Not quite the anniversary you had in mind

By Zack Schmiesing September 17, 2014

Zack Schmiesing_Marking a 25th anniversary in the rolling hills of Northern California wine country sounds appealing — unless you commemorate that event with a 6.0-plus magnitude earthquake. On August 24, one hit north of San Pablo Bay in the Napa Valley region, eerily close in timing to the 25th anniversary of the 6.9 magnitude Loma Prieta earthquake that shook San Francisco during the 1989 World Series. Commercial real estate professionals and property insurers quickly recalled the devastation from that quake: $1.8 billion in inflation-adjusted insured damage.

The Loma Prieta quake was followed five years later by the 6.7 magnitude Northridge earthquake, which resulted in $24 billion in adjusted insured damage. According to a recent article in USA Today, the United States Geological Survey predicts a 99.7 percent chance of a 6.7 or higher magnitude earthquake in California by 2037. That’s why property insurers put such emphasis on risk management practices in areas of seismic risk. Just ask any southern Midwest insurer about reinsurance costs along the New Madrid fault, a region that has barely stirred since the early 19th century.

Property Claim Services® (PCS®), a Verisk Analytics business that performs insurance industry loss estimating, puts the initial event loss value at less than $200 million, subject to an update in 60 days. However, as is often the case, there are nuances to data. AIR Worldwide, another Verisk Analytics business, noted in an ALERT(AIR Loss Estimates in Real Time) that damage in American Canyon — the town closest to the epicenter — was negligible. On the other hand, the historic downtown of Napa, which is 6 miles north-northeast of the epicenter, did experience some significant damage. AIR called attention to analyses that attributed the disparity of damage to the rupture propagating to the northwest, toward Napa and away from American Canyon, and the geophysics and soil makeup of Napa that amplify ground motion. This insight shows the value of sophisticated seismic risk assessment tools such as those offered by AIR’s catastrophe modeling as opposed to relying solely on simplified metrics such as “distance to fault.”

Insurers have long used risk assessment tools, such as Probable Maximum Loss (PML) and Maximum Foreseeable Loss (MFL) estimates, to determine exposure from seismic events, fire, and other perils. The industry recently improved its seismic risk management practices with enhanced research, modeling that incorporates global event characteristics, and secondary metrics developed around loss mitigation. Insurers now use new metrics about building code enforcement, exploring potential weaknesses in construction and maintenance that could introduce risk to their assets. The tools provide a better understanding of annual, near-term, and long-term financial implications and loss potential at a specific location or as part of a countrywide portfolio.

The commercial real estate industry also has an obvious vested interest, but despite efforts by ASTM International, there’s a lack of standardized approaches that take advantage of the science available today. In comparison to the insurance industry, commercial real estate due diligence and risk management have become almost perfunctory. Oversimplification of risk data can lead to unanticipated problems down the road. Too often, metrics are used as bargaining chips to get the deal done — with a PML under 20 percent based on the appetite of the buyer, lender, and broker.

Earthquake events remind us that seismic risk can have ripple effects beyond the damaged buildings, and billions of dollars of property and assets are susceptible to this peril. The risks are too great for commercial real estate owners, lenders, and investors to stand by and operate under the status quo. They can have the tools to fight those risks now — if they’ll use them. Contact Verisk Commercial Real Estate to find out how. Please go to www.verisk.com/cre or email me at ZSchmiesing@verisk.com.


Zack Schmiesing

Zack Schmiesing is the director of thought leadership at Verisk Commercial Property.