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The greatest failure of our times

Our industry suffers from low self-esteem — it doesn’t always feel that great about itself. But when big losses strike, they can be great moments of validation for what is an otherwise extremely unappreciated backwater of the financial services sector.

When the great earthquake of 1906 struck San Francisco, it was famously the making of Lloyd’s, but was also a great opportunity for younger rivals Munich Re and Swiss Re to stand up and be counted and do right by (re)insureds — all came through that trial with reputations hugely enhanced.

The industry has many things to be proud of and it is only when a news-dominating catastrophe event occurs that insurance has the chance to occupy the psyche of a nation and the wider world.

So how come a hundred years on from San Francisco is take-up of earthquake insurance so shockingly patchy across the globe?

It’s not often I’m dumbstruck, but allow me to ransack AM Best’s superb 2006 Annual Earthquake study to put a series of terrible facts to you.

The US is long overdue a big earthquake — Am Best says “cataclysmic ruptures are already considered overdue for the Los Angeles end of the San Andreas fault and the Cascadia Subduction Zone” (Cascadia in the Northwest Pacifc coast area encompassing major population centres of Seattle and Vancouver, amongst others).

And consider this — the last “big one” in the States was San Francisco in 1906 — yet RMS estimates that a $100bn-plus earthquake loss hitting anywhere in the United States is only a 1-in-18 year event.

This is because the contains four major quake zones — of course there is California, with which everyone is familiar, but the Cascadia zone mentioned above is also highly significant, as is the New Madrid zone, which stretches all the way from Arkansas up to the great lakes, taking in Memphis, St Louis and Chicago. Last but not least is a significant fault line that runs from New York to Philadelphia.

And look at the numbers — RMS reckons that a quake of only 6.5 magnitude (it is not until a quake measures 7 magnitude that it is considered “major”) on the New York to Philadelphia fault would cause about $110bn in insured property losses.

It goes on — a smaller 6 magnitude quake hitting Chicago would cause approximately $102bn in property damage alone. AIR models a 7.6 magnitude temblor in the San Francisco Bay Area that would cause insured losses of over $100bn. Here are some more from AIR; Memphis-St Louis $140bn; Pacific northwest — more than $40bn; Los Angeles — more than $70bn. Top these off with another from RMS — Newport-Inglewood, California — $101bn.

Feeling dizzy yet? I’m not surprised —especially since the AM Best study puts the total annual US earthquake premium pot at a paltry $2bn. And there are doubtless many other hypothetical permutations and combinations that produce $50bn-plus insured loss events

Now think again and consider yourself lucky — compared to the economy as a whole, the industry is getting off extremely lightly. Take that New York-New Jersey-Philadelphia quake — yes insured losses come out at $110bn, but the overall damage is an eye-watering $901bn — and you thought that Hurricanes were a menace.

And so the pattern of underinsurance continues to a greater or lesser extent with the other scenarios. In fact the most shocking finding of the AM Best report is that between 85% and 90% of US homeowners don’t have earthquake coverage at all. Even in quake-prone California — and the only state to have set up a scheme (the California Earthquake Authority) that actively encourages take-up of earthquake cover, take-up is an anaemic 12% for residential customers and a paltry 11% for commercial policyholders.

AM Best reports that in the US earthquake insurance is a standard exclusion from homeowner or commercial insurance — coverage is only usually available via a specific write-back. However, homeowners do get cover for fire following quake and motor policies do include physical damage cover.

But since most people’s home or business is their largest asset, the main exclusion of damage by shaking is a recipe for extreme confusion and financial ruin for many — as well being yet another boon for a certain type of plaintiff lawyer.

Yes – fire following quake is a major peril, but a policyholder confronted with a burnt-out pile of rubble is going to be in for a shock when his insurer applies a hefty average to the claim.

I can just hear the adjuster saying “Yes, sir, you are covered for fire following quake, but since the building was reduced to an uninhabitable mound of concrete before the fire came, I reckon we only need to pay you for fire department expenses and maybe some rubble removal if you’re lucky”.

This situation is bizarre enough in the world’s largest economy, but even more astonishing is that faced with such a challenge, the US industry is currently backing away from the problem. Back in June personal and commercial lines giant Allstate announced that it was going to stop selling earthquake endorsements on its policies nationwide, after seeing its appetite for catastrophe risk severely blunted by massive losses sustained from Hurricanes Katrina and Rita.

But this cannot be the way forward. Insurance is a great product because bad things happen and people need indemnity when they do. Thousands of houses burn down every year, but we don’t have a stampede insurers rushing to exclude fire — customers will not allow it — that is the product.

If Cuthbert Heath’s first words upon hearing of the San Francisco disaster of 1906 were “exclude quake!” it is doubtful as to whether Lloyd’s would still be in existence today.

US Earthquake cover is a massive missed opportunity and a huge failure on our industry’s part. And reinsurance has a massive role to play here — there is no reason on earth why for a reasonable price US citizens shouldn’t get the cover they need, the wider US economy and ultimately the US Treasury gets the protection it is sadly lacking. Get out there and do you duty — and that paltry $2bn premium pot should multiply.

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