The California Earthquake Authority (CEA) is a not-for-profit, public-private partnership that offers earthquake insurance to residences throughout California. Their offerings include policies for renters or owners of single-family homes, condos, mobile homes, and buildings of up to four units. The CEA insures more than 800,000 policyholders, which represents about 70% of those in the state who choose to buy earthquake insurance. However, only 12% of California households actually buy coverage.
Since the 1980s, California law has demanded that insurance companies which sell homeowners’ insurance make earthquake insurance available to those homeowners.
On January 17, 1994, a 6.7 earthquake centered in the San Fernando Valley struck Los Angeles County. Financially, the so-called Northridge earthquake was one of the nation’s biggest natural disasters. Insured residential losses topped $12 billion. Overall, the tab came to $44 billion, making it the costliest earthquake in U.S. history. Insurance companies lobbied to get the mandatory earthquake insurance law changed and when they failed, many companies simply stopped selling insurance in the state. Their position was that the required offer of earthquake insurance carried such large potential risks that they would rather not sell homeowners’ insurance to Californians at all.
Within a year of the Northridge earthquake, 93% of the state’s homeowners had been affected. They could either not buy insurance at all, or found that their homeowner policies were severely restricted in coverage. In response, the state Legislature created a reduced-coverage earthquake insurance policy for homeowners which covered the home, but excluded swimming pools, patios, and detached structures—a no-frills “mini-policy.” Once the state made this available, major homeowners’ insurance companies returned to the state and participated in the California Earthquake Authority.
In December 1996, the CEA began selling policies. Private insurer contributions provided the initial seed capital. Eighteen months later, the CEA became the world’s largest residential earthquake insurer. By 2010, the CEA wrote 70% of all such policies in the state. Still: in 2012, only an estimated 12% of California’s households are insured against earthquakes.
In 2010, CEA took steps to reduce its largest expense: reinsurance. Because the cost of covering damages from a devastating earthquake might be too much for even the well-financed CEA to absorb, it uses reinsurance agents to spread its risk among vastly larger capital markets. About one-third of the Authority’s $9.4 billion claim-paying capacity is through reinsurance, but its cost is prohibitive. The CEA spends about 40% of the money it receives as premiums from Californians to pay companies to secure the financing. In August 2010, CEA took a more direct path by entering the capital markets itself and cut out the middleman.
History (CEA Website)
Standing on Solid Ground (by Robin Jones, Westways Magazine)
California Earthquake Authority Completes Landmark Deal (CEA website) (pdf)
California Earthquake Authority Completes $150m Embarcadero Re Catastrophe Bond (ARTEMIS)
The CEA is a publicly managed and largely privately funded organization selling earthquake insurance to California residents. It also educates the public about earthquake preparedness, risk and potential loss with publications and widely-distributed earthquake preparedness handbooks.
The CEA sells earthquake insurance to more than 800,000 Californians: homeowners, condominium and townhouse owners, renters, and owners of mobile homes, and individually-owned residential structures of up to four units. Owners must already have a property insurance policy before they can buy earthquake insurance. Currently, 19 insurance companies participate and an up-to-date list of these with contact information can be found on the CEA website. These companies—and only these companies—sell CEA policies, process applications, changes, policy renewals and payments and handle all claims. About 70% of the earthquake insurance sold in California is sold through the CEA.
Three contracted employees, and their staff, manage the CAE’s daily business: the chief executive officer, the chief financial officer, and the operations manager. These three employees report to the Governing Board, which is credited as the real management of CEA. The board is made up of the state’s governor, treasurer, insurance commissioner, Speaker of the Assembly and chair of the Senate Rules Committee. Of these, only the first three officers may vote. An 11-member advisory panel advises the governing board on certain matters; the panel is composed of appointees. Six are named by the governor, three by the Insurance Commissioner, and one each by the Speaker and the Senate Rules Committee chair. The Insurance Commissioner is a non-voting member of this panel.
About the CEA (CEA website)
At a Glance (CEA website) (pdf)
Testimony of Glenn Pomeroy before the House Committee on Financial Services (CEA website) (PDF)
The California Earthquake Authority does not have the wherewithal to pay off insurance policies should a disaster occur. Instead, it relies heavily on reinsurance obtained in the marketplace where it can transfer risk to trillion-dollar capital pools. The CEA cost of obtaining this coverage is enormous and consumes about 40% of the premiums it collects.
