Earthquake Insurance for the Commercial Real Estate Owner
The recent 7.3 magnitude earthquake in Iran on Sunday, November 12th was tragic. Pasadena based Jet Propulsion Laboratory (JPL) predicted a 99.9 % chance of a 5.0- magnitude or higher earthquake in Los Angeles by April 2018, according to a Los Angeles Times article dated October 22, 2015.
The commercial real estate owner usually carries the burden of paying for earthquake insurance if he is covered at all. The majority of commercial real estate owners don’t carry earthquake insurance, according to Erez Golomb an insurance agent at InTouch Insurance Services in Lake Balboa. Golomb said property owners don’t carry the insurance because it is normally expensive and the deductible is high.
Many insurance companies don’t cover earthquake insurance, because the risk is too high, Golomb said. Losses caused by earthquakes are usually excluded in typical commercial property insurance policies. The companies that do carry earthquake insurance usually use a “Difference in Conditions Coverage (DIC) form.”
The DIC can be used to write coverage for flood or earthquake insurance if the primary insurance carrier doesn’t cover it or to add more coverage if the primary insurance limits are too low. For example, a primary commercial property policy may only offer $500,000 earthquake coverage, so the DIC will be used to write coverage in excess over the primary limit.
The owner can impose the cost of earthquake insurance on a new tenant before the tenant enters into a lease. The industrial vacancy rate in Los Angeles is so low that if the tenant didn’t want to pay for the earthquake insurance, they may not find another industrial vacancy elsewhere especially one that doesn’t require earthquake insurance.
In contrast, existing tenants are exempt from paying for earthquake insurance based upon a standard lease. However, it is advisable for an existing tenant to purchase earthquake insurance if they are making improvements on the property worth $1 million or more.
Earthquake policies using a DIC form often provide coverage at limits that are much less than the full value of the property, because full coverage for earthquake insurance is usually not available. DIC’s contain separate limits for flood and earthquake insurance. The DIC policy covers direct physical loss or damage to covered property caused by any covered cause of loss. The separate limits are an aggregate limit, a catastrophe limit, and an occurrence limit. “Most DIC earthquake insurance forms consider all earthquakes and aftershocks as one event.”
There are no standard DIC coverage forms; however, the Insurance Services Office (ISO) and the American Association of Insurance Services (AAIS) offer policy forms in their non-filed inland marine guides. Being non-filed means that insurers do not have to file rates for approval with state insurance departments and have greater flexibility in setting rates and drafting policy language.
DIC policies contain separate deductibles for earthquake and for all other perils. Earthquake deductibles are larger than those for all other perils as well as those found in general commercial property policies. DIC forms use percentage deductibles for loss by earthquake when the exposure is particularly high like in Los Angeles. For example, a deductible may be 10% on a $1 million policy. That means the property owner will pay the first $100,000 out of pocket if an earthquake damages his property.
After an earthquake, the commercial real estate owner is responsible for the repairs of the damaged building. This can be costly. It may take months to repair, and the owner could lose rents for several months. The earthquake insurance plan can pay the lost monthly income to the owner if it is covered in his or her plan. “However, not many plans offer lost income.”
Golomb recommends obtaining earthquake insurance to commercial real estate owners if they can afford it. “It’s like fire insurance,” Golomb said. “How often is your building destroyed by fire?” He added; it’s the same philosophy as earthquake insurance. Nobody knows if there’s going to be a big one. Therefore, the owner should make sure to amend a new lease so that the new tenant pays for earthquake insurance.