Federal Role in Catastrophe Insurance Would Increase Earthquake Coverage

A proposal for the federal government to support state-run catastrophe-insurance programs would increase the number of people buying earthquake coverage in California and modestly lower both uninsured losses and government assistance following a major quake, a new study has found.

Only about 12 percent of insured households in California currently have earthquake insurance, which means that a large portion of property loss would be uninsured following a major earthquake.

In an effort to increase the availability and affordability of insurance for catastrophic events, federal legislation was introduced last year that would authorize the federal government to guarantee private market loans to state catastrophe-insurance programs to help them pay claims following a major disaster.

Supporters of the Catastrophe Obligation Guarantee Act say that by lowering insurance costs, the act would spur more households to buy catastrophe coverage, decrease uninsured losses following disasters and decrease demand for federal disaster assistance.

The California Earthquake Authority, the state’s catastrophe-insurance program that would qualify for federal loan guarantees, asked RAND and Risk Management Solutions, a provider of catastrophe risk-modeling services, to estimate the effect of the legislation on losses following an earthquake.

“While catastrophe obligation guarantees could substantially reduce earthquake insurance costs in California, they would ultimately have a modest effect on decreasing uninsured losses and reducing the amount of disaster assistance spending.” said Tom LaTourrette, lead author of the study and a senior physical scientist with RAND, a nonprofit research organization.

The study predicts that lower premiums will produce a 13.2 percent increase in the purchase of earthquake insurance from the California Earthquake Authority. But because a substantial portion of earthquake losses are expected to fall below policy deductibles, this increase in coverage would translate to less than a 1% increase in the amount of losses that would be reimbursed by insurance after an earthquake. Consequently, demand for disaster assistance would decrease by only by a small amount.

The cost of providing the loan guarantees in California is anticipated to be modest as well. When considering both the cost and the benefit from decreased disaster assistance spending, the net fiscal impact to the federal government is expected to be small.

Study co-author James N. Dertouzos, director of the RAND Institute for Civil Justice, said officials should consider other avenues for increasing earthquake insurance coverage, such as increased public education and marketing, and offering new earthquake insurance products that provide more-attractive options for consumers.

Preventing uninsured losses during a major earthquake affects more than just federal expenditures, Dertouzos said. Uncompensated disaster losses may have far-reaching economic impacts on families and communities, including depletion of individual savings, losses to lenders from widespread home mortgage defaults, local decreases in property values and property tax revenue, increased unemployment, decreased income tax revenue, and lower business investment and entrepreneurship. Few of these would be covered by disaster-assistance programs, so they would only be reduced by increased insurance coverage.

“This independent research from RAND relates homeowners’ earthquake insurance to federal disaster-assistance savings for the first time,” said Glenn Pomeroy, CEO of the California Earthquake Authority. “And increased earthquake insurance take-up is now clearly associated with additional and substantial benefits that support community resilience and recovery. We strongly believe a federal loan-guarantee program would allow both lower insurance rates and, consistent with points made in the RAND study, much-reduced deductibles and richer product choices as well.”

The study, “Earthquake Insurance and Disaster Assistance: The Effect of Catastrophe Obligation Guarantees on Federal Disaster-Assistance Expenditures in California,” was also authored by Christina E. Steiner and Noreen Clancy, both of RAND.

Research for the study was conducted by the RAND Institute for Civil Justice.