If you have equity in your home, you have a valuable asset that is worth protecting. The question is how much is that protection worth?
The likelihood of a major earthquake striking California in the coming decades is significant, bordering on inevitable. According to US Geological Survey (2015 UCERF3 Report), there is a 94% chance that an earthquake of at least 6.7 magnitude will occur in Southern California in the next 25 years, and a 95% chance that one strikes Northern California over the same timeframe.
If you focus on just the most developed metropolitan areas, the likelihood is still very high: the Los Angeles region has a 60% chance of a 6.7 or greater earthquake, and the Bay Area has a 72% chance.
For Californians who have owned their homes for 30 years or so, they are living in this home effectively rent-free (property taxes for long-term owners may be $3,000-$4,000 per year). Consider the loss of this home due to earthquake: that small annual property tax payment would be replaced by rent of 10x to 20x that amount — a difficult prospect for anyone, but particularly for those on a fixed income. When added together, the appreciation and avoided rent combine for an annual benefit that is well over $60,000.
Let’s say you have paid off your home in California, meaning you have an asset worth $750K. That asset is likely appreciating over time, so at a conservative 2% annual appreciation, it gains $15,000 in value per year.
In the highest risk earthquake zones, you can generally purchase insurance coverage for under $2,000 per year. That $2,000 expenditure is about 3% of the property’s annual benefit, and less than 0.3% of its present value — and it protects the $750,000 of built up equity as well as the annual benefits it provides.
Even if that home “only” has $200,000-$300,000 of equity (which, in California, many have built up simply through appreciation over the past 5-10 years), earthquake insurance could still be a smart move. The only way a Californian loses all their hard work and equity in their largest asset is by not purchasing earthquake insurance. While saving the modest cost of annual premiums, an owner is putting a very valuable asset at risk of total loss.
An additional risk factor for homeowners is the outsized growth of condos as a percentage of the total housing stock, as condos and other multifamily residential structures are far more vulnerable to earthquake damage.
Over the last 25 years, the number of Californians living in multifamily housing has more than doubled, rising from 2.6 million units in 1994 to 5.4 million units today.
In 1994, the Northridge earthquake devastated the San Fernando Valley, causing roughly $20 billion in damage to residential structures alone. Detached homes fared much better than multifamily structures. Although multifamily dwellings accounted for only 22% of the area’s housing, they represented 84% of the damaged properties and nearly 72% of the “red-tagged” homes (homes that were too dangerous to inhabit).
With the increase in condos as a percentage of homes, the number of homeowners at risk has gone up as well.
Professional investors regularly protect themselves against “black swan” events — extreme but unlikely events — through financial hedges. Earthquake insurance, by contrast, is effectively a hedge on an extreme “likely” event.
Many owners think the Federal Government will step in to provide assistance after a disaster. To put it simply: the US Government will not step in to save the equity in your home. Funds distributed through the Federal Emergency Management Administration (loans or grants) are only for health and safety.
After past earthquakes, FEMA has capped individual assistance at $5,000, however that figure has increased to $33,000 after recent flood and windstorm events.
Even at this higher level, government assistance will help an owner find alternative housing or take proactive steps to stop further damage, but it won’t rebuild a lost home, and in most cases, must be paid back over time.