An Overview of the California Earthquake Authority

• Author: Daniel Marshall
• Published date: 01 March 2018
• Date: 01 March 2018
• DOI: http://doi.org/10.1111/rmir.12097

Risk Management and Insurance Review

C

Risk Management and Insurance Review, 2018, Vol.21, No. 1, 73-116

DOI: 10.1111/rmir.12097

PERSPECTIVE

ANOVERVIEW OF THE CALIFORNIA EARTHQUAKE

AUTHORITY

Daniel Marshall

PREFACE

The California Earthquake Authority (CEA) is a one-off, public catastrophe-insurance

organizations often seem to be that—formed to replace dysfunctional private insurance

markets—but each unique to its own political and economic setting.

The CEA owes its existence to a single earthquake over 20 years ago and a 1980s-era

state law: Without the 1994 Northridge earthquake and the 1985 law requiring sellers

of home insurance in California to offer earthquake insurance, there would be no CEA.

And without appreciating its primary legal columns of support, the CEA cannot be fully

understood (See Figures 1 and 2).

Because CEA’s organizing genome is so particular, to California and to the insurance-

market aftermath of a damaging earthquake in a crowded California urban belt—and

because this article is offered to help form a map to explore future reform and improve-

ment of national catastrophe-insurance programs—the following observations aim to

explain CEA as an entity, to help potential “explorers” both form specific insights and

draw broad lessons.

In that vein, the background of CEA is the first key: What happened, who did what,

what alternatives were on the table, and why did the choosers choose the CEA model,

and what did they expect(?). Without depth in those matters, there can be no useful or

creative comparison of CEA to present or future states of other organizations.

As well, after more than 20 years of operation CEA is no longer just a bright idea—it is

a mature insurance provider with a broad portfolio of ideas: market-leading insurance

products, unique loss-mitigation programs, and innovative financing techniques. CEA

is the largest and by far most active California player in addressing and mitigating

both structural and financial residential earthquake risks, and its CEA experience is

instructive.

INTRODUCTION

After the 1994 Northridge earthquake caused massive, unexpected, and wholly un-

precedented insured losses to residential properties in Southern California, the losses

Daniel Marshall is at The California Earthquake Authority; email: DMarshall@calquake.com. The

statements, views, and opinions in this article are solely those of the author, who is the general

counsel of the California Earthquake Authority. They do not necessarily express the view or

official policies of the CEA or its Governing Board, or of the State of California.

73

74 RISK MANAGEMENT AND INSURANCE REVIEW

FIGURE 1

LA Times Front Page—Northridge Aftermath [Color figure can be viewed at wileyonlineli-

brary.com]

FIGURE 2

Mandatory Quake Insurance Offer—New Version [Color figure can be viewed at wiley-

onlinelibrary.com]

led to an ever-worsening home-insurance crisis and market failure—and after 2 years

of frustrating efforts to address the crisis and people’s mounting concerns—the State

of California in 1995 moved to solve the crisis when it created a first-of-its kind public

instrumentality.

It was 1996 when the final enabling legislation, passed with declared urgency, took

effect, and the California Earthquake Authority (CEA) set off on its journey of—so

far—21 years.

ANOVERVIEW OF THE CALIFORNIA EARTHQUAKE AUTHORITY 75

Although CEA as public instrumentality provides basic residential earthquake insur-

ance throughout California in a voluntary insurance market, its principal (and statuto-

rily declared) function was to restore California’s homeowners’ insurance market. Often

termed “fire insurance” in home-mortgage-document requirements, homeowners insur-

ance (unlike earthquake insurance) is typically required as a condition of obtaining and

maintaining a home mortgage. Indeed, the title of principal CEA-enabling legislation

was the Homeowners Insurance Availability Act of 1996.

But to imply that the California Legislature acted in 1995 and 1996 solely to save the

homeowners-insurance market (anticipating impacts from home-insurance unavailabil-

ity on California’s massive residential real estate market) would be to imply that gov-

ernment cared little about earthquake coverage or did not mind leaving Californians to

fend for themselves the next time the Earth shook.

That was not the case: The reason there was a homeowners-insurance availability crisis

was the effective refusal by the Legislature in 1995–1996 to even consider removing

California’s statutory “mandatory offer” of residential earthquake insurance, which had

been in place since 19851and can be seen as an unusual way to form an insurance

contract.

A formal legal requirement binding insurers to make a mandatory offer of earthquake

insurance, which if accepted guarantees coverage, is unique to California:

rIn a typical property insurance policy, the application by the potential insured is

considered the contract “offer.” If the insurer decides to accept the risk, it accepts

the applicant’s offer—and upon that acceptance, an insurance contract is formed.

rWith California residential earthquake insurance, the insurer makes the insurance-

contract offer and the applicant can accept it or not—this gives the applicant the

power to form the insurance contract that establishes the earthquake-insurance

coverage.

In their attempts to advance their vision of how to fix the paralyzed market caused

by their refusal to sell new home-insurance policies freely, insurers strongly advocated

repealing this mandatory-offer arrangement. But the Legislature, as strongly, insisted

the earthquake offer continue, hoping to assure market availability. That standoff over

the mandatory-offer set the stage for CEA.

These factors demonstrate that CEA is a product, in significant part, of California’s

mandatory residential-earthquake-insurance offer scheme. And the offer mechanism is

also why CEA enjoys a unique market posture, since not a day goes by that California

home insureds up and down the state are not offered CEA quake coverage by their

CEA-participating home insurers—which together represent about 80 percent of the

California homeowners market. So, with the biannual mandatory-offer continuously

blanketing the state, within the span of just 2 years effectively all such home insureds

are presented with the opportunity and power to insure through CEA.

1Offer is to be made upon inception, and biannually upon renewal, of the home-insurance policy.