebuild or undamaged house wouldn't sell).
(c) Some kind of government bailout or community help program will be available.
For smaller earthquakes, it's likely I'd either fail to meet my deductible or be unable to pay the non-covered portion (which has to be paid out first before they'll begin to pay for further repairs).
Am I wrong, or is there something I'm missing? I wish this weren't the case.
Different country, but for the Christchurch earthquake in 2011:
- our equivalent of CEA (EQC) did indeed run out of money, although it’s mostly reinsurance and govt backed
- insurance companies went under, because even for a small city (400k), costs ran to $40 billion
- it’s now very very expensive to get earthquake coverage, in some parts of the country you are paying multiples of what less earthquake prone parts of the country pay, so people don’t bother. so they’ll lose everything next time, and we’ll foot the bill as a country
Scale of California probably means amplification if these effects, hundreds of billions in losses.
> CEA will quickly run out of money and I won't be covered anyway.
I don’t understand why insurance companies can run out of money whenever they need to pay claims. I’m sure they know they’re going to go under, why can’t they get insurance on themselves?
Most insurance works on the basis that we have some underlying risk (probability) and resulting cost (multiplied together gives us the expectation) of annual payout. A lot of these funds however are financed through CAT bonds [1]. The idea of CAT bonds is that the sort of financial business cycle (a la 2007/8 housing market crash) are decorrelated enough with other financial movements that you "shouldn't™" both have a bad natural disaster and a sudden shift in the business cycle. However, a lot of these insurance companies are then further reinsured with specific contractual limitations so that ideally the fund won't run out.
In the real world, the government can act as insurer of last resort and use tax dollars to with financing (though these usually are ideally set up with the initial fund).
Insurers often issue reinsurance for/with each other.
Both insurers and general reinsurance firms will some times sell their risk to investors (in the capital markets) through vehicles such as Insurance Linked Securities. An ILS provides one form of risk transfer. There are others.
In both cases, if the risk is tied to say, catastrophe insurance, then this offers (investors) returns uncorrelated with the stock market.
What’s the incentive to purchase insurance? It will reduce their profits. If you are an executive of a company offering earthquake insurance, better to just keeps profits high now, make a high salary, and when the big quake hits, declare bankruptcy and walk away.
they're much more sophisticated than that. they'll do things like say the damage was caused by wind, not water. they'll influence forecasters to call it a "super-storm" instead of a hurricane, and for an earthquake, something equally creative:
- the building was defective/you didn't have it inspected by our experts, so maybe the foundation already had cracks from the last EQ, in that case we can't pay the claim
- insurance only covers up to 5.0/6.0
- although it was reported as a 7.5, you live 4 miles away from the epicenter, meaning the EQ was likely below a 6.0, in which case your policy doesn't kick in/we'll only pay 30% of your claim
- the EQ cracked a water main/gas line, and most of the damage to your house is from the flood/fire, which isn't covered under EQ policy. try suing the insurance of the utility company.
- we determined that fracking is likely the cause of this quake, in which case it's manmade and not covered. you can sue the oil company though.
- we checked the seismometer and we dispute the USGS reporting that it was a 6.0/7.0/8.0/our geologist has published research saying that current methods of measuring earthquakes are in question. so although we don't need correct science to collect your premium, we do need perfect science to pay any claims. Or if you settle now, we'll pay 40% of your coverage or else you can try to sue us and maybe get paid 10 years from now
- we don't cover the specific region where all the earthquake damage occurred/that requires a different policy
- we only cover incidental/secondary damage, like clocks falling off the wall (which, of course, you must have a receipt for and will be paid minus depreciation and deductible). your policy doesn't cover utility line damage, structural damage, or earth-moving damage.
They'll take a hit in their ratings if they do. Insurance companies are rated by independent analysts such as A.M. Best, Moody's, and Standard and Poor's. Customers, especially large customers, research issuers before purchasing insurance, and a poorly-rated company is likely to get fewer customers.
Some risks are just uninsurable, even for countries. Large scale flooding and earthquake damage caused so much loss that no one can afford to pay for it. The US is lucky it can issue debt cheaply.
(a) CEA will quickly run out of money and I won't be covered anyway.
(b) The whole community will be ruined so assuming all of my family is still alive we'd best move somewhere else anyway (and a rebuild or undamaged house wouldn't sell).
(c) Some kind of government bailout or community help program will be available.
For smaller earthquakes, it's likely I'd either fail to meet my deductible or be unable to pay the non-covered portion (which has to be paid out first before they'll begin to pay for further repairs).
Am I wrong, or is there something I'm missing? I wish this weren't the case.