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Will We Ever Have Enough Homeowner's Insurance?

Contributed by mm | September 15, 2005 9:45 AM PST

Let me start by saying I'm risk averse: I have $500,000 liability limit on both auto insurance and homeowner's insurance, plus $1,000,000 extra umbrella insurance on top of that. I don't care too much about high deductibles -- the $1,000 deductible on my homeowner's insurance policy will only set me back by a week or so based on my current saving rate -- but I do care a lot about protecting our family assets from a catastrophic financial meltdown.

The unfortunate happenings in Louisiana does let me wonder one thing: will we ever have enough coverage for our house?

Take a look at my homeowner's insurance policy: I have a coverage of $240,000 on my 4-bedroom house, $120,000 for personal properties, and up to 12 months' coverage of loss of use, all "replacement value" (vs. inferior "cash value" policies). $240,000 should be sufficient to rebuild my house based on my agent. Do I have enough coverage?

My house is probably worth a bit over $400,000 now, and I understand a big chunk of the value is actually the value of the land, which, presumably, will not diminish if my house itself is burnt down. And I can totally understand the rationale that insurance companies will not insure the value of land -- it is hard to value and more or less driven by market sentiments. Plus, in front of a disaster that destory the house in its entirety, the homeowner still owns the land, and the value of the land should not change, supposedly.

Only supposedly. But is it true for those in New Orleans? I cannot help but imagine that some beachfront mansions were demolished, and the complete community becomes uninhabitable. If someone was willing to pay $1 million for a good lot by the sea before the hurricane, will he still be willing to pay the same amount for the same lot with mud and human or animal remains, which is so polluted that is no longer inhabitable for human beings?

My point is: even without a housing market meltdown, the land value of individual communities can still be send to a tailspin by natural disasters. In light of this, how can a rational investor in Florida or the gulf area get enough protection?

I don't have an answer, and I doubt a type of insurance can be developed commerically when we are dealing with the subjective value of land instead of objective value of rebuilding cost. Fortunately enough, I don't see a big issue for me. After all, my house is on a plateau, and unless Seattle is completely submerged, my house and community should stay relatively unharmed.

On a separate and only loosely related topic, Steven E. Landsburg argued "Why we shouldn't aid Katrina's victims too much" at Slate. His economic analysis-based argument is: if people in the gulf area choose to take the natural disaster risk and live in the area for the "Big Easy" lifestyle, other risk-averse society members should not be penalized at the expense of New Orleans citizens' risk-taking decisions. (Federal aid reduced the government's ability to support other regions' development and thus harm the welfare of other states.)

Don't get me wrong. I'm not taking an absolute position on this. Now that the disaster happened, I believe we ought to show some love, even it means tens or hundreds of billion dollars, but if people in New Orleans choose to rebuild the city again in these flood-prone below-the-sea-level areas when they have safer alternatives, I will question whether they deserve another multi-billion-dollar bailout when the next major hurricane visits the region in the next few years or decades.

This Post Has Received 18 Comments. Share Your Opinions Too.


tl Commented on September 15, 2005

mm: If you can get insurance for a volcanic eruption you might want to consider it. There is no guarantee Seattle will exist if Mt. Ranier does a Mt. St. Helens. As of now the risk is probably lower than that of a hurricane, but not if it starts showing activity.

There are those who would say you are taking a risk living in Seattle. Me, I like Seattle.

Living in the midwest, I'm vulnerable to another earthquake from the New Madrid fault. I don't have earthquake insurance but Katrina has me thinking about it.

I'm with you on having adequate insurance. I'm more fearful of falling out of the middle class than I am hopeful of rising above it.


MrOpine Commented on September 15, 2005

This raises another interesting question....if you had the money to pay off your mortgage would you do it?

I have a 3 year plan to pay off my entire mortgage. As of today, I'm about 40% of the way there but Katrina got me thinking...If I take all my extra cash and pay off my home and if the city I live in gets wiped out by a natural disaster or terrorist attack, how easily would I be able to recover?

If my job were gone, I would need to wait for insurance company to cut me a check. If my home were uninhabitable permanently (nuke attack) then I'm royally screwed. I don't know of any insurance company that will insure against "radiological fallout." So this leaves the possibility that my "paid off" real estate investment is totally worthless - so much for the equity!

Now I'm not sure I know what to do. Do I take my cash and invest it in a second home or do I pay off my mortgage? Do I keep huge cash reserves in case of disaster and basically "self insure" for the worst case scenario?

I also agree that I don't think there isn't any where in the US that