At a little past five o'clock on the morning of April 18, 1906,San Franciscans were shaken out of bed by a massive earthquakemeasuring between 7.9 and 8.3 on the Richter scale. The groundshook for nearly a minute, and would do so again as many as 27times that day–destroying much of the city in the resulting flames,as well as many of the ways the insurance business handled fire andcatastrophic risks.

The total loss caused by the quake is in dispute, perhapsbecause industrywide records were not as carefully kept as they aretoday.

The Insurance Information Institute in New York estimates the1906 quake loss at $235 million–about $4.9 billion in 2005terms–which would make 1906 the third-worst U.S. quake loss, behind1994's Northridge, Calif., event (over $17 billion in 2005 dollars)and 1989's Loma Prieta, Calif., quake ($11 billion).

One reason 1906 fails to take the top spot on total losses issimply because San Francisco didn't have as many homes andcommercial properties to destroy a century ago as did the quakesthat hit California in more recent times. (See the related story onthe impact a quake that size in San Francisco might havetoday.)

Insurance at the opening of the 20th century was different inmany ways from the current business, although the basis for many ofthe problems faced by companies after the earthquake–uninsurablerisks and a lack of uniformity–reverberates in different formstoday.

To insurers in 1906, earthquakes were roughly the equivalent ofwhat terrorism is today–widely considered an uninsurable risk dueto the potential for enormous, concentrated losses and a lack ofclaims experience on which to base rates.

“No one wrote earthquake insurance,” said Andrew Castaldi, asenior vice president heading up the catastrophe perils team atSwiss Re America and the author of a study examining the role thequake played in history. “It was considered uninsurable.”

In fact, much of the research that would lead to modeling forearthquakes and other catastrophes was done in the aftermath of the1906 quake, leading to the first earthquake premiums appearingroughly 10 years later, according to Mr. Castaldi.

Risk-sharing was also a different concept for insurers at thetime, and typically meant that insurers offered only policies withvery low limits–meaning multiple insurers covered part of the riskto the same property. Although the average home in San Francisco atthe time cost only $2,000 to $5,000, Mr. Castaldi noted that it wasnot unusual for as many as five insurers to provide coverage on thesame property.

Although different companies provided the same coverage to astructure, they each did so under their own policies–with their ownexclusions and contract language, according to Mr. Castaldi. Chiefamong these exclusions were those for fires in the aftermath of anearthquake, he noted–although different companies had differentthresholds for the exclusion.

Some companies, Mr. Castaldi said, would invoke the exclusionfor any fire caused by a quake (such as those started when a lampwas knocked over), while some only excluded those causedintentionally (such as the buildings destroyed to serve as a firebreak to prevent a conflagration from spreading). Perhaps the moststringent, however, were those exclusions that revoked coverage ifa quake simply limited the ability of local firefighters to dotheir job.

Based on these exclusions, Mr. Castaldi said, “there was a legto stand on to say that fire was no longer covered” after the 1906earthquake.

However, as the industry looked more closely at the situation,insurers eventually decided they couldn't simply walk away from theworst U.S. catastrophe in history up until that time on policytechnicalities.

At first, companies operated under the idea of “let's pay forwhat we can prove,” Mr. Castaldi noted, generally using the statusof chimneys as a bellwether for determining if a structure had beendestroyed by a quake or just by fire. If a building's brick chimneywas still standing, it was considered a fire loss and the claim waspaid, but if the chimney had fallen, it was quake-damaged.

Eventually, the major insurers met in New York to discuss theproblem, resulting in an agreement to use the New York StandardFire Policy as a benchmark, and to cover fire claims regardless ofthe cause.

As a result, Mr. Castaldi noted, 80 percent of total claims forlosses incurred during the 1906 earthquake were paid. The remaining20 percent, he said, represented claims paid at a discount byinsurers for properties where the owner would not rebuild, as wellas those filed with insurers that either couldn't pay or refused togo along with the New York agreement.

As a reinsurer, Mr. Castaldi said Swiss Re was facing a simplersituation, in that the reinsurance industry and its policies weremuch more uniform at the time, absolving the company of anyobligations to primary carriers. As losses mounted, however, Mr.Castaldi said Swiss Re felt “morally obligated” to cover the claimsand agreed to “follow the fortunes” of its cedants, regardless ofpolicy language. “We wrote the check and paid in full,” hesaid.

In the aftermath, Swiss Re began sending representatives to meetwith primary insurers in the United States, eventually establishinga local office. “We became tied to the United States, and have beenbuilding on that ever since,” Mr. Castaldi said.

