Decisions to pay claims from quake were momentous

The 1906 San Francisco earthquake shares several similarities with Hurricane Katrina, which slammed the Gulf Coast last August.

The two disasters wiped out major cities of roughly the same population, leaving hundreds of thousands of residents suddenly homeless.

Just as the flooding that followed Katrina caused much of the destruction associated with that catastrophe, the conflagration that followed the 1906 earthquake caused more damage than the initial ground shaking.

In both cases, insurers faced demands for coverages that their policies explicitly excluded.

Ongoing lawsuits spurred by Katrina, for instance, seek to have insurers pay for storm-surge damage, despite policy language excluding flood coverage. Similarly, many of the fire policies that covered about 90% of San Francisco's property in 1906 excluded earthquake damage and fire damage resulting from earthquakes, according to insurers.

But following the 1906 event, insurers met in New York and uniformly agreed to pay fire losses regardless of the cause, unless irrefutable evidence showed that ground trembling alone had destroyed a structure.

And, despite a lack of policy uniformity and several exclusion clauses with varied wording, insurers settled about 100,000 claims. Out of $235 million in insured losses, insurers paid out about $180 million, according to the New York-based Insurance Information Institute.

The III says that at least 12 insurers went bankrupt and financial impairment kept some underwriters from paying more than a portion of insured losses.

According to Swiss Reinsurance Co., its contracts at the time stated the reinsurer would not pay when its cedents' excluded earthquake losses. But the Zurich-based reinsurer reversed course and decided to follow its cedents' lead, regardless of policy exclusions.

That action "represents our largest ever natural-hazard loss payment expressed as a percentage of annual nonlife premium," the reinsurer states in a report on the 1906 earthquake titled "A Shake in Insurance History--The 1906 San Francisco Earthquake."

Some insurance observers say that political pressure led insurers to settle claims despite being excluded. But paying out losses also gave rise to insurance lore and helped burnish reputations. Swiss Re, for example, says that its decision helped strengthened its market position.

Munich Reinsurance Co. said its chief executive officer at the time traveled to San Francisco and enhanced the company's reputation with his efficient handling of client requests for cash.

The 1906 event still represents the biggest single loss from a natural disaster in the 125-year history of Munich Re, the company said.

The famous telegraph from the Lloyd's of London underwriter Cuthbert Heath ordering a San Francisco agent to "pay all of our policyholders in full irrespective of the terms of their policies" cemented Lloyd's relationship with the United States, according to Wendy Baker, president of Lloyd's America in New York.

Lloyd's had begun writing nonmarine coverages just three years before the 1906 earthquake, and Mr. Heath's decision to pay all claims cost the market $50 million, equal to about $1 billion today.

Now the United States is Lloyd's largest insurance market, totaling 40% of its business, or $9 billion worth of insurance and reinsurance contracts, Ms. Baker said.

Lloyd's currently provides surplus lines earthquake coverage for U.S. commercial entities and reinsurance for the Sacramento, Calif.-based California Earthquake Authority, an entity that offers residential earthquake insurance to California homeowners.

Today, only about 15% of Californians buy coverage from the CEA, which was created in the mid-1990s to address an insurance availability crisis that homeowners faced following the Northridge earthquake in 1994.

Insurers estimate that about 30% to 40% of all California-exposed values are insured for earthquake losses.

Yet, according to the U.S. Geological Survey, "a repeat of the 1906 earthquake is only one of a wide number of future major damaging earthquakes likely to impact the Bay Area."

Catastrophe modeler AIR Worldwide estimates that a recurrence of the 1906 event would cause $300 billion in total property losses today. According to Boston-based AIR, there exists a 6% probability of such an earthquake taking place over the next 30 years.