Hurricane Sandy is a stark reminder of the importance of getting disaster insurance. Actuaries estimate insurance companies will likely have to pay out more than $25 billion in claims as a result. Looking on the bright side, this means those paying for insurance are able to collect. On the dark side, lives have been turned upside down.
As a long time resident of San Francisco, I wonder about getting earthquake insurance every single year. San Francisco lies close to the San Andreas fault line which could start shifting at any moment. The last big earthquake was the Loma Prieta earthquake on October 17, 1989 which killed 63 people. After 23 years, perhaps we are due.
California mandates insurance companies send earthquake insurance prospectuses to all homeowners every single year. Each time I look over the earthquake insurance documents, I get this much closer to getting insurance, but I never go through with it because of the enormous deductible of around 10-15%. In other words, if my home is worth $2 million dollars, I’ve got to pay the first $300,000 out of pocket first before getting anything from the insurance company. Furthermore, the yearly premium is around $5,000.
A CHECK LIST TO DECIDE WHETHER OR NOT TO GET DISASTER INSURANCE
* Do you live in a high-risk area? Homeowners tend to downplay the risks they face because hardly anything really ever happens. Even when a hurricane does pass through, chances are high nothing will happen to your home. If you live in a coastal state, Texas, Louisiana, or Hawaii, you are subject to hurricanes. If you live west of the Rockies, in Alaska, New England, and along the Mississipi River, you are subject to earthquakes. If you live right on the coast, in low lying areas, or near water, you are subject to floods. Basically, disaster can strike anywhere at anytime. You’ve just got to figure out how risk prone you are.
* When was the last time you invested in disaster mitigation? After the 1989 earthquake, homeowners in danger zones were mandated to “earthquake proof” their homes with stronger foundations. All new construction after 1989 also required stricter foundation construction. As a result, buildings are now safer than ever before. Obviously we won’t know how strong our homes are until angry nature comes, but we should believe the more we invest in disaster mitigation, the better we will come out at the other end.
* Have you talked to your long time neighbors? One of the first things I did before and after I bought my house was ask my neighbors how the 1989 Loma Prieta 6.9 earthquake affected our block. One 69 year old neighbor who has owned his building since 1975 told me not a lot happened at all. Some dishes fell off the shelves, but that was about it. However five blocks west of us several houses had to redo their facades due to cracks. The houses that sustained structural damage were situated 15 blocks away as they were built on top of sand.
* What is the estimate of potential damages? After speaking with my neighbors and doing more research about the 1989 earthquake online, I made a realistic $25,000 damage estimate if a similar 7.0 magnitude earthquake hits. I compared $10,000-$25,000 to my earthquake insurance deductible + $5,000 in annual premiums and decided it wasn’t worth it. It’s important each of us assess realistic estimates of what a disaster might cost us out of pocket. Now that I think more of it, $25,000 might not be enough since construction costs have increased over the decade.
* How big is your emergency savings? The less emergency savings you have, the more you need insurance. If disaster strikes, you could borrow from your 401K, borrow through P2P lending, draw money from a HELOC, or go directly to friends and family. Given people will be much more open to lending you money in times of disaster, the need for an emergency fund decreases, as does the need for insurance unless everyone you can borrow money from is also affected!
* How dependent is your retirement on your home? Given our homes are often our largest asset, there’s no doubt many people count on their homes to provide rent-free security once the mortgage is paid off, or rental income if they are a landlord in retirement. Some may even depend on their homes to do a reverse mortgage for income. Whatever the case may be, the higher your home is as a percentage of your net worth, the more you need to consider getting disaster insurance.
* How much equity do you have in your home? This is probably the only situation where having little to negative equity is a good thing if disaster strikes. You can simply walk away from your house without the need to repair it. Disasters are one of the biggest reasons why people should not pay down their mortgage. As I wrote before, the ideal mortgage amount is $1 million if you can afford it. That $1 million is debt your bank will eat if something bad happens, not you. If you have lots of equity in your home, definitely raise your consideration of getting disaster insurance.
IF THINGS GET REALLY BAD THERE IS SOME GOOD
The only positive out of a really bad situation is that the Federal Emergency Management Agency (FEMA) might step in to provide small grants for emergency repairs and temporary housing. Meanwhile, the Small Business Administration (SBA) may offer up to $200,000 in a low-interest loan for rebuilding. The irony is that if you have insurance, you will be less likely to get such assistance from the government. The same thing happens to people who responsibly paid their mortgages on time during the housing crisis. Only those who didn’t pay, got help!
