As you get into the very large commercial loans, especially in California, the issue of earthquake risk looms large. When lending on large commercial properties constructed prior to 1980, commercial lenders will sometimes require a PML Report.
A PML Report is an earthquake damage report completed by a civil engineer. The report asks the question, “How badly damaged would this building be if there was a really big earthquake?” Is the building going to completely collapse, like those unreinforced masonry buildings in San Francisco did in 1989 during the Loma Prieta earthquake?
My old friend, Mike Thurman, was actually at Candlestick Park for game three of the World Series when the Loma Prieta earthquake hit. Fortunately the stadium was well-designed to absorb earthquake shock, and everyone was able to calmly leave the stadium to drive home.
Unfortunately those driving home to the East Bay discovered that the central strand of the Oakland Bay Bridge had collapsed, hurtling several passengers and their cars to their death hundreds of feet below. Interesting note: When a section of the upper-deck freeway in Oakland collapsed onto a lower deck, sadly crushing and killing 60 drivers below, among the victims was a car thief attempting to make his getaway.
More specifically a PML Report seeks to quantify the Probable Maximum Loss. The Probable Maximum Loss (PML) is a tool used to evaluate the seismic risk of a building and identify assets with high seismic risk. The Probable Maximum Loss report identifies the PML value, expressed as a percentage of the building's replacement cost and estimates the potential damage during a 475-year earthquake - the lower the percentage, the lower the expected damage. The PML value can be expressed either as the Scenario Expected Loss (SEL) or the Scenario Upper Loss (SUL). They mean the same thing.
If the Maximum Probable Loss is too high – let’s say greater than 45% - a lender making a large commercial loan might require earthquake insurance. Earthquake insurance is phenomenally expensive, on the order of 2% to 3% of the value of the building annually!
To make matter worse, the earthquake insurance deductibles are huge – on the order of 15% to 20% of the value of the property.
Let’s suppose you own a $15 million commercial building in Los Angeles. The land is worth is worth $5 million, so you only insure the $10 million building. Suddenly an 8.2 earthquake hits L.A., the building collapses, and the loss is total. Even if you had the entire building insured, your insurance company might only pay you $8.5 million, rather than your entire $10 million loss.
And to make matters worse, the insurance company probably wouldn’t survive to pay the claim anyway.
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