A century of aftershocks: the Great San Francisco Earthquake and Fire of 1906 remains a milestone in insurance risk assessment. On its centennial, the post-Katrina world is asking the obvious: "What if ...?".

Key Points

* The 1906 San Francisco earthquake shook the insurance industry into thinking differently about risk.

* The event shaped the industry's approach to disaster planning, cat modeling and risk management.

* Such a quake in the Bay Area today would be primarily a structural exposure, not a fire exposure.

"The city of San Francisco is one year old today. There was a city of San Francisco a year and a day ago; an old city, as time runs in this new land; the embodiment of 50 years of stirring Western life ... set at the gate where the Farthest West meets the Farthest East, and sharing many of the characteristics of both; a loved city, whose generous faults are remembered with no less affection than its virtues. That city is gone, never to return."

"San Francisco's First Birthday" Coast Seaman's Journal, May 8,1907--The Virtual Museum of the City of San Francisco 

A century after the pinnacle event that shaped insurance history--the Great San Francisco Earthquake and Fire of 1906--insurers are asking themselves, and each other: What if it happened again?

About 5:12 a.m. on April 18, 1906, the San Andreas fault, which runs 600 miles from the Gulf of California northwest along the California coast, gave way to ever-building seismic pressure and exploded in one of the largest quakes to hit California. It was estimated to be magnitude 8.3-8.7 on the Richter scale; turn-of-the-century seismic machinery failed due to the sheer intensity of the quake.

Buildings shook, then gave way in an explosion of bricks and stone. Streets split in two as the ground beneath them heaved, and water and gas mains ruptured. And what still remained standing after the last shocks subsided was consumed over the next three days by ensuing and unquenchable fires.

The episode, which included more than 25 aftershocks, took more than 3,000 lives; leveled some 28,000 buildings, according to the U.S. Geological Survey; and incurred losses of some $400 million, equal to more than $8 billion today, according to statistics kept by Fireman's Fund Insurance Co. Other sources put that 1906 estimate at closer to $500 million, with an insured liability estimated at $235 million.

"The event shaped the insurance industry," said Andrew Castaldi of Swiss Re, Zurich, who along with colleagues Mariagiovanna Guatteri and Martin Bertogg authored, A Shake in Insurance History--The 1906 San Francisco Earthquake, to mark the quake's centennial and provide insight into that century-old question: What if it happened today?

According to recent estimates from the USGS, there's a 70% chance that an earthquake of magnitude 6.7 or greater will strike the San Francisco Bay area over the next 30 years. Luckily, the insurance industry has learned much about earthquake preparedness over the past century. While fire caused about 80% of the destruction of 1906 San Francisco, it was not an insured risk 100 years ago, Castaldi said.

"Since earthquakes were not covered (they were then considered 'uninsurable'), the fire that followed the quake, whether caused as a result of the quake or indirectly, was not covered for the most part," said Castaldi, who heads Swiss Re's Cat Perils team for the Americas. "Insurers of the day drew a very fine line between fires caused by the quake and by other elements, such as accidental fires caused by survivors."

"After that, fire was covered whether it was from an earthquake or not," Castaldi said. "This affected the insurance industry. It also proved that earthquakes probably could be insurable. We survived it."

Early death reports due to the 1906 quake ranged from 400 to 700; the San Francisco Police Department later upped that to 1,000 to 1,500 fatalities. The true number of more than 3,000 killed wasn't revealed until many years later, as city officials did not want to deter people from repopulating the city. More than half of San Francisco's 400,000 citizens--about 223,000--were left homeless, living in tent cities or in shelters made from debris.

Swiss Re's experts predict fewer fatalities in a 2006 event. In a worst-case scenario--a similar-size quake hitting downtown San Francisco at 2 p.m.--they estimate approximately 1,200 deaths, said Guatteri, a catastrophe perils earthquake specialist. That's due to improved building codes and infrastructure.

The 1906 event "remains a milestone in insurance history, having acted as a catalyst for many changes in the way this industry evaluated and mitigated natural catastrophe risk," she said.

"Cat modeling was built off of the science that was created in response to the 1906 quake," Castaldi said." Scientific and engineering research, seismic studies and model applications were the direct result of this new science, which eventually led to cat models."

"Modeling and mitigating risk is an ever-evolving process," Guatteri added. "The centennial of this catastrophe showcases the need for--and Swiss Re's ongoing commitment to--understanding risks and provisioning for the possibility of infrequent large events."

"I think the insurance industry shouldn't lose sight of how important that event was to us," Castaldi added.

