Earthquake risks are rising, but take-up isn’t
The West Coast’s risk of ruin is even greater than we previously feared. According to the just-released Third Uniform California Earthquake Rupture Forecast, the likelihood that California could see an earthquake of 8.0 or more over the next 30 years is now estimated to be about 7 percent, up from 4.7 percent when the last UCERF was issued in 2008.
The new report incorporates evolving scientific understanding of the multi-fault ruptures, in which earthquakes and aftershocks can hit multiple faults simultaneously. But you wouldn’t know there was any significant cause for alarm by looking at the state’s earthquake insurance take-up rate, which remains at or below 10 percent.
It isn’t just California where take-up rates fail to mirror levels of risk. The Cascadia Subduction Zone lies at sea off the Pacific Coast, running from northern California to British Columbia. More than 300 years ago, the fault line slipped and resulted in an earthquake that measured an estimated magnitude 9.0 on the Richter scale. Since the Pacific Northwest was largely unsettled at the time, the historical record of the event is sparse and an associated sense of the northern Pacific Coast’s huge risk is dim.
Yet we see in Oregon, the take-up rate, while better than California’s, is still only around 20 percent. Even worse, in Washington, even after the serious Nisqually earthquake of 2001, the take-up rate hovers around 12 percent. The unwillingness of consumers on the West Coast to purchase earthquake insurance is remarkable in light of the peril they face.
Conventional wisdom suggests principal reasons that residents forego coverage: underestimation of the risk; the high cost of coverage; and misguided belief in the inevitability of a government bailout. But another reason, generally underappreciated, is that most people fail to understand the role insurance plays in reconstruction. By providing certainty and private capital, earthquake insurance offers a qualitatively different path to rebuild than the slow and uncertain one promised by taxpayer-sponsored bailouts.
The paradigm for how private risk transfer effectively leverages capital and insulates taxpayers from risk can be seen in New Zealand, which, like the United States, is an advanced nation with a concentrated and severe earthquake risk. Unlike the United States, its strategy for handling earthquake risk is predicated on promoting deep earthquake insurance penetration. This is the result of long-term thinking, and the effort was proven to be wise.
Beginning in 2010, a string of profound seismic events struck New Zealand. Among those earthquakes was a magnitude 7.1 shock near Christchurch in September 2010; a magnitude 6.3 near Lyttelton in February 2011; and yet another magnitude 6.3 earthquake centered in Christchurch in June 2011. The total economic impact of these seismic events is difficult to quantify but, by some estimates, rebuilding in the Canterbury region will cost nearly NZ$40 billion.
Though difficult to monitor and quantify, the pace of recovery relative to the damage sustained appears to be brisk. The construction necessary to completely rebuild will take more time, but housing shortages have been addressed through a combination of repair and new construction. As a result, the region’s population, which diminished in the wake of the quakes, has begun to meaningfully rebound. This recovery was possible because private insurance contributions amounted to 80 percent of the losses experienced. Crucially, in spite of the great severity of the damage, capital found its way to the region without delay.
By contrast, when northern Italy was subject to two less severe earthquakes, magnitude (6.0 and 5.8, respectively) over a nine-day period in 2012, it suffered roughly U.S.$16 billion worth of loss, but only about U.S.$1.3 billion of it was insured. Because of the low earthquake insurance take-up rate, the total insurer contribution to the region’s recovery was only 14 percent. To rebuild, a state financing body called Cassa Depositi e Presiti was forced to disburse U.S. $15.8 billion.
Further aid was later required from the European Union, but became a political bargaining chip for budget negotiations. Not only did Italian taxpayers take a hit, but those in the region were subject to long periods of delay in beginning their recovery. This is the result of insufficient long-term planning, and the lack of economic preparation was proven to be foolish
At the moment, the future of the Pacific Coast looks far more like Italy than it does New Zealand. West Coast earthquakes are not a matter of “if,” but of “when.” It is long past time for our politicians and consumers to embrace the solution offered by private earthquake risk transfer. Until they do, residents and policymakers will rest perilously easy with their own economic swords of Damocles held over their heads by a sure-to-fail geological hair.