Just as the 1906 quake led to the establishment of Swiss Re onU.S. shores, it also proved to be a seminal moment for the world'soldest insurance market–Lloyd's of London. Although Lloyd's hadbeen around for two centuries prior to the quake, it had beenprimarily focused on maritime coverage and in 1906 had only begundabbling in nonmaritime coverage a few years earlier under thedirection of Cuthbert Heath–described on Lloyd's Web site as “aprominent underwriter who wrote the first Lloyd's reinsurancepolicy on American risks.”

British underwriters provided more than one-fifth of thecoverage in San Francisco at the time, according to Thor Valdmanis,vice president of communications for Lloyd's in New York, who saidthe quake proved to be a property insurance baptism by fire forLloyd's, which paid more than $50 million in claims–over $1 billionin 2005 terms.

However, Lloyd's was not a part of the debate over fire andearthquake damage. Instead, Mr. Valdmanis said Mr. Heath cabled thecompany's San Francisco representative with one simple command:“Pay all of our policyholders in full.”

The payment “made Lloyd's mark” in America for propertycoverage, Mr. Valdmanis said, as well as in other areas around theglobe. “Our response to this cemented our reputation,” headded.

The 1906 earthquake took an enormous financial toll on insurers,and according to Swiss Re is still the company's largest paymentever for a natural catastrophe as a percentage of annual nonlifepremiums.

However, foreign companies such as Lloyd's and Swiss Re had thebenefit of distance. For San Francisco-based Fireman's Fund, the1906 earthquake in its own backyard tested the company's veryexistence as much as its bottom line.

In 1906, Fireman's Fund was “financially stable and had anexcellent reputation” as one of the major insurance companies inSan Francisco, according to Chris Heidrick, vice president ofmarketing for personal insurance. The company was formed more than40 years beforehand in 1863, with a social mission as well as abusiness plan that required a portion of the insurer's profits bedonated to the widows and orphans of fallen firefighters.

The company had already seen its share of disasters, such as theChicago Fire of 1871, and paid off all of its claims resulting fromthat fire despite losses exceeding its assets at the time.

In 1906, however, Fireman's Fund had to face the San Franciscoearthquake not only as an insurer, but also as a victim. “That wasprobably the most severe test that any insurance company has everbeen through,” Mr. Heidrick said, “and Fireman's Fund survived thattest.”

The company's headquarters was destroyed, and in the timesbefore such innovations as remote data storage, this meant thatmuch of the company's files were lost as well. The only records tosurvive the quake were lists of Fireman's Fund's agents andstockholders. Both of those lists were in the desk of the company'spresident, and were carried out by three employees who happened tobe nearby when the quake hit–who tried, unsuccessfully, to alsosave documents in the company vault.

At the end of the day, Fireman's Fund had no headquarters, andmost of its employees had lost their homes. In addition, there waslittle, if any hope of receiving income from the company'sinvestments, most of which had been made in San Francisco areabusinesses that had suffered equal destruction.

The end result of the economic disaster “was like a run on abank,” Mr. Heidrick said, as policyholders sought to have theirclaims paid from a company that had suffered as much as theyhad.

Today, the first problem facing an insurer whose records hadbeen destroyed would be figuring out exactly who theirpolicyholders are, but this proved to be one of the fewcircumstances in which the old ways of the industry provided asolution.

“Business was done more by relationships then,” Mr. Heidricksaid. “Companies had many more employees, and agents didn't have asmany customers.” These relationships, he added, allowed Fireman'sFund to identify its policyholders.

Paying them, however, would prove to be more difficult. Mr.Heidrick said Fireman's Fund came up with a “very creative way” toprovide for its policyholders. Effectively, the company literallyrecreated itself, offering policyholders stock in the new companyas part of claims payments. The policyholders held a “town hall”style meeting to debate the offer, and ultimately voted to agree tothe settlement plan.

Ironically, much of the plan's success was based on the factthat Fireman's Fund did not know how much its loss actually was.“They didn't realize the full extent,” Mr. Heidrick said. “That'swhat kept Fireman's Fund out of insolvency.”

By the time the company was able to fully assess losses, thesettlement program had already been approved and policyholderstaken care of. “By that point the company had recapitalized,” headded.

In the end, Mr. Heidrick said the settlement plan was a“win-win” that compensated policyholders for their losses and gaveFireman's Fund the financial wherewithal to play a leading role inrebuilding its home city.