Earthquake risks are among the biggest and most complex risks to insure. Covering earthquakes requires good models and close coordination with clients.
The Greek god Poseidon shook the ground with his trident when he was upset, earning him the name of the god of earthquakes alongside his better-known position as master of the seas. In California, individuals, businesses and governments fear the wrath of Poseidon.
If a big quake hits, it will mean a dent in one of the world's largest economies. With a gross state product of $1.6 trillion in 2006, California is responsible for 13 percent of the entire American economy. The Northridge earthquake, which struck the Los Angeles area on January 17, 1994, caused approximately $12.5 billion in property claims to the insurance industry.
That is roughly $17.5 billion in present dollar terms, making it the fourth-costliest industry event in US history. Given the severity of loss that can be associated with a significant earthquake, it is important that the exposure to loss is properly monitored.
According to the US Geological Survey, each year southern California has 10,000 earthquakes. Several hundred are 3.0 or higher on the Richter scale, but most go unnoticed. Forecasting larger events is still beyond the reach of science, but aggregate experience has led to insights.
Seismologists focus on calculating seismic hazard and using probability methods to determine risk. Insurers essentially take the same approach. William Schneider, Vice President, Underwriting, at Allianz Global Corporate & Specialty (AGCS) Americas, says the company covers property damage from earthquakes under property contracts in all the sectors it specializes in.
A separate unit of the company, focusing on builders' risks based in Burbank, California, a suburb of Los Angeles, offers quake coverage for contractors as well as project owners.
Schneider, a civil and structural engineer, has been working in commercial property insurance for decades. He says the way AGCS uses industry-standard models, such as those from Risk Management Solutions, gives it an important advantage: "We obtain secondary characteristics, such as more information about the construction of buildings, and feed it into the model."
Modeling programs combine information such as soil features and fault characteristics with data on building contents, location and occupancy rates. They produce statistics that form the basis for underwriting.
"We use the model closely and carefully, and we are meticulous about the data that we put into it," Schneider says. "We want to offer the right amount of coverage based on the financial size of our organization." AGCS focuses on products and services for very large corporate and specialty clients, while the Allianz-owned US subsidiary Fireman's Fund offers quake insurance to middle market clients.
"In addition to monitoring potential for loss in our portfolio, we coordinate with loss-control engineers from Allianz Risk Consultants and work with clients to minimize loss potential," says Schneider.
"This includes disaster planning and working with clients to ensure adequate plans and procedures are in place should an event occur. It also includes accessing items and working with clients to minimize physical damage should an event occur." Most companies insure against damage, but also purchase a "time element" that protects against business interruption.
Infographic: How earthquakes arise. Click here for full-size image (455 KB)
After the shaking stops
Companies can face many problems after a quake, even a small one: The earthquake can cause fires, civil commotion and rioting, and a civil authority may restrict access to facilities. For this reason, during the risk assessment process, AGCS and loss-control engineers always inspect sites.
"Based on the information our loss engineers collect, we provide input to clients about how to mitigate losses," says Schneider. "We recommend precautions such as installing seismic valves, and we discuss with the client what needs to happen after a quake."
An automatic seismic shut-off valve is basically a simple device with a steel ball on a rim around the perimeter of the natural gas piping. When shaking occurs from an earthquake, the ball falls from the rim and enters the center of the pipe blocking any flow of gas past the ball. The seismic valve is installed outside the building where the natural gas line enters the building.
During an earthquake the natural gas lines inside a building may break and can leak gas in the building. With a natural gas leak inside a building, it is possible for an electrical spark (turning on a switch, pilot lights, etc.) to ignite the gas, causing it to explode. The valves automatically shut off the supply of natural gas to a building to prevent such a fire or explosion.
"Numerous facilities that we insure have installed seismic valves," says Schneider, "which cost from between $500 to $3000 to install, depending on the size of the natural gas line. We have one account with multiple buildings in the San Francisco area. When we began the partnership with this client in 1999, only about half of the buildings had seismic shut-off valves. Today, all of their buildings have this valve, and this requirement is included in their specifications for new facilities."
He points to another example in Los Angeles. "That client originally had only two seismic valves on 13 of their natural gas lines. The facility is in the city of Los Angeles, which requires all new facilities to have seismic valves installed. We've worked with the client, and all 13 natural gas lines now have seismic valves. Certainly, we'd rather not test these valves in an actual event, but it is good to know that we have clients that work closely with us to minimize the potential for loss."
Another exposure associated with earthquakes is potential for water damage after an earthquake. "Our engineers analyze facilities to ensure correct sway bracing for fire protection piping," he adds.
"This is necessary to keep the sprinkler piping moving with the building during an earthquake, preventing sprinkler pipe breakage, which can lead to water damage inside the building. This is something our engineers analyze during their inspections of facilities in earthquake-prone areas," says Schneider.
Choice of risks
AGCS also monitors its coverage mix closely to assure its clients that it is not over-exposed. "We don't write one or two billion dollars of accumulation in downtown Los Angeles," says Schneider. The risk distribution must work. The firm's ratings have gone up since one of the biggest recent natural disasters, Hurricane Katrina.
Edwin van Zijll heads underwriting of technical business at AGCS NA. His team specializes in underwriting large, complex engineering risks and offers earthquake coverage for project owners and contractors. Projects covered range from condominiums to power plants and petrochemical facilities. Except for workers compensation, AGCS insures property damage of an entire construction site, including holes in the ground.
"You wouldn't believe how expensive it can be to repair a hole," van Zijll relates. Compared to standard property contracts that are in force for one year, coverage for engineering risks can be written for six to seven years, depending on how long it takes to build a project.
In addition to insuring physical loss or damage to the project, owners can also choose to insure against the financial risks associated with delays to completion resulting from the physical loss or damage against which they are insured. With such long-term contracts, AGCS is potentially exposed for not just one but several earthquakes.
"We are located in California," says van Zijll. "We really know exactly what the risk exposure is." Van Zijll, a Dutch national, has long called California home. He sees his team as the "lucky" ones since they work on new projects that are built based on the most current building codes and earthquake standards. Still, they do their due diligence in underwriting and assessing their risks.
"We obtain the soil report and find out what type of foundation is going to be put in. We also verify if the site is susceptible to liquefaction which can cause settlement of the buildings and/or collapse," he says. They also look at general information about clients, thereby improving service and underwriting.