Should I Get Disaster Insurance For Earthquakes, Floods, And Hurricanes?

Earthquake Fault Lines In SF Bay AreaHurricane 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)

Magnitude      Date                    Location             Comments
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.

Recommendations For Property Homeowners:

* Get the best home insurance possible. In order for your property to grow in value you must protect your property from damage. Fires, floods, leaks, theft, and other accidents happen all the time. If you have cut-rate insurance, you could very well pay way more than you should. I highly recommend checking with USInsurance.com online to find the best home insurance rates. They have a huge network of providers that will compete against each other to provide the most tailored home insurance coverage possible that is affordable. Mobile home insurance, renters insurance, condo insurance, and homeowners insurance are just a few of the options based on the type of home in which you reside. Leverage the internet to save money and protect your largest asset.

* Check Your Credit Score: Take a moment to check your free credit score through GoFreeCredit.com, a company I trust. Over 30% of credit reports have errors which can really bring down your borrowing capabilities. I once had a $8 missed utility bill payment which crushed my credit score by over 100 points!

Regards,

Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. pcash says

    This is exactly the article I was going to ask you to write. I co-own three properties in the LA area, and I too don’t have earthquake insurance. Thanks!

  2. Ivy says

    In NJ earthquake insurance doesn’t make much sense (for now:-)

    Hurricane is covered by regular home insurance policies with 5-15% deductible (plus I was told by my insurance company a storm in NJ rarely meets the hurricane criteria if you live inland, so all good here)

    Flood is only through FEMA, I have yet to see any insurance company offer private flood insurance. This is something I would actually give up in a heartbeat, the moment my mortgage is paid off (we are actually paying it down aggressively with that explicit goal in mind) – it’s mandatory for us because a quarter of our backyard is in the official flood zone. It’s ridiculously expensive (4 times our home insurance premium), and it covers almost nothing inside, just structural elements if you read the fine print. Unless you are at the coast and at risk of complete destruction, self-insurance is a much better option. However try going and convincing our mortgage company.

  3. says

    Wow earthquake coverage is more expensive than I thought! I don’t think I know anyone who pays for it here. Hopefully the next big one won’t happen while I still live in the Bay Area. I do have disaster kits at work, home, and for the car though!

  4. says

    I survived the Northridge earthquake without insurance. I sold that property and moved to a townhouse that had extensive damage in the earthquake. It was repaired and meets 1996 building codes. I choose to have earthquake coverage because it costs me a few hundred dollars a year. I only have a 10% deductable too. Since I live in a condiminium I could be assessed for the communitiy’s deductible. Last time it was $17K. I shopped my insurance extensively and found a AAA rated company that covers (HOA) assessments from a loss.
    I can agree with your logic regarding your circumstances and still take disaster insurance coverage for my place. My approach is not that different from yours, but my cost is significantly less.

    • says

      10% deductible is not THAT bad, but it is still a lot of money if you live in even a $500,000 house. What is the annual premium?

      Why did you decide to move into a place that got crushed by the earthquake? Was it a good deal? Thx

  5. says

    We went through this process this year when our insurance company dropped coverage on part of our structure (the pool & cage). Details here – http://www.plantingourpennies.com/2012/08/01/how-we-decided-to-self-insure/

    But we basically figured out that when you considered capped coverage limits during hurricanes and tropical storms, deductibles, and premiums, we felt better off taking a calculated risk of not purchasing coverage that would include those areas. We figured out our “breakeven” and went with it. So far, so good.

    • says

      Capped coverage limits should be adjusted for the amount we are willing to pay for coverage. If people knew Insurance companies wouldn’t screw them over all the time, maybe more people would get more insurance and the insurance companies could make more!

  6. Mike says

    I think I’ll be doing more research on this. I am not exactly sure where to start but I guess I’ll figure it out! Never thought of disaster insurance like this.

  7. JayCeezy says

    My own thought is that the odds are remarkably low for a total loss, even in a high-risk area like San Francisco, that I will accept that risk. In Sam’s example, 20 years premium at $5K/yr is $100K, plus the 15% deductible of $300K means an outlay of $400K on a $2mm home. I am not sure of the details (and I’m not asking!) on the land/structure ratio for Sam’s example, but one consideration is that home values include the land (location, location, and that other one) and rebuilding is much less. In my case, the land is 40% of my home’s value.

    If the worst did happen, I would most likely want to take my $400K and start over somewhere else, rather than fight through years of claims and rebuilding and living elsewhere anyway (assuming I survive).

    But everyone’s circumstance is different, and as one builds net worth it is a valuable thing to evaluate and re-evaluate.

    • says

      You are spot on regarding the analysis. The hope is to last 20 years of disaster insurance avoidance to be able to reap the rewards.

      Land is worth even more a percentage of total home value in places like SF. In my case, it’s probably 60-70%. Unfortunately,
      Cost per sqft to build high end is now reaching $350-$400/sqft, so this example would only be able to build a 1,200sqft home.

      Lots of different permutations in our calculations. The important thing is for everyone to call, inquire, and do the math to no what they are dealing with!

      • JayCeezy says

        Absolutely. Something I failed to make clear above, but will hopefully prove of value to a few of your readers, is that I overinsured for a number of years on both home and catastrophe insurance. I insured for the market (instead of replacement) value of my home, when 40% of my premium was essentially insuring dirt. Just one of my many money mistakes; if your blog was around then, it would have saved me both money…and regret!:-)

  8. says

    Perfect timing with this article! I happen to live near a potential earthquake site as well, and have been getting a lot of letters in the mail recently asking me if I want to enroll in earthquake insurance.

    I can’t say I’ve put too much thought into this just yet. But this may just be the heads up I need. Thanks for taking the time to write this!

  9. says

    WE bought earthquake insurance this year. It was surprisingly affordable (under $500). The caveat was that there are huge deductibles. but, in my evaluation, that’s okay. I’d rather pay a deductible of several thousand dollars to save $10′s of thousands when the earthquake hits. It’s a certainty there will be an earthquake, the only question is when and how bad.

  10. says

    I live in Florida and our entire street is in a flood zone so we have to have flood insurance. One thing to keep in mind is that there is flood insurance that covers the contents of your home and another that covers the actual property. It is expensive to have either one! Make sure you read the fine print to ensure you are getting what you need!

  11. Galen says

    I had never thought of a huge loan as effectively an insurance policy for catastrophic events. That is an interesting idea. Is it always the case that you can just “walk away” from a home loan with no expectation of repayment? If so, maybe I should take out a second (line-of-credit) mortgage and keep it maxed out? Could I even withdraw the line-of-credit money right after an earthquake, or would it be a problem accessing the line of credit if the loan were NOT already tapped out at the point of the earthquake? Thanks,

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