Insurers Seek to Further Curb Quake Coverage

With $12 billion in Northridge earthquake losses behind them and the potential for even worse losses ahead, insurance companies in California are grimly trying to pull back from the fault line.

After all but shutting down the market for new earthquake and homeowners policies and flooding the state Department of Insurance with applications for big rate hikes, insurers are focusing on the Legislature, where pending bills would shrink their exposure to future California earthquakes.

The effects of the industry’s retreat already are hitting home. Sticker shock from premiums that have doubled has stunned and angered homeowners, while would-be buyers are scrambling to find insurance and often settling for stripped-down coverage at luxury rates.

Such problems may be compounded on July 1, when the Federal Home Loan Mortgage Corp. (Freddie Mac), a key wholesale buyer of mortgages, begins requiring earthquake insurance on many California condominiums. The move could hamper condo sales and further squeeze insurance availability.

Consumer advocates accuse insurance companies of trying to fob off all their risk onto helpless consumers and the already overburdened state and federal governments.

“They will try to find a way to cancel every policy they have,” said Harry Snyder, co-director of Consumers Union in San Francisco, of earthquake insurers.

But industry representatives, for their part, say it does not do policyholders any good to force a carrier to insure against an event that ultimately will drive it out of business.

“How on earth we can expect some insurance company to be capable of paying multiples of what its capital is, is beyond me,” said Tom Hutton, president of Risk Management Solutions, a Menlo Park-based consulting firm that uses computer modeling to help insurers gauge earthquake risk.

American carriers cannot help drawing comparisons with their counterparts in Japan, where January’s 7.2-magnitude Kobe earthquake left more than 5,000 people dead and a quarter of a million homeless, yet left the Japanese insurance industry relatively unscathed.

Total damage from the Kobe quake is estimated at $110 billion, of which insurance is expected to cover only $2 billion. (Earthquake insurance in Japan is so expensive and restrictive that almost no one buys it.)

The year-earlier, 6.7-magnitude Northridge quake, by contrast, caused perhaps one-quarter as much destruction but hit U.S. insurers six times as hard.

The disaster nearly scuttled 20th Century Insurance Co., a large home-grown company, and caused a major financial ratings agency to downgrade ratings for units of State Farm Mutual Automobile Insurance Co. and Farmers Insurance Group, the nation’s largest and third-largest personal property insurers.

A Kobe-sized quake in Los Angeles today, insurance executives say, would put some of America’s biggest carriers out of business and throw the whole industry into turmoil. State Farm puts its potential loss in a 7.2-magnitude Los Angeles quake at $13 billion, or five times its Northridge loss.

Many California lawmakers, regulators, insurers and consumer advocates agree that the best way to cope with natural disasters is through a nationwide, risk-sharing pool that would cover everything from earthquakes to hurricanes to snowstorms and would be funded--under one proposal--by a mandatory surcharge on every homeowners policy.

Federal legislation to create such a pool has been pending for two years, but few political observers think it has enough momentum this session to divert Congress from its government-reform and tax-cutting agenda.

Absent a federal solution, insurers are fighting to slash their exposure in any way they can.

Out front is Farmers, seeking a controversial 174% increase in its earthquake insurance rates, with higher deductibles and sharply limited coverage. The proposal is such a departure from traditional coverage that Farmers officials acknowledged in recent administrative hearings that they were “pushing the envelope” of what the public might accept.

Under Farmers’ proposal, in the most extreme case, certain homeowners in the highest-risk areas could see annual premiums for $100,000 of coverage jump to $1,196 from $225 now. Moreover, the deductible would rise to $15,000 from $10,000, and the maximum payout in a total loss would drop to a flat $100,000, after the deductible, from the current $215,000 (including contents, exterior structures and alternative living expenses).

An administrative law judge last week tentatively disapproved the filing, but the ruling is incomplete and Farmers probably would appeal an adverse decision.

With Northridge losses of $1.7 billion, more than one-third of the company’s capital, “it’s a survival issue for us,” Farmers spokesman John Millen said.

Although Farmers has drawn the most fire, about 70 earthquake rate increases--many of 100% or more--have been approved since last fall by Insurance Commissioner Charles Quackenbush and his predecessor, John Garamendi. Just last Wednesday, Quackenbush signed a 65% rate hike for State Farm.

And earlier this month, Fireman’s Fund Insurance Cos., one of the last large carriers still writing new homeowners insurance in the state, announced restrictions that would shrink the number of policies it writes in Northern California by more than half. State law requires the provider of a homeowners policy to offer quake insurance as well.

Insurers aren’t the only ones trying to cut their losses.

Freddie Mac, the nation’s second-largest mortgage buyer, imposed its new quake insurance requirement because of projected loan default losses of up to $50 million on condos damaged in the Northridge earthquake.

Freddie Mac holds about one in six U.S. home loans, purchasing them from banks, savings and loans, and mortgage bankers. Its slightly larger rival, the Federal National Mortgage Assn., known as Fannie Mae, so far has not imposed any quake insurance requirement of its own.

The real estate industry fears that Freddie Mac’s new rule will make it harder to buy and sell condos in an already soft market.

Not only is the availability of insurance uncertain, but individual condo owners will be required to put their share of the deductible on deposit under the rule, adding thousands of dollars to the upfront cost of buying a condo.

The California Assn. of Realtors attacked Freddie Mac in a report last week, charging that the rule falls disproportionately hard on low-income and minority residents, for many of whom a condo is the only affordable route to home ownership.

The requirement “will severely affect the very people this federally chartered, quasi-governmental organization is supposed to be helping,” said Joel Singer, association vice president.

But Mark K. Stamper, Freddie Mac’s chief credit officer, responded that the swarm of defaults caused by the Northridge quake demonstrates that uninsured condo owners risk losing their dwelling and their entire investment--a more serious concern than affordability.

The insurance and real estate industries are pressing lawmakers for relief.

Last year, the Legislature adjourned without taking action on homeowners and earthquake insurance, apparently concluding that the predicted real estate crisis had failed to materialize.

But today, although there exists little evidence that the problem is crimping home sales, the annoyance level among consumers has definitely risen.

Even among the insurers still writing new homeowners policies, some are rejecting coverage for older homes, figuring that if the applicant demands earthquake insurance as well, an older home probably will suffer heavier damage in a quake.

For instance, a Riverside woman, who asked that her name not be used, has been on the brink of buying a 50-year-old house in Los Angeles for weeks. But almost every insurer has rejected her request for homeowners coverage, citing the building’s age and its lack of foundation bolts or other earthquake proofing.

Two carriers have offered to provide the coverage, the woman said, but their quotes--as high as $2,000--are up to four times what the seller is paying. “It’s ridiculous,” she said.

A bill now on the state Senate floor, sponsored by Sen. John R. Lewis (R-Orange), would repeal the California law requiring companies to offer earthquake coverage to their homeowners policyholders.

The only reason that insurers are refusing to write new homeowners coverage is that they fear taking on more earthquake exposure, proponents of the legislation say. “De-linkage” of homeowners and earthquake insurance would solve that problem immediately, they argue, and free up the market for the 70% of California homeowners who don’t want quake insurance.

The Lewis bill also would make it easier for insurers to refuse to renew earthquake coverage for existing customers. Wide-scale non-renewals would make the problem snowball, experts say.

Quackenbush, Gov. Pete Wilson and numerous legislators have said that they oppose de-linkage without some provision to make sure that earthquake coverage will remain available.

State Sen. Herschel Rosenthal (D-Los Angeles), chairman of the Senate Insurance Committee, is proposing a stand-alone earthquake insurance program through the California Fair Plan, the industry-sponsored high-risk pool for property insurance. The Fair Plan, under an emergency program expiring Sept. 30, now offers bare-bones quake insurance for consumers who cannot find it elsewhere.

Quackenbush also is floating the idea of a new earthquake program to be capitalized by contributions from insurers and by securities sold to the investing public.

Snyder of Consumers Union is skeptical that investors would be interested. He fears that the Legislature will pass de-linkage in exchange for vague promises of a stand-alone program. Then, if the program fails, “we’ll be left with no product for consumers.”

Snyder and others have been trying to craft a compromise under which the mandate to offer quake insurance would stay in place, but companies could sell no-frills coverage that would reduce their exposure yet not leave consumers naked in the event of a quake.

Such a “mini policy” might, for example, cover structural damage to the home but not replacement of contents or repairs to swimming pools, driveways or chimneys.

But with the de-linkage bill moving through the Legislature, the insurers have stopped negotiating, Snyder said.

Snyder said an insurance lobbyist told him that as long as the Lewis bill is alive, there’s no point in compromising.

Should the Lewis bill pass, Gov. Wilson will be on the spot to either veto it or hold out for definitive companion legislation to assure that earthquake coverage would still be available. Wilson has hinted at a veto of the Lewis bill, but has yet to take a formal position.