Over a 14-year period, CEA has collected about $6 billion in premiums and paid $2.8 billion for reinsurance. It is by far the largest expense incurred by the Authority on an annual basis.
CEA projected its 2012 expenses at $300.5 million and $200.5 million of that would be for “risk transfer.” Commissions account for $68.6 million, and investment, finance and participating insurer expenses cost $31.1 million. Contracted services like marketing, communications and legal gobble up $14.1 million, operating expenses cost $11.4 million and consulting fees cost $2.8 million.
The CEA is wholly outside the state budget. It draws its money from the premiums it writes and its investment returns. However, California law regulates how CEA funds are spent. No more than 3% of annual written premiums can be spent on operating expenses, for example. A pie chart view of its 2008 expenses is available on the CEA website, and shows that 10% of the CEA budget went to agent commissions. Fees paid to participating insurance companies accounted for 4%, and financing expenses took 3%. Purchasing reinsurance took over a third of the fund each year, at 34%. The capital retained for that year was 44%.
Since the CEA has grown its capital each year, its claims-paying capacity is nearly $10 billion.
Financial Strength (CEA website)
California Earthquake Authority Balance Sheet as of January 31, 2012 (pdf)
California Earthquake Authority Insurance Services Proposed 2012 Budget (pdf)
90% of California Residences Aren’t Insured
In the late 1990s, when the CEA was new and the memory of the Northridge earthquake relatively fresh, CEA insurance covered around 940,000 California homeowners. Today, that number has dropped to just over 800,000, or about 12% of insurance-buying homeowners. Why?
Earthquake insurance policies “are expensive and impose big deductibles, meaning that policyholders won’t receive a cent unless a house suffers damage equal to 10% to15% of its insured value,” said the Los Angeles Times in a 2011 editorial on Senate Bill 637 (see Reforms). To Los Angeles residents, “that means paying more than $1,000 annually for a policy that doesn’t cover the first $27,500 in losses. An earthquake would have to be pretty severe to wreak that much havoc.”
In January 2012, the CEA reduced premiums statewide by about 12.5%. “The average CEA earthquake policy currently costs about $840 per year, so the average premium will decrease by about $100,” according to Westways Magazine, a publication of the Automobile Club.
Robin Jones of Westways interviewed the CEA CEO, Glenn Pomeroy, who said that “most homeowners policies totally exclude damage caused by shaking from an earthquake. . . . The federal government may provide disaster assistance with low-interest loans and other types of assistance, but they won’t come in and rebuild homes after an earthquake.”
That appeal to practicality may not sway everyone. An article in Insure.com suggests a psychological reason why people don’t buy earthquake insurance. “Human beings are hardwired to believe in their heart and soul that disasters don’t happen and won’t happen to them,” the article quoted researcher Dennis Mileti and others to explain why “the decision to forgo earthquake insurance has as much to do with psychology and biology as with economics.”
Evolutionary biology professor Jay Phelan said, “Our brains developed to handle the risks we faced as small groups of hunters and gatherers and weren’t designed to wrap themselves around concepts such as earthquake risk, a rare event and one that primitive people couldn’t do anything about anyway.
“You’re asking us to solve a problem we’re not built to solve.”
Maybe the CEA should be hiring psychologists.
Affordable Quake Insurance (Los Angeles Times)
Standing on Solid Ground (by Robin Jones, Westways Magazine)
Why Won’t Californians Buy Earthquake Insurance? (by Barbara Marquand, Insure.com)
Should Earthquake Insurance Be Required for California Homeowners?
“A lack of earthquake coverage isn’t just California’s problem. With its economy among the top 10 largest in the world, California’s uninsured property losses after an earthquake would send shock waves throughout the country.” That’s the opinion of Insure.com, raising the question, should people be forced to buy insurance?
