The Shekel Drops / Does Earthquake Insurance Make Sense?

An earthquake. That's a good description for the study that the National Economic Council, an arm of the Prime Minister's Office, published last week. An earthquake, literally and figuratively, in that it shakes up preconceptions and describes how financially prepared Israel is for a temblor of gigantic proportions, the kind not experienced here for centuries, but that will inevitably happen one day - the kind of quake that would shatter homes and infrastructure up and down the land at the same time.

The study found, predictably, that Israel isn't ready at all for any such mega-disaster. Especially worrisome was the council's conclusion that the insurance companies aren't ready either. If the collective damage to Israeli homes from a big earthquake mounts beyond $10 billion, at least some of the insurance companies could wind up in bankruptcy, the council concludes. A statement like that could fairly be considered an earthquake in and of itself.

earthquake - AP - January 26 2011

To the best of our memories at TheMarker, this is the first time an official, senior body in the State of Israel has admitted that the insurance companies are not ready for giant earthquakes, and that they could collapse. Even if they thought so, official bodies usually tend to keep such thoughts to themselves in order not to arouse irresponsible thoughts among the general public, for instance about whether or not they should buy earthquake coverage.

If the insurance companies are going to collapse in a major quake anyway, the irresponsible public might think, then why pay good money for coverage?

The answer to that evidently lies first and foremost in geography.

The Great African Rift stretches 4,830 kilometers, from Mozambique in the south to Syria in the north, and passes right under the Dead Sea and Lake Kinneret. This yawning chasm is the source of temblors in Israel, and more to the point, anybody living alongside this scar on the face of the planet - for instance in the Jordan Valley, the eastern Galilee and the Arava - needs to insure their home against earthquake.

This is for two reasons, one being that homeowners along that line are more likely to experience earthquakes, from tiny ones to continent-shakers, so in any case they should buy insurance. The second is that in their case, there is no risk of the insurance company going belly-up. Even if Beit She'an, which is right on the rift, were to be destroyed again, no insurance company would founder as a result. Simply, there are no great concentrations of population along the rift in Israel.

To drive home the point, let us look at the mega-quake that shook Chile a year ago, which measured 8.8 on the Richter scale. It was one of the most powerful in recorded history. But because the quake happened in a relatively low-density area, the damage was not vast - it amounted to about $10 billion, and no insurance company went broke as a result.

However, the issue is far more acute for anybody living along the Israeli coast and greater Tel Aviv area. The chance of a quake destroying Tel Aviv is much smaller, if not infinitesimally so. And in any case if a quake happens that is so shattering that it destroys the greater Tel Aviv area, probably nobody will be left to pay anything anyway.

Insurance companies can afford to rebuild Beit She'an. They would have tremendous difficulty rebuilding Tel Aviv, where the costliest assets of Israel are located, assets worth hundreds of billions of dollars.

Is there any reason to buy coverage in Tel Aviv?

So what is the point of buying insurance coverage in Tel Aviv? Let's put it this way: In the event of a mega-quake, the state will have to take over from the insurance companies and save the citizens itself. But since the state wants to encourage its citizens to behave responsibly and buy insurance, it will have to create a discriminatory policy - giving more help to people who bought insurance, even if the insurance was rendered meaningless by the sheer scope of the disaster, causing the insurance vendor to crumble.

People who scorned buying insurance will get less help. And that in turn makes it sensible to buy earthquake insurance, even if exercising the policy is done indirectly, through the pocket of the state.

Will the state however have the horse sense to adopt such a policy, to preserve the merit of earthquake insurance?

At this very time, the state faces just such a conundrum, albeit smaller in scale, following the fire on Mt Carmel in December.

The accountant general at the treasury, Shuki Oren, is shaping government policy on compensating homeowners whose homes burned down. It turns out that 74 families suffered that fate, losing everything they had to the flames.

The heart bleeds for them, and the truth is that their number is small enough for the state to be able to afford succor for all without thinking twice: It could rebuild all their homes easily.

But it must not. The Carmel disaster could create a precedent for something much broader - the entire insurance market in Israel. Most notably, earthquake insurance.

The state must stick to its principles, and first and foremost help the people who bought insurance for their homes. Even if that means people who lost everything they had won't be able to rebuild, the state must stick to its principles. The precedent at stake matters more.