This is the second post in a two-part series.
In the last post, we saw that home damage is typically ‘all or nothing,’ and your fate depends on only a few factors.
Once you answer that, you might wonder how likely it is to ever see an insurance payout after a quake. Here I’m talking about conventional insurance, not Jumpstart’s automatic-payout approach, which will pay out regardless of physical damage.
There’s now a user-friendly and scientifically-credible app that helps with this calculation. With Temblor, you simply open the app, make any needed adjustments to the default location or other data about your home, and Voila! You see a break-down of your seismic risk – specifically, your chance of exceeding certain damage thresholds. It’s no coincidence that Temblor uses thresholds equal to common quake insurance deductibles: 5% and 15% of the replacement value. (and also 65%, which could be considered a ‘total loss’ requiring rebuild)
For my house in Oakland, Temblor got the location and the square footage (approximately) correct, and it uses a reasonable replacement cost ($300/square foot). It doesn’t know that the wall around our crawl space is retrofitted, so I adjusted the ‘Year Built or Retrofitted’ from ‘Before 1975’ to ‘After 1976.’
Conveniently, as I was writing this post, Temblor added a new feature describing the likelihood of receiving a payout from an insurance policy that has a 15% deductible. It tells me a 1 in 11 chance in 30 years, which is about 9%. Roughly, this is 0.3% chance per year (9% / 30 years). (This is not statistically precise, but it works for the sake of argument.) In other words, an earthquake policy on my house would pay out on average once in 300 years (1 / 0.3%).
Wait, what? We know the earthquake will happen, but there’s only a tiny possibility of a payout?
What about a smaller deductible, say 5%? From Temblor’s output chart, over 30 years I have a 6 in 10 chance of ‘no’ structural damage (I interpret this to mean less damage than a loss of $30,000, which would be a 5% deductible). So the chance of exceeding a 5% deductible is 40% over 30 years (100% minus 60%). Roughly, this is a 1.3% chance per year (40% / 30 years).
The next obvious question is, ‘Is this worth it’?
Continuing with the 5% deductible, I should then expect premiums to be about 1.3% of the potential payout. Using the CEA premium calculator, and a $600,000 rebuild cost, premiums at my house would cost about $3,000 per year. From this I can infer a $225,000 expected payout ($3,000 / 1.3%), which means expected losses of $255,000 ($225,000 plus $30,000 deductible). This is more than 40% of my rebuild cost! But per the previous post, my house should only experience a 40% loss if I have a major vulnerability.
What about a 15% deductible? This would be a $1,600/year premium for my house. And along the same lines, $1,600 / 0.4% chance per year = more than $400,000 of damage. Either way, CEA seems to think my house will be a total loss.
What this means, to me at least, is that conventional insurance is ‘worth it’ only if you think a total loss is possible.
And total losses are typically limited to houses with a known vulnerability. (Refer to Part 1 in this series.)
Here’s another perspective: Temblor also tells me the chances of a total loss (>65%) are 1 in 29 (3.4%) over 30 years, which is an annual probability of (roughly) 0.1% (one in 1,000 years). In this case, let’s use the highest deductible of 25%, which is $150,000 ($600,000 * 25%). In a total loss, my payout would be $450,000 ($600,000 minus $150,000). So my premium ‘should’ cost around $450 per year ($450,000 * 0.1%), which still doesn’t match with the $1,100 premium that CEA estimates for my house with a 25% deductible.
Why don’t the numbers work out?
Simply put, there’s a factor of 4 to 5 between your ‘true’ risk and the cost of annual premiums, because there are too many ‘hands in the pot.’ Intermediaries drive costs through the roof. Repeat: currently, conventional earthquake insurance costs up to five times more than the underlying risk.
Technology is quickly making it possible to minimize intermediaries as much as possible. That’s the first of two reasons Jumpstart will be so much more affordable. The second important reason is that Jumpstart covers just-enough to get you back on your feet, but not total losses.
Over to you: Do you expect a payout from conventional insurance when the quake occurs? Why or why not?
Postscript: How Conventional Quake Insurance Works:
A conventional homeowner’s earthquake policy typically accompanies your standard homeowners’ policy (for fire and theft). The limit (maximum payout) is the replacement value of your house, as specified in your standard policy. For earthquake, you can choose from various deductibles specified as a percentage of that replacement value, for example, 5%, 10%, 15%, or 25%. Just as for car insurance, the higher the deductible, the lower the annual premium.
Example: If you have conventional quake coverage on your home, with an insured replacement value of $500,000 and a 10% deductible, you would be responsible for the first $50,000 of property damage losses, and your insurance would pay for losses exceeding $50,000 up to $500,000. You would be responsible for losses exceeding $500,000.
Important Note: Replacement value does not necessarily equal the market value of your home.