Homeowner Insurance - Do You Need Earthquake Insurance?

Imagine driving up to your home and finding nothing but a mass of wreckage. Could you afford to repair or rebuild your home? For the vast majority of homeowners, the answer would depend on the cause of the damage. If the devastation was the result of fire, wind, explosion, or an automobile accident, then the cost of repair would be covered by standard homeowner insurance, which most lenders require homeowners to have until the mortgage is paid off. If the damage was caused by an earthquake, however, the answer could be quite different. Standard homeowners insurance covers some damage caused by earthquakes, but not all. The only way to be certain that the damage would be covered would be to carry earthquake insurance.

More than 5,000 earthquakes occur in the United States each year. Most hit the West Coast, but since 1900, earthquakes have struck in 39 different states, causing damage in all 50. The Federal Emergency Management Agency reports that earthquakes cause $4.4 billion in property losses each year, ranking just behind floods ($5.2 billion in losses), hurricanes ($5.4 billion in losses), and fires ($8.6 billion in losses).

Earthquakes cause damage in two ways: directly, through earth movement, or shaking; and indirectly, by triggering other destruction. Roughly half of all earthquake damage is due to shaking. The other half is due to indirect damage, such as when natural gas leaking from a broken line ignites and starts a fire, for example, or when water flooding out of a broken pipe destroys walls, ceilings, or personal property. Indirect damage is covered by traditional homeowner’s insurance. Damage due to shaking, however, is not.

The motion of an earthquake can cause serious damage to a home. Brick and stone structures such as chimneys, fireplaces, and walls are particularly vulnerable to shaking. Tile work also is at risk. Many homes, especially in the western states, are built on concrete slabs. The shockwaves of a powerful earthquake cause the ground to undulate, cracking the slab. Foundations are also susceptible to cracking and shifting. Even if the home is left standing, it might be “red tagged,” or condemned as unsafe for habitation. In extreme cases, the house might have to be torn down and the foundation repaired or replaced.

A strong earthquake can wreak havoc with personal property as well. The movement of walls and cabinets can send expensive electronics crashing to the floor. Artwork and photographs can become dislodged and fall. Sculptures and glassware can fall over and break. Many homeowners take care to secure loose objects, but if a cabinet or entertainment center collapses, the contents likely will be damaged.

Insurance against earthquake damage is available as an endorsement to an existing home owner insurance policy or as an entirely new policy. Insurance companies stopped writing earthquake insurance in California after the 1994 Northridge quake, but the state legislature stepped in and passed a law requiring property insurance companies doing business in California to offer earthquake insurance on a limited basis through the California Earthquake Authority (CEA). Through a combination of private premiums, taxpayer support, and sound investments, the CEA has a fund of more than $8 billion to pay out claims, should a major earthquake strike. To limit the cost of claims, the CEA-backed policies cover dwellings only, not pools, fountains, patios, or decks. Restricted to living spaces, these policies often are referred to as “mini-policies.”

Rates for earthquake insurance vary widely, depending on a home’s location, age, and construction type. For obvious reasons, homes located near fault lines cost more to insure than those further away. Older homes cost more to insure than newer ones because they have fewer earthquake-resistance designs and because the materials used to build them lose their flexibility over time. For example, 40-year-old lumber will be drier and more likely to crack than lumber that is only a few years old. Similarly, brick homes cost more to insure than wood-frame homes, because masonry is less flexible than wood and less able to “roll with the punches.”

Earthquake insurance deductibles are calculated as a percentage of the home’s replacement cost. Deductibles range from 2 to 20 percent of the replacement cost. The higher the deductible, the less the insurance company pays in losses, so the lower the premiums. Many homeowners accept a higher deductible in order to keep their premiums low. Opting for a higher deductible can be risky, however. For example, a 20 percent deductible on a home that costs $300,000 to rebuild would mean that the homeowner is picking up $60,000 of the costs. When most homeowners think of paying tens of thousands of dollars for something, they often think of tapping into their home equity. The problem with paying for earthquake damage is that the home equity will be wiped out along with the house. A home with $60,000 or more in damage will not be worth as much as it was before the quake.

Homeowners with high deductibles will be out a lot of money, but those without insurance will be out even more. Not only will they have no home equity, they will have no insurance benefits to pay for repairs or reconstruction. They will, however, have a mortgage to pay. The chances of being hit by an earthquake may be slim, but the financial exposure is great—too great to ignore the protection afforded by earthquake insurance.