Handling Losses

In 1906, about 100 insurance companies were writing policies for households and businesses in San Francisco. Some 90,000 claims poured in within the first week, and around 37 insurance firms were forced to pass on the liability to their stockholders--assessing them a total of $32 million in claimed money. The insured losses put dozens of insurers out of business, and put the rest through the ultimate test: How much loss could they handle?

"We came up with some unique ways to pay the claims that insurance regulators may not approve of today," said Chris Heidrick, vice president of marketing, personal finance for Fireman's Fund. The company's downtown headquarters was destroyed, and the company itself was made insolvent by paying its claims (about $11 million in insured losses). It recovered by forming a new company and giving its remaining unpaid policyholders stock in the newly formed entity.

"And that's in addition to not having a building anymore, and having every one of your employees at the very least homeless, and having no policy records. They were all kept in a vault that was exposed to fire and destroyed," Heidrick added. "We didn't even know who our customers were."

Earthquake insurance is "a unique risk for an insurance company," Heidrick said. "You know an earthquake is going to happen in California at sometime, somewhere. Not having any more information than that makes it very hard to insure."

But it has become easier to prepare. "Our headquarters today are built on rollers," he said. Rollers enable the building to sway with the earthquake movement, rather than against it. In the early 1980s, Fireman's Fund relocated its headquarters 30 miles north to Novato, Calif.

Seismic experts have said it's unlikely the next great San Francisco quake will originate from the San Andreas Fault. Two other major faults also run through San Francisco: the Hayward, which runs on the eastern side of the city from San Jose up through Berkeley to the bay, and the Calaveras, which runs from the southern part of the state parallel to the Hayward. Folks are betting on the Hayward Fault.

"It's the idea of seismic movement building up in the Earth's crust," said Patricia Grossi, a manager for earthquake modeling at Risk Management Solutions, a cat risk management provider founded at San Francisco's Stanford University in 1988. While seismic energy has been building up in the Hayward Fault for more than a century, its last major seismic release was in 1830. It's due.

RMS is in the process of re-evaluating its 1995 report titled, What If the 1906 Earthquake Strikes Again? Grossi said. In the report, RMS projected 3,000 to 8,000 fatalities and 8,000 to 18,000 serious injuries, with insured losses of $80 billion to $105 billion. The figures are partly based on logistics.

"Building exposure and population exposure have increased exponentially," Grossi said. And while the major exposure in 1906 was due to the fire that followed, "we wouldn't expect the same today. Residential building fire response would be much better in terms of fighting fires. Infrastructure has improved."

Risk management firm Eqecat of Oakland, Calif., estimates insured losses of such an event at $30 billion to $40 billion, said Senior Vice President Tom Larsen. "If this type of event were to occur today it would include property, as in 1906, but also workmen's comp," he said. How severely workers' comp would be impacted would depend on the time of day the quake hit.

But a major quake near San Francisco also could affect the state's drinking water, should tremors reach the delta area eastward near Stockton and Sacramento. "People talk about the delta and the potential to have an island submerge," Larsen explained. "It's 80 miles from San Francisco, but it would cause huge water-quality issues. It could cause very widespread problems."

The city has done much over the past 100 years to reinforce its firefighting water lines and now has a supplementary water line, he added. In 1906, ruptured water lines hindered firefighting efforts. Yet, "there's the potential [for fire following] because San Francisco still has a lot of wood buildings, but it's not a high likelihood," Larsen said. "There's a lot more masonry today."

Changing Exposure

Such a quake in the Bay Area would be primarily a structural exposure, not a fire exposure, agreed Joann Selleck, a member of Cozen O'Connor law firm and the office managing partner of its San Diego office. "San Francisco is a very different place now than it was in 1906. Then, it was really a wood city," Selleck said. "There are many more earthquake-savvy health and safety mechanisms in place in the city. We probably can just flip a switch in many locations to turn off the gas and electricity."

Upgraded mandates from the International Code Council have helped to mitigate such risks. "Many new buildings constructed since the 1980s have retrofitting as a result of building codes and improved construction practices," Selleck said. Yet the growth of San Francisco's population centers since 1906 would have a "tremendous" demand on resources responding to losses. "Accessing the site of an earthquake is a challenge," Selleck said.

Two major events are forcing people to think differently today about risk: the terrorist attacks of Sept. 11, 2001, and Hurricane Katrina, said Harvey Schiller, chairman and chief executive officer of risk management solutions provider GlobalOptions Group, Washington, D.C. The Sept. 11 attacks sent "a strong statement to government" about major risks and the response to those risks, while Katrina made individuals think harder about personal risk.