In New Zealand—another earthquake-prone area—quake insurance “is compulsory attachment to fire policies, and has been underwritten by the earthquake commission since it was created in 1945,” reported Meg Green at BestWeek. In her article she quoted Howard Mills, chief adviser to Deloittes Insurance: “In American society, there seems to be an expectation that when something bad happens, the government will bail us out. . . . But the message and the lesson should be that the rest of the country will not foot the bill for those who live in these zones and are irresponsible.”
Even before the 1994 Northridge earthquake, the Cato Institute produced a report questioning how American society should deal with earthquakes. After pointing out that most California homeowners do not try to mitigate the risks or buy insurance, the report said, “the vast majority of the population is not located in earthquake-prone areas. If the past is any guide to the future, then all taxpayers will help to pay for the uninsured losses of victims through some form of disaster assistance or low-interest loans.”
Why Won’t Californians Buy Earthquake Insurance? (by Barbara Marquand, Insure.com)
Earthquake Insurance, Viewed as Expensive, Unpopular in US Despite the Risk (by Meg Green BestWeek)
How Should Society Deal With the Earthquake Problem? (by Howard Kunreuther, Neil Doherty and Anne Kleffner, Cato Institute) (pdf)
The CEA has found a new funding source. In 2011, the CEA signed a $150 million reinsurance contract with Embarcadero Reinsurance Ltd. Embarcadero, with the help of Deutsche Bank, sold the amount in three-year cat bonds to 25 investors. Proceeds were placed in a collateral trust account that CEA can access if needed (in other words, if there is a major earthquake in California) for insured losses. The program was so well received that the CEA plans to tap capital markets regularly, every four to six months.
On the federal level, HR 3125—or the Earthquake Insurance Affordability Act—would allow the federal government to guarantee bonds issued by state catastrophe insurance program. The bonds would be used instead of purchasing reinsurance, a much costlier method of paying for earthquake damage. A similar Senate bill, S 637, is also being debated.
CEA CEO Glenn Pomeroy said the bill would save his agency over $100 million annually and cut reinsurance needs in half. Two-thirds of the nation’s earthquake risk is in California. Other groups call the bill a special favor for the CEA, and say it could make taxpayers responsible for billions of dollars in losses, or that it interferes with the private market. HR 3125 is currently before the House Subcommittee on Insurance, Housing, and Community Opportunity. Its Senate counterpart has been read twice and is now before the Committee on Banking, Housing, and Urban Affairs.
Update: CEA’s CEO Says Cat Bond Diversifies Authority’s Claims-Paying Capabilities (A. M. Best Company)
CEA Chief Pomeroy Defends Quake Backstop Bill Against Criticism it Would Hurt Private Market (by Sean P. Carr, A.M. Best Company, Inc.)
Bill Summary & Status, 112 Congress (2011-2012, H.R. 3125 (Library of Congress)
Bill Summary & Status, 112 Congress (2011-2012, S. 637 (Library of Congress)
California Earthquake Authority Completes Landmark Deal (CEA website) (pdf)
California Earthquake Authority Completes $150m Embarcadero Re Catastrophe Bond (ARTEMIS)
Two bills are before the U.S. Congress: S 637 and HR 3125 (both called the Earthquake Insurance Affordability Act). Both would establish a program to provide guarantees for debt issued by state catastrophe insurance programs to help recovery from earthquakes, volcanic eruptions, and tsunamis.
Bill Summary & Status, 112 Congress (2011-2012, H.R. 3125 (Library of Congress website)
Bill Summary & Status, 112 Congress (2011-2012, S. 637 (Library of Congress website)
These Bills Are Terrible and Should Be Thrown Out!
Eli Lehrer of the Heartland Institute said that HR 3125, introduced by California representative John Campbell, “is among the very worst ideas introduced in the current Congress—and that’s saying a lot. It would cost taxpayers billions of dollars, displace a productive private industry, and do nothing to make California consumers safer. One really has to wonder what Rep. Campbell is thinking by forwarding such a terrible idea.”
