The California Earthquake Authority, the state’s privately funded and publicly managed earthquake “instrumentality,” is growing like mad. A spate of recent natural disasters—in combination with savvy management, new product offerings and a concerted effort to raise the profile of earthquake risk and coverage—allowed the CEA to break the 1 million policy threshold for the first time ever in 2017.
But growth comes at a cost, and the CEA now faces questions about how it will fund that growth moving forward.
The CEA’s growth is good news for California and the nation, since the Golden State’s seismic risk is enormous and dramatically underinsured. In spite of its growth, the take-up rate for earthquake coverage remains low. That means that, in the event of a major quake, there is a real risk that mortgage lenders—largely backed by the American taxpayer—will be on the hook for properties left unprotected.
Treating earthquake risk like flood risk, by requiring coverage in seismic zones to protect taxpayer investments, is an idea whose time may soon come. Short of that, the best way to ensure California is resilient in the face of earthquake peril is to foster a competitive marketplace for coverage. Yet the CEA’s growth poses a challenge to the organization and its ability to offer that coverage affordably.
To protect its more than 1 million policyholders adequately, the CEA must maintain substantial capital. Of the $17.3 billion that the CEA can call upon to satisfy its obligations, more than $9 billion is sourced via risk-transfer agreements. These agreements, in the form of reinsurance and catastrophe bonds, involve the CEA paying a premium to access capital in the event of an earthquake. Thus, not unlike a driver whose range is limited by the amount of gas she can purchase for her car, the CEA’s size is limited by the amount of risk transfer it can afford.
In the years to come, if the CEA’s recent growth—more than 70,000 new policies per year—remains consistent or accelerates, the authority’s risk-transfer costs will continue to increase. Privately, the CEA is concerned that that cost will prevent it from providing coverage to all who desire it.
Fortunately, there is a mechanism already in statute that could afford the CEA roughly $430 million more in claims-paying ability. All the Legislature needs to do is make a simple technical fix to unlock it.
When the CEA was created in the wake of the Northridge quake, policymakers recognized it might not be able sustain the full cost of a comparably large earthquake. Unlike today’s CEA, the fledgling authority was not yet capitalized with decades of premiums. For that reason, a provision was added to its enabling statute allowing the CEA to assess policies if other capital sources, like the authority’s surplus and reinsurance, were exhausted. Fortunately, the CEA has not to date ever had to make such assessments.
But while it has the clear statutory authority to do so and each CEA policy includes a provision warning policyholders of the possibility of a surcharge of up to 20 percent of annual premium, the ratings agencies that evaluate the CEA’s financial strength and claims-paying ability do not currently take the capital available via the policyholder assessment into account when they make their determinations about the authority’s financial strength. As a result, the CEA is compelled to offset the $430 million in claims-paying capacity in other ways.
To unlock that capital, and to bolster the CEA’s ability to continue to write earthquake coverage affordably, all the Legislature needs to do is amend the existing policyholder assessment provision (CIC §10089.29(b)(1)) in a manner consistent with similar provisions in other states, like Florida, that currently do satisfy ratings agency concerns. This simple fix would make a big difference and provide the CEA with breathing room as it continues to educate Californians about the earthquake peril that many of them face.
As California Earthquake Authority CEO Glenn Pomeroy said during a recent press conference, “if you’ve seen one earthquake, you’ve seen one earthquake. You don’t know what the next one has in store.” He’s not wrong. The next one could be massive. The Legislature should take this simple step, one that it intended to take more than 30 years ago, to give the CEA access to capital that it should already have. Turning “should” to “does” may be one of the most important things the body accomplishes this year.
Image credit: SUNG YOON JO