GlobalOptions acquired disaster recovery and mitigation management firm James Lee Witt Associates LLC of Washington, D.C., in January. Witt, who remains chairman and chief executive officer of JLWA, identified some 450 natural disasters within the past decade in the United States alone. Coupled with terrorism, the world risk environment has certainly changed over the past century, Schiller said.

Witt, a former director of the Federal Emergency Management Agency under President Clinton, also is chief executive officer of the International Code Council. While Uniform Building Codes have made California better prepared against a major quake, current cat model predictions show if either the San Andreas or Hayward faults produce a major quake, "it could be a $400 billion event," Witt said.

A $400 billion event "would affect not only California in a disastrous way, but also affect our national economy. So everything we can do today will lessen that impact," Witt said. "We're better off today than we were 20 years ago, but we still have a long way to go making sure that we are prepared."

Getting Prepared

Witt would like to see a revival of Project Impact, a FEMA project created during the Clinton administration, which provided partner communities with seed money to help identify, develop and implement their own risk plans. Also, California is one of two states--including Florida--that have a state-directed catastrophe pool, and Witt would like to see more of them.

As a leading partner of the grassroots group, ProtectCalifornia.org, Witt said, "We're going to try to encourage states to develop cat funds for each, depending on what risks they have." In each state, 20% to 30% of the fund would go toward mitigation, prevention, public awareness and prevention. He's also pushing Congress to pass a national catastrophe fund to pick up where individual state pools leave off. "I think it's the right thing to do at the right time," he said.

Castaldi, who belongs to the Reinsurance Association of America, is opposed to a federal catastrophe backstop. Speaking for the RAA, Castaldi said he sees "no need for federal pools."

"The only reason people are pushing for them is to cover for fundamental problems where over-regulation is suppressed," Castaldi said. "If you support a federal program, you're supporting actuarially unsound rating approaches."

Yet obtaining earthquake insurance is "a big problem" for Californians, Witt said. It's "very expensive" and "the deductibles are high." While it's estimated that just 25% to 60% of all the homes affected by Hurricane Katrina were protected by flood insurance, in California fewer than 15% of all homeowners carry earthquake insurance.

After the Northridge quake in Southern California in 1994--the most costly quake in U.S. history, causing an estimated $16.5 billion in insured property losses--some homeowners told Witt of deductibles as high as $30,000. "That needs to be addressed" he said.

In 1995, California lawmakers declared insurers must offer earthquake insurance. In 1996 they formed the California Earthquake Authority, a privately financed, publicly managed organization that offers basic earthquake insurance through its member insurance companies. CEA rates average $2.79 per $1,000 of coverage, per year. Residents in higher-seismic-risk areas pay higher rates than those in lower-seismic-risk areas. Base-limits CEA policies carry a 15% deductible based on insured value.

Direct premiums written for earthquake coverage in California (excluding the CEA) totaled $722 million in 2004, or 45.3% of total U.S. earthquake premiums of almost $1.6 billion; and the CEA, the largest provider of earthquake insurance in California, accounted for $465.4 million of the total earthquake premiums in 2004, up 5.2% from $442.4 million in 2003, according to figures obtained by the Insurance Information Institute. Today the CEA has access to more than $7.2 billion to pay claims, enough to cover two earthquakes as severe as the Northridge quake.

The CEA voted in August to cut insurance rates by more than 22%; policyholders could see premiums decrease by $100 to $600 per year depending on the location and age of the building. As of late February, the rate change had not yet been approved. Commissioner John Garamendi did not respond to requests for an interview.

With the low take-up rate of residential earthquake insurance, it's easy to see how Californians are "iii prepared" for the next big disaster, Castaldi said.

"If you take a sizable event like Katrina, and you've heard of all the anguish of people who didn't have the proper flood insurance, there was a significant amount of pain," he said. "Think about the earthquake--and that there are only one out of five people covered."

There are further lessons to be learned from the 1906 quake, Castaldi said. "It's a reminder: In a year or two years from now, I wonder how we're going to think about storm surge flooding in New Orleans and areas like that?" he said. "We move on; perhaps sometimes we move on too quickly."

Making History

Alfred M. Best's special report on the losses and claims paying practices of 243 insurers and reinsurers following the Great San Francisco Earthquake and Fire of 1906 established A.M. Best Co. as the trusted source of financial solvency data. Some excerpts from that report:

* "Taken as a whole, the companies paid their losses remarkably well, but it is nevertheless the fact that there were many companies which, while able to pay in flail, met their creditors in an arbitrary and technical spirit."

