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California Earthquake Would Accelerate Mortgage Meltdown

As a result of not having mandatory earthquake insurance in California, a new report from a capital advisor in Chicago says high levels of mortgage defaults would take place in the state if an earthquake ever occurred there.

According to the analysis, "The Annual Global Climate and Catastrophe Report 2008," by Impact Forecasting LLC, a division of Aon Benfield, 86% of Californian homeowners do not have earthquake coverage, despite most of them having mortgaged their homes.

"Freddie Mac and Fannie Mae — the beleaguered financial entities that helped provide liquidity to the U.S. mortgage market — never required homeowners to purchase earthquake insurance for their properties,” said Bryon Ehrhart, chief executive officer of Aon Benfield's analytics division. He said the 1994 Northridge earthquake cost the mortgage industry up to $400 million in mortgage defaults due to foreclosure expenses, property repair costs, lost interest income, writedowns of existing loan balances and other administrative costs.

“It is hard to believe that there could be further downside for investors in mortgages than experienced in 2008 but the earthquake risk to the mortgage market is realm,” he said.

In light of current economic conditions, a major catastrophe like an earthquake would bring new misery to both U.S. and international financiers. According to the report, the most significant natural catastrophe in 2008 was the tragic earthquake in China on May 12. Impact Forecasting said very little insurance was in place on the destroyed properties, and the rebuilding costs are significant, currently estimated at $146 billion.

The largest insured loss event in 2008 was Hurricane Ike, where costs are still being tabulated but it is likely to be the third most costly hurricane on record, the report said.

Additionally, the Climate and Catastrophe Report reveals that between 1995 and 2008 there has been an increase in the average frequency of hurricanes in the Atlantic Basin. Average hurricane activity for the period stands at around eight hurricanes per year compared to a 59-year average of 6.2 hurricanes per year.

Hurricane intensity has risen dramatically in the same period, with a 45% increase in Category 3, 4 and 5 hurricanes, and a staggering 82% increase in Category 4 and 5 hurricanes, the report noted.

Whether the increase in severe storms is a direct result of warmer Atlantic Ocean temperatures is still a hot topic of debate, according to Steven Drews, associate vice president and lead meteorologist of Impact Forecasting and co-author of the report.

"Debate on this subject will continue through 2009 as additional research by experts within the climatological and meteorological fields is peer-reviewed, published and debated on in various science and environmental publications. As this debate continues and the insured risk along coastlines continues to grow, insurers and reinsurers need to become even more aware of their risk in hurricane-prone areas and continue to manage that risk through portfolio optimization and catastrophe modeling," Mr. Drews said.