Catastrophes: Insurance Issues Surrounding the Northridge Earthquake and Other Natural Disasters

December 1994
Executive Summary

Introduction
The Northridge earthquake struck at 4:31 a.m. Pacific Standard Time on January 17, 1994, in the San Fernando Valley, California. In addition to 46 deaths and numerous injuries, the earthquake caused severe structural damage, disrupted essential services, and triggered secondary hazards, such as dam ruptures, fires, landslides, and release of toxic materials.

Three weeks after the Northridge quake, estimates of the insured losses stood at $2.5 billion. Eight months later, these estimates had climbed to $9 billion and were still rising. These figures make the quake the second costliest insurance catastrophe in U.S. history — exceeded only by Hurricane Andrew.

The consequences of major catastrophes, such as the Northridge earthquake, Hurricane Andrew, and the Midwest floods, are telling reasons why society needs to reevaluate the way it deals with catastrophes and their aftermath. This ISO Insurance Issues Series publication delves into how such catastrophes affect various segments of society, including the uninsured and insured victims; the federal, state and local governments; and the insurance industry. The study also discusses the various methods that government and insurers are proposing to help mitigate losses and control and spread the costs of disasters equitably.

Government Disaster Relief
As in the past, government disaster programs played a major role in the relief effort following the Northridge quake. Assistance, which federal, state, and local agencies provided, was a dire need because many property owners did not carry earthquake insurance.

But given the size of the recent disasters, even the government is starting to feel the financial pinch of disaster aid. The federal government has reduced its share of certain public assistance costs from 100 percent for Hurricane Andrew, to 90 percent for the Midwest floods, to 75 percent for the Northridge earthquake. And state and local governments, with their own financial burdens, are consistently turning down proposals to expand their relief. Ultimately, this means that the victims and their insurers will have to bear more of the costs of natural disasters.

Insurer Concerns
Insurers, because they have exposure to catastrophe losses, also have a number of concerns. These include population growth in quake-prone areas and lack of available reinsurance. Also, insurance regulators, subject to political pressures, have attempted to limit insurers' ability to raise prices and impose higher deductibles.

For instance, since 1985, California has required all insurers selling residential property insurance in California to offer earthquake coverage. After the Northridge quake, the California insurance commissioner limited insurers' ability to cancel policies and deny renewals in designated areas. Both of these actions have led to decreased availability of residential property insurance. These actions also impede an insurer's ability to avoid excessive concentrations of risks.

Risk Spreading
Insurers, government agencies, and others are currently using a number of ways to spread catastrophe risks. These include reinsurance, state and private pools, FAIR plans, and trading options on a catastrophe index that the Chicago Board of Trade maintains. Studying these mechanisms can be instructive, but few view them as a comprehensive solution to the catastrophe problem. The mechanisms lack capacity and geographic diversity.

Many insurers advocate a proposal put forth by the Natural Disaster Coalition. This proposal provides for:

mandatory coverage of hurricanes, earthquakes, volcanoes, and tsunamis, at actuarially sound rates
a federal reinsurance program
incentives for state governments to develop loss mitigation programs

Recent versions of this proposal limit the federal government's involvement in the reinsurance program. Nevertheless, the variety of the disasters covered and the geographic scale of the proposal make it the most comprehensive plan proposed to date.

Loss Mitigation
Loss mitigation programs can limit property damage and the loss of life from a natural disaster. To reduce losses, ISO and the insurance industry have worked for the development of effective building codes and the enforcement of these codes.

Conclusion
The enormous size of recent catastrophes and the potential for more of the same have caused the government to reevaluate its role as a provider of disaster relief. Still, many feel that some government involvement is necessary, but its ultimate role is unclear. The public is becoming increasingly aware of the risk of catastrophes, and insurers are under greater pressure to provide coverage. These trends are likely to force more and more of the financial burden of disaster relief onto the potential victims and their insurers, which may not have the capacity to handle very large catastrophes.