* "An insurance company which meets its obligations under ordinary conditions, but which in the face of extraordinary losses endeavors in every way to evade its just obligations, is not the Company which the thoughtful and conservative business man will choose to indemnify him against loss."

* "When it is remembered that only the capital and net surplus of an insurance company are available for payment of claims, it is remarkable that a greater number of failures did not occur."

* "The sworn statements ... filed by 76 domestic fire insurance companies licensed in California at the time of the conflagration (which were those most heavily involved) ... indicate that no less than 44 domestic companies were insolvent immediately after the fire."

Learn More

California Earthquake Authority A.M. Best Company # 12534 Distribution: Through 17 participating insurance companies, via agents or company representatives.

Fireman's Fund A.M. Best Company # 00034 Distribution: Agents and brokers

Swiss Re A.M. Best Company # 85010 Distribution: Reinsurance brokers

For ratings and other financial strength information about these companies, visit www.ambest.com.

Future Shakes

Many critical facilities in the Bay Area of California will likely experience damaging earthquake shaking in the next 30 years.

[TABULAR DATA OMITTED]

Taking the Brunt

Top writers in earthquake, auto, homeowners, commercial and reinsurance would likely experience the greatest losses if a repeat of the 1906 San Francisco earthquake were to occur today.

Top 5 Writers, Calif.,
Commercial Multi-Peril,
2004

Group market shares (%) are based on direct
Premiums written.

St. Paul Travelers Group   9.08
Farmers Insurance Group    8.81
Allianz of America, Inc.   8.73
Nationwide Group           6.74
Hartford Group             6.49

Source: A.M. Best Co.

Note: Table made from bar graph.

Top 5 Writers,
Calif., Earthquake,
2004

Group market shares (%) are based on direct
premiums written.

California Earthquake Auth       39.19
St. Paul Travelers Group          8.61
Zurich Financial Svcs NA Group    8.30
State Farm Group                  4.44
Axis Insurance Group              3.69

Source: A.M. Best Co.

Note: Table made from bar graph.

Top 5 Writers, Calif.,
All Private-Passenger Auto,
2004

Group market shares (%) are based on direct
premiums written.

State Farm Group                  13.66
Farmers Insurance Group            9.74
Mercury General Group              9.21
Automobile Club of S. Calif. Gr    8.93
California State Auto Group        8.65

Source: A.M. Best Co.

Note: Table made from bar graph.

Top 5 Writers, Calif.,
Homeowners Multi-Peril,
2004

Group market shares (%) are based on direct
premiums written.

State Farm Group              22.28
Farmers Insurance Group       16.57
Allstate Insurance Group      13.52
California State Auto Group    5.67
USAA Group                     4.48

Source: A.M. Best Co.

Note: Table made from bar graph.

Top 5 Global
Reinsurance Groups

Ranked by consolidated gross premium written
in 2004.

($ Millions)

Munich Re                  $30,558
Swiss Re Group             $28,047
Berkshire Hathaway Group   $13,085
Hannover Re                $13,053
Lloyd's of London          $11,883

Source: A.M. Best Co.

Note: Table made from bar graph.

San Francisco Under Attack

If a repeat of the 1906 earthquake were to occur today, the city of
San Francisco (excluding surrounding areas) would likely experience
the following losses:

Total economic   Shaking only       Losses include building damage,
losses           $40 Billion        business interruption, lost wages,
                                    lost rental income and cost of
                                    relocation.

Buildings        Shaking only       Poor soil conditions would account
damaged          $29 Billion        for approximately 10% of the
                 (28% of total      damage citywide (up to 20% in the
                 value)             worst soils areas.) Some $20
                                    billion due to damage to
                                    residential buildings.

                 Shaking and        The damage caused by fire
                 fire following     following strongly depends on
                 $38 Billion        weather conditions. The estimate
                 (36% of total      is an average of various wind
                 value)             conditions.
                                    In the downtown area, fire
                                    destruction could be as high as
                                    40% of the total damage (in 1906,
                                    about 80% of the building damage
                                    was due to the fire following).

Buildings        Shaking and fire   28,000 buildings were destroyed in
destroyed        45,700             1906.

Casualties       1,220 fatalities   Estimate for a 2 p.m. scenario,
                 4,750 requiring    for which the highest number of
                 hospitalization    casualties is expected due to the
                                    high presence in office buildings.

Displaced        136,000
households

Source: Swiss Re