Every time we have a big earthquake, Los Angeles homeowners ask themselves, should I buy Earthquake Insurance?  The right answer for you may be different from the answer to your neighbor when it comes to purchasing Earthquake insurance. LA real estate is valuable, and you likely want to protect your investment.

By David Rae Certified Financial Planner™, Accredited Investment Fiduciary™

I’ve lived in Southern California for the vast majority of my life, and I’ve experienced numerous Earthquakes.  While I’ve known many people who’ve had their homes destroyed by fires, I have yet to meet anyone who lost their home to an Earthquake. Of course, the BIG ONE could be coming any day now. Alternatively, it may not come during any of our lifetimes.  This uncertainty makes the decision of buying Earthquake insurance or not more complicated.

If a 7.1 earthquake hits Los Angeles, we could see billions of dollars in property damage.   For the 90% of California homeowners who don’t have any Earthquake insurance, you may want to keep reading.  Owning a home in Los Angeles, or California for that matter means the risk of Earthquake damage.

 LA Homeowners Insurance and Earthquake Coverage:

I’m assuming most of you are away that your ordinary homeowner’s insurance, condominium insurance, or even renters insurance won’t cover damage from an Earthquake.  They cover fires.  It will cover robbery.  Probably won’t cover flooding.  However, it definitely won’t cover Earthquakes.

According to the California Department of Insurance, around 21% of homeowners in Los Angeles County and Orange County have coverage for Earthquake Insurance.  To be honest, this is higher than I would have guessed.

The rate of homeowners having earthquake insurance drops when you head out to the Inland Empire, with just 8% of San Bernadino home having coverage.  Riverside is a little better, with 9% of homes having earthquake insurance.

Why People Don’t Buy Earthquake Insurance in Los Angeles and Beyond

Let’s be real; buying insurance is no fun.  To make matters worse, earthquake insurance is expensive.  It can easily double the cost of insuring your home.  The average premium is around $800 per year.  Keep in mind that this is probably on the average Los Angeles home, which apparently costs between $500,000 and $600,000.  I don’t know where these homes are, nothing in my zip code sells for less a million dollars, and that is just land value.

Earthquake insurance also comes with large deductibles.  Older earthquake insurance policies came with at least a 15% deductible.  Today you can help reduce (or increase your premiums) with deductibles ranging from 5% to 25%.  

Like your miserable health insurance (I hate my current plan….), the higher your deductible, the lower your premiums. Also, the more you will have to pay out of pocket when disaster strikes. To put that in plain English, if you had to rebuild your home for say $750,000, you would still have to pay $172,125 out of pocket even with insurance at a 25% deductible.

Home Equity and Earthquake Insurance:

How much equity you have in your home will also play a role in whether you should buy earthquake insurance on your Los Angeles home.  I had the misfortune of purchasing my home right before the financial crisis hit. Like many Los Angeles homeowners, I was underwater for several years.  If an earthquake has taken out my home in 2008-2010, my mortgage holder would have had to deal with it.

Now more than a decade later, I have substantial home equity that I would want to protect.  When I owed more than the home was worth, I really didn’t have much motivation (if any) to purchase earthquake insurance.  Even now, the vast majority of the value of my home is the land underneath the house.

Just to be fair, if the bank owns a vast majority of your home, and an earthquake we to damage it extensively, your credit score would take a huge hit if you chose to walk away. All the same, damaged credit is likely better than having to pay several hundred thousand dollars in repairs out of pocket.

If it’s the bank, and you’re prepared to take a hit to your credit score by walking away from a quake-damaged structure, then the added cost of quake coverage may not make much sense.

The Cost of Rebuilding in LA After An Earthquake:

We have seen the cost of rebuilding skyrocket in many areas hardest hit by the recent wildfires in California.  If Los Angeles suffers a major earthquake, many homes will need repair or rebuilding, which will only increase the cost of putting your life back together. Also, the more people displaced by an earthquake, the more pressure on rents for the remaining homes in the area.

A total loss of your home may be scary. The reality is that most likely (no guarantee here, I don’t have a crystal ball), is for many homeowners, most damage from an earthquake will fall below their deductible amount, assuming they have insurance.  Your TV may fall off the wall, or some pictures come crashing down to the ground.  An earthquake may also add some cracks to your walls. None of this is fun, but also not necessary “that” expensive to fix.

Does the California Earthquake Authority Have Money to Pay Claims?

I hate to be dependent on the government in times of crisis, remember their response to Katrina?  That was with a President who actually cared and things were….still a mess, but ….well I could go on for days….but none of that ranting will help you decide if you should buy Earthquake insurance.  Now Donald Trump insurance, that would be nice.

If Los Angeles gets hit with “the big one,” it is conceivable that the California Earthquake Authority could struggle to pay all claims or run out of money completely.  You should know, the California Earthquake Authority is a privately funded, publicly managed entity that provides coverage on behalf of about two dozen insurers.  They have a reported $17 billion with which to pay claims.

The CEA believes it has sufficient reserves to handle a large Earthquake catastrophe here in California.  However, they have also stated that “if an earthquake causes insured damage greater than the CEA’s claims-paying capacity, policyholders with earthquake damage may be paid a prorated portion of their covered losses.”  Meaning you may not get all that is promised by the insurance policy you have been paying into.

While I’m a fiduciary financial planner in West Hollywood, not a contractor, you may find more value making sure your home is properly bolted to your foundation, as well as other retrofitting or upgrades that can help minimize the risk of major damage to your home during an earthquake. This is especially important in older homes.

 You will also want to consider what other funds you may have to self-insure. If you are carrying credit card debt, you likely don’t have money to rebuild without insurance. On the other hand, if you are socking away a large amount of money each month, and have built up a multi-million dollar net worth, you may not want to worry about buying Earthquake insurance.

Free Calculator to Crunch Earthquake Insurance Numbers:

You can visit the CEA site, and play with their calculators. This can help you make the right decision about Earthquake insurance for you and your personal financial situation.

Free online calculator for Earthquake Insurance.

What do you think? Do you have Earthquake insurance? Please comment below.

DAVID RAE, CFP®, AIF® is a Los Angeles-based fiduciary financial planner with DRM Wealth Management, a regular contributor to Forbes.com,  he has also appeared on TV over 100 times.  He helps smart people across the USA get on track for their financial goals.  For more information visit his website at www.davidraefp.com

ABC Video – Stock Market Tumbles What to do Now?