When things get really bad even worse things often happen. Rebuilding costs soar during times of emergency, largely due to an upward shift in the demand curve. There will also inevitably be price increases by suppliers of material and services to help mitigate such a surge in demand. Lines for gas at the pump last for hours, while electricity might not come back on for weeks, if not months. How long can you go without gas or electricity? I’m at about two weeks before I go crazy.
The worst feeling in the world is losing everything and not knowing whether you will ever recover if you don’t have insurance. The second worst feeling during a disaster situation is having insurance, and not knowing whether you will ever collect. Hysteria seeps in leading people to think irrationally about losing everything outside and inside their homes.
SOME OF CALIFORNIA’S LARGEST EARTHQUAKES (RANKED BY MAGNITUDE)
|7.9||Jan. 9, 1857||Fort Tejon||2 killed, 220-mile surface scar|
|7.9||April 18, 1906||San Francisco||3,000 killed, $524 million in property damage, including fire damage|
|7.8||March 26, 1872||Owens Valley||27 killed, 3 aftershocks of 6.25+|
|7.5||July 21, 1952||Kern County||12 killed, 3 aftershocks of 6+|
|7.3||Jan. 31, 1922||West of Eureka*||37 miles offshore|
|7.3||Nov. 4, 1927||SW of Lompoc*||No major injuries, slight damage|
|7.3||June 28, 1992||Landers||1 killed, 400 injured, 6.5 aftershock|
|7.2||Jan. 22, 1923||Mendocino||Damaged homes in several towns|
|7.2||Nov. 8, 1980||West of Eureka*||Injured 6, $1.75 million in damage|
|7.2||April 25, 1992||Cape Mendocino*||6.5 and 6.6 aftershocks|
|7.1||Oct. 16, 1999||Ludlow (Hector Mine Quake)||Remote, so minimal damage|
|7.1||May 18, 1940||El Centro||9 killed, $6 million in damage|
|6.9||Oct. 17, 1989||Loma Prieta||63 killed|
|6.7||Jan. 17, 1994||Northridge||61 killed, $15 billion in damage|
|6.6||Feb. 9, 1971||San Fernando||65 killed, $50 million in damage|
REMEMBER TO THINK LIKE AN INSURANCE COMPANY
Insurance companies are there to make money. They can only exist if the collective premiums they take in, and the returns they make from the premiums consistently beats the claims they pay out. You need to be prepared to FIGHT for every claim because some insurance companies will make it extremely difficult for you to collect, especially during times of low investment return. The horror stories I hear in the health insurance industry are absolutely despicable.
What I recommend everyone do is find a respectable insurance company and concentrate as many policies as you comfortably can so that you build leverage. For example, bundle your auto, property, umbrella policy, and disaster insurance together. Your agent will love you, and you will be tiered as a higher valuable customer. As a higher valued customer, they will give you less grief during filing, and will also give you the best rates.
I’ve got my auto insurance, property insurance, personal property insurance, umbrella policy and several CDs with one insurance company. When I filed a $7,500 claim for a lost watch, I told a nice claim agent that I lost it on the beach in Hawaii. I answered about seven questions in under 10 minutes and three weeks later I got a check for $7,500! They didn’t bat an eye because they are making lots of money from me for the past 15 years.
GET DISASTER INSURANCE IF THE FOLLOWING APPLIES
* You live in an area prone to disaster and plan to live in your house throughout the disaster cycles. Let’s say massive hurricanes hit once every five years for the past 100 years. You plan on living in your house for the next 40 years. Disaster insurance is appropriate.
* You can’t sleep well at night knowing you do not have disaster insurance. A lot of insurance is about peace of mind. If you are a worry wort, then getting disaster insurance provides better value to do those who hardly ever worry.
* You are thinking about selling your house in the next 12-24 months. The worst thing that can happen is that you sell your house because you need the money only to have your house get destroyed.
* You have a lot of your net worth tied up in your home. The more of the home you own, the more you have to lose, but the insurance coverage is the same. Therefore, you get a better return on your disaster insurance for your assets.
I pray the big one never hits San Francisco just as I pray all of you never have to experience such disaster. Hopefully this article will help you make a more informed decision and save you money in the process.
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