California quakes immaterial to reinsurance, but not baked into valuations

California has been hit by a series of earthquakes with the two largest being the magnitude 6.4 quake that struck on Thursday and a more significant magnitude 7.1 on Friday, both of which struck the Ridgecrest City area of the state.

Thursday’s magnitude 6.4 earthquake was said to have seen as many as 2,000 policyholders of earthquake insurance coverage provided by the California Earthquake Authority (CEA) exposed to strong shaking.

Friday’s magnitude 7.1 quake was stronger and shaking hit a wider area, with more damage reported as well. It struck at a shallow depth of just 0.9km, which meant the ground movements were likely more severe than Thursday’s event.

However, while there are damage reports from Friday’s magnitude 7.1 event, the impacts are expected to be minimal, both on an economic basis as well as to the insurance or reinsurance sector.

Friday’s earthquake was given a 25% chance of resulting in economic losses above $100 million and an 8% chance that the costs would exceed $1 billion.

Even combined, the damage from the two largest quakes to occur is not expected to be particularly impactful on an economic or insured basis.

Reinsurance layers will not come into play it seems, given the relatively sparsely populated nature of the region of California where the earthquakes struck.

Speciality California-based catastrophe exposed property insurer Palomar Insurance Holdings said of both the July 4th and 5th magnitude 6.4 and 7.1 earthquakes, “The total insured value of Palomar policies within a one hundred-mile radius of the epicenter is considerably less than Palomar’s excess of loss reinsurance program.”

The same is likely to be true of the magnitude 7.1 quake event that struck on Friday, given the damage does not appear to have been all that much more widespread.

California remains characterised by a lack of earthquake insurance penetration, with just around 13% said to have homeowners coverage that includes quake cover currently in the state.

The CEA has around 41% of the earthquake insurance market in the state, followed by Zurich with around 9% and Chubb with 5%, analysts at Morgan Stanley said.

Analysts at KBW said that the quakes are expected to have an immaterial impact on the insurance and reinsurance firms they rate, although they did note that given there has not been a major California earthquake since 1994, published valuations for re/insurers do not have the true impact potential of a quake in the state baked in.

The lack of experience is a factor for the re/insurance sector in California, as no major loss has been seen for such a long time. Memories are often short and it’s to be questioned whether the industry is fully prepared for the next big one.

Here it would have to be asked whether they truly have enough protection in force as well. As given the lack of recent quake loss activity it’s likely questionable whether all primary insurers operating there have an adequate level of reinsurance in place, should a much larger quake strike a more populated center in California.

As a reminder of the potential for major losses to occur, the 1994 Northridge quake was only a 6.8 magnitude quake event, but it caused ~$26 billion of insured losses (2018 $ levels), Morgan Stanley’s analysts said.

That’s a significant loss for a state where quake insurance coverage uptake is so low. It further demonstrates the potential for loss in California, which along with these recent quake events should heighten the urgency to take up cover in the state, it is to be hoped.

Of course the catastrophe bond and insurance-linked securities (ILS) market would now provide a significant amount of the reinsurance protection for any major quake loss in California.

According to our catastrophe bond market data, minimally $3.8 billion of outstanding cat bonds are covering U.S. earthquake risk as a sole peril, while another billion or more of multi-peril deals also have exposure to quakes in California.

Add in the collateralized reinsurance exposure to California quake risks and the ILS market’s impacts from a major event in the state would be significant, although much of this coverage sits at higher layers of reinsurance towers and is targeted at a repeat of 1994’s quake, or an even more costly event.

The occurrence of these earthquakes could help on the demand for protection side though, providing a reminder to Californian’s and insurers of the need to ensure they are covered when impactful quakes happen.