Lehrer was specific in a Weekly Standard article, acknowledging that, “The problem the bill seeks to confront isn’t trivial, and nobody who has taken a serious look at the issue believes that Californians now buy enough earthquake insurance.” But the bill “can’t possibly work as advertised since it egregiously violates the risk-pooling principles at the heart of insurance. When they’re underwriting almost any type of large risk, insurers (including CEA) buy reinsurance to spread their risks around the world. Private reinsurance might pool the risks of a quake in California with, for example, the risks of a flood in Germany and an industrial accident in Brazil. Because the events will almost never happen at the same time, reinsurers can make profits.” The bill before Congress “would concentrate risk in the United States under the aegis of federal guarantees.”
“The solution, therefore, isn’t a new federal liability but measures that would encourage homeowners to take responsibility, rather than assume an eventual taxpayer bailout.”
“A prefunded bailout,” is how the FrumForum blog characterized HR 3125. “It’s difficult to overstate how bad an idea this bill is and how much damage it could do to the country.” In order to break even, “the federal government will have to either charge more than the private sector [for earthquake insurance] which defeats the purpose . . . or under-price its coverage on an ongoing basis and leave taxpayers holding the bag.”
FrumForum compares the latter scenario to what happened with the National Flood Insurance Program, which “was also promised to break even when Congress created it but currently has run up debts of over $17 billion that it has no way of paying back.”
Campbell Earthquake Bill a Terrible Idea (by Eli Lehrer, Heartland Institute)
A Beverly Hills Bailout? (by Eli Lehrer, Weekly Standard)
Rep. Campbell’s Terrible, Horrible, No Good, Very Bad Bill (by David Frum, FrumForum)
Earthquakes Are Not Just California’s Problem; These Bills Benefit All
“Earthquakes pose a significant threat to 75 million Americans in 39 states,” reads the headline at the Earthquake Insurance Affordability Act (EIAA) website. “EIAA will significantly decrease the cost of earthquake insurance—making it affordable for more Americans living with the day-to-day threat of a damaging earthquake.”
Most Californians don’t buy earthquake insurance because it’s so expensive, and the reason the insurance is pricey is that the CEA “is required to amass enough reserves to meet the claims that would be likely in a once-in-500-years disaster,” wrote the Los Angeles Times in an editorial. To meet that requirement, the CEA “spends more than $220 million a year—40 cents of every premium dollar—buying an extra layer of insurance from a third party.” The proposed bill provides a “low-cost alternative to commercial reinsurance,” which will lower the rates on earthquake insurance. The bottom line to the Times is that “all federal taxpayers will be on the hook to help the uninsured if California is hit by a temblor . . . the more people who have insurance coverage, the better off everyone will be.”
Talk show host Eric Hogue claimed that passage of the EIAA “would allow the CEA to save $100 million in reinsurance expenses each year. These savings would go directly to CEA policyholders, dropping their premiums by as much as 20 percent. . . . The Earthquake Insurance Affordability Act is a fiscally sound solution that will help families recover and rebuild without federal subsidies. Preliminary estimates by the nonpartisan Congressional Budget Office conclude that its cost to the federal government and taxpayers is zero. Compare that to the fact that federal taxpayers were on the hook for more than $9.5 billion after the Northridge quake.”
Can We Recover? (Earthquake Insurance Affordability Act website)
Affordable Quake Insurance (Los Angeles Times editorial)
Quake Near D.C. Can Help Us Prepare for the “Big One” (by Eric Hogue, Sacramento Bee op-ed)
Tim Richison, 2007-2008 (interim)
Elaine Bush, 2002-2007. Bush, the longest-serving CEO thus far, left the CEA when Governor Arnold Schwarzenegger appointed her Chief Deputy Director of the California Department of Mental Health.
David Knowles, 1998-2002. Knowles, a former Assemblyman who received money in campaign contributions from insurance companies, was a controversial choice for CEO. He was chosen by the governing board in the closing days of Republican Governor Pete Wilson’s administration. Although he signed a four-year contract, he resigned almost a year early after a closed-door meeting with the board.
Gregory Butler, 1996-1998. The founding CEO of the CEA, Butler set up the agency and all its policies, operational procedures, reinsurance placement, and more. When he left CEA, he joined another new enterprise: ICAT, an insurer of small and middle market businesses in hurricane and earthquake-prone regions of the U.S.
- Table of Contents
- Overview
- History
- What it Does
- Where Does the Money Go
- Controversies
- Suggested Reforms
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