Loophole Leaves Taxpayers on the Hook for Earthquake Damage

The vast majority of homes in earthquake-prone areas lack any insurance protection against earthquakes, exposing American taxpayers to hundreds of billions of dollars of risk if disaster strikes. And while some lawmakers, including Rep. Sean Duffy and Sen. Tim Scott, are urging policymakers to address the problem, Congress has yet to enact reforms.

The crux of the problem is that federal regulations allow the giant government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac — which combined account for about one-third of the $15 trillion in outstanding mortgage debt in the United States — to purchase mortgages without earthquake protection.

Though the Federal Housing Finance Agency, which oversees the GSEs, requires mortgaged properties to have insurance for fire, flood, hail, theft, vandalism, windstorm, and other risks, there is no requirement to hold earthquake coverage in areas deemed as high risk. This exception makes no sense, especially in light of the fact that earthquakes are among the most devastating and costly natural disasters.

Yet the Federal Housing Finance Agency does not even track the GSEs’ exposure to uninsured earthquake risk.

So when the next big earthquake strikes, the GSEs will be left holding tens of thousands of mortgages belonging to destroyed homes that have no coverage in place to deal with the damage. A recent study estimated that the GSEs’ uninsured mortgage risk is approximately $204 billion. In other words, a major earthquake strike in the United States would potentially destroy billions of dollars in structures that serve as collateral for GSEs’ mortgage portfolios and mortgage guarantees, leaving taxpayers on the hook.

As the probability of major seismic activity grows, policymakers can no longer ignore this problem. In 2008, scientists put the likelihood of a California quake of magnitude 6.7 or larger — the size of the 1994 Northridge earthquake that killed at least 60 people and caused massive damage to the San Fernando Valley — at 99.7 percent over the next 30 years. Today, we’re 10 years closer to that near-certain disaster, and only 13 percent of California homeowners have earthquake coverage.

But it’s not just California. Experts warn that many regions — including the Pacific Northwest, Alaska and Hawaii, and many southern states — are at relatively high risk of a major seismic disaster in the next 30 years. Nearly half of all Americans are exposed to potentially damaging ground shaking from earthquakes, but residents of earthquake-prone areas are consistently uninsured against those risks.

In short, the question is not if a powerful earthquake will strike, but when.

Policymakers can do nothing to stop earthquakes, but they can take positive steps to mitigate the damage and limit taxpayer exposure. The Federal Housing Finance Agency could direct the GSEs to tighten their standards and begin requiring earthquake insurance on homes in quake-prone areas.

An alternative approach would be to transfer the GSEs’ earthquake risk to the private market through reinsurance, a common practice used by insurance companies to mitigate catastrophic risk. This model has been used successfully by the National Flood Insurance Program to limit losses from Hurricane Harvey.

No matter what approach Congress selects, it must carefully avoid placing excessive burdens on borrowing or making housing supply shortages worse. But one this is certain. Congress must not postpone action on this issue.

While we can’t delay or prevent earthquakes, we can be ready when they come.