Northridge Retrospective: The Earthquake that Changed the Insurance Industry

This post is the first in a three-part series looking back to the Northridge earthquake of Jan 17, 1994.

The Magnitude 6.7 Northridge earthquake was an enormous surprise and bitter pill for the insurance industry.

Before the Northridge earthquake, as many as 30% of Californians carried earthquake insurance, according to a 2014 article by NBC.  And then insurers had to pay – $12.5 billion (1994 dollars) is the figure most-commonly cited for insured losses from Northridge.  This was around 30% of the total economic losses from that quake, often cited as $40 billion, nicely proportional to the percentage insured.

The surprise was that the $12.5 billion was three times what insurers expected to pay, based on their earthquake and actuarial models at the time.  According to a 2015 report by the Insurance Information Institute,

“The insurance industry ended up paying out more in claims for this [Northridge] quake than it had collected in earthquake premiums over the preceding 30 years. While no insurer became insolvent, some came very close.”

Northridge caused many insurers to consider pulling out of the California homeowners’ insurance market altogether.  (Offering the option for earthquake coverage had been a condition of offering homeowners’ policies since 1985.)  But an insurance shortage was avoided, by the 1996 formation of the California Earthquake Authority, which assumes earthquake risk on behalf of participating insurance companies.

However, earthquake coverage available now isn’t as appealing as it once was, for reasons nicely summarized in the 2014 article.

Today, the percentage of Californians covered for earthquake is closer to 10%.  This means Californians are less financially prepared than they were 21 years ago, at least by a factor of three.  But probably, worse than that – more like a factor of five.  Higher deductibles and coverage exemptions mean that a 10% buy rate no longer translates proportional insurance losses – we can expect insurance to pay much less than 10% of anticipated economic losses.

In other words, post-quake reimbursements today could be as little as 1/20th what’s needed to rebuild and recover.

Northridge changed the landscape of earthquake insurance in California.  Let’s hope we can improve our post-quake economic outlook before the next big one strikes.