Earthquake Insurance Idea Would Further Rattle California’s Finances
Given California's $26 billion budget deficit, it's disheartening to find that U.S. Senators Barbara Boxer and Dianne Feinstein, both of California, have proposed a new federal law, the Earthquake Insurance Affordability Act, that could force the state to take on even more debt.
This proposal, intended to help the state's semi-public earthquake insurer, the California Earthquake Authority, or CEA, can't possibly work as advertised and would deepen the problems that the already strapped state would face after a big quake. Quite simply, it's a bad idea.
Some background first. The CEA is a government-run, privately funded entity that writes the earthquake insurance for most California homes that have it. By all accounts, it's currently capable of paying whatever claims come its way without costing taxpayers a penny.
Government to Absorb Debt
Because CEA's management and many politicians believe not enough Californians have earthquake insurance, however, they're pushing for laws that would require the federal government to absorb some of CEA's debt. Such guarantees, they say, would lower CEA rates. This, they say, would increase earthquake insurance purchases at almost no risk to taxpayers.
The effort cannot possibly work as advertised. Here's why: Particularly when insuring against major catastrophes, insurers—even quasi-governmental ones like CEA—buy international reinsurance (insurance for insurance companies) that can pool quake risk in California with the risk of floods in the United Kingdom and cyclones in Australia. Because these events won't happen at the same time, reinsurers can make profits in one area even when they pay big claims in another.
Risk Concentrated in U.S.
By relying on the federal government, however, CEA's risk will be concentrated in the United States. Thus, to break even, the U.S. Treasury will have to charge more for its guarantees than the private sector does now. Otherwise the program will end up systematically underpricing coverage and then try to make up the difference by raising rates on CEA policyholders after a big quake.
But even this won't work: It will make insurance a lot more expensive and, thus, lead many people to drop their CEA policies post-disaster. California taxpayers would almost certainly end up on the hook for the CEA's bills just as taxpayers in Florida and Mississippi have had to bail out similarly structured insurers in those states after their own mega-disasters.
Insurance Sales Decline
All that said, the problem the senators seek to confront—low earthquake insurance takeup rates—is real. In 1994, more than a quarter of Californians had earthquake insurance; today, only 11 percent do. But the government doesn't need to take over the market for that to improve.
Efforts to retrofit older buildings against quakes—most newer ones are highly resistant to quakes already—can reduce the need for insurance in the first place. In addition, federal policies that make it nearly impossible for lenders to require borrowers to secure earthquake insurance need to change. Nobody should be forced to buy earthquake insurance, but the government has no business stopping lenders from protecting their own investments.
Whatever members of California's Congressional delegation do, they need to recognize that the Boxer-Feinstein proposal is a bad deal for taxpayers.
Eli Lehrer (firstname.lastname@example.org) is a Heartland Institute vice president and runs Heartland’s Center on Finance, Insurance, and Real Estate.