Novel Quake Insurance Plan Proposed

Insurance Commissioner Chuck Quackenbush on Thursday proposed a new state-run--but privately financed--earthquake insurance pool to supply coverage that California’s insurance industry is still too gun-shy to offer 18 months after the Northridge earthquake.

The bold but controversial legislative proposal would limit the insurance industry’s potential earthquake losses--something the industry has dearly sought since paying claims of more than $12 billion in the Jan. 17, 1994, quake, the second-worst insurance disaster in U.S. history.

But the plan also places homeowners at risk for hefty premium surcharges in the event of another major earthquake, an aspect that drew criticism from consumer groups.

The proposal amounts to a compromise effort to solve a problem that the Legislature has been struggling with for the past year. As Quackenbush admitted, his approach, which he terms a “public-private partnership,” has never been tried before.

Other states are watching the progress of Quackenbush’s plan, viewing it as a possible model for resuscitating insurance markets that have been KO’d by catastrophes ranging from hurricanes and floods to earthquakes and volcanic eruptions.

A major goal of Quackenbush’s plan is to free up the California market for homeowners insurance, which has all but dried up since last summer. Because of a state law requiring insurers of homeowners to also offer earthquake coverage, most carriers either stopped writing new homeowners policies or severely curtailed their sales.

With their earthquake exposure capped, Quackenbush predicted that companies would “come roaring back into the homeowners market and begin to compete again on price and quality.”

Under his plan, the new California Earthquake Authority would be capitalized with an initial $1-billion contribution from insurance companies and, in a novel idea, another $1.5 billion from private investors who would buy what amount to high-yield, high-risk IOUs.

Additional resources would be lined up to cover claims that exceeded the first $1 billion. Total funds available would be up to $12.5 billion.

Much of this extra cushion would come from an additional assessment on insurers, but--in the most controversial part of the plan--earthquake insurance policyholders would face premium surcharges if an earthquake were big enough to exhaust the first $6 billion of reserves.

And if the quake toll reached $8.5 billion, homeowners policyholders--even those without earthquake coverage--also would be on the hook for surcharges. By Quackenbush’s estimate, under a worst-case scenario, policyholders could end up paying surcharges of up to $50 a year for 10 years in a row.

The policies to be sold by the new authority would be stripped down compared to conventional policies: There would be a maximum of $400,000 in structural coverage for a residence, with a 15% deductible and limits of $5,000 for contents and $2,000 for living expenses while the home is being repaired.

Quackenbush said the limitations on the coverage--plus the fact that the authority would write only residential policies, not commercial ones--would mean that a quake as severe as Northridge would cost the fund about $4 billion, or about one-third of the actual toll.

Quackenbush’s approach, developed through discussions with legislators, consumer groups, seismic experts and Wall Street financiers, has never been tried. Officials in hurricane-battered Florida and Hawaii and in other states with major disaster exposure have expressed interest in the plan, the commissioner said Thursday.

Although Quackenbush has carefully lined up the support of key legislators, the proposal is no slam-dunk politically.

No sooner had Quackenbush released details of the plan than consumer groups began attacking it.

“It looks like the companies are putting up too little and the consumers are putting up too much,” said Harry Snyder, co-director of Consumers Union in San Francisco.

“It constitutes a multibillion-dollar hidden tax, including a tax on those that don’t want or need earthquake insurance,” said Robert Gnaizda, policy director of the Greenlining Institute, a San Francisco-based consumer advocacy group.

Insurance industry trade officials welcomed the plan and predicted that it would be embraced by most California insurers.

State Farm Mutual Automobile Insurance Co., the state’s largest carrier by far with about 25% of the earthquake and homeowners insurance market, promised to support the plan if it clears the Legislature in the form outlined by Quackenbush.

State Farm figures that under the proposal, its earthquake losses would be capped at about $1.6 billion, spokesman Bill Sirola said. That is well below the $2.5 billion it lost in Northridge and far below the $13 billion that company experts project as its maximum potential loss in a huge Los Angeles earthquake.

What happens if losses from a quake exceed the $12.5 billion provided for in the Quackenbush plan? He said the authority would pay claims on a prorated basis until its funds were exhausted.

After that, victims most likely would rely on federal aid, as they do now, Quackenbush said. The state treasury has no responsibility for any losses, he added.

Quackenbush, industry officials and consumer advocates stressed that the ultimate solution to California’s earthquake exposure is some sort of national disaster pool.

Although such a plan is pending before Congress, Quackenbush said House Speaker Newt Gingrich told him in a phone conversation Sunday that the legislation is going nowhere this year.

The most unusual part of Quackenbush’s plan is its reliance on Wall Street investors for a large part of the capital for the new authority.

Rather than be introduced as new legislation, Quackenbush’s plan is to be absorbed into other legislation that is before a Senate-Assembly conference committee.

Consumer Union’s Snyder called this approach “undemocratic” and called for a full set of hearings before the appropriate legislative committees. A Quackenbush spokesman said there is every intention for the plan to receive hearings before it comes to the House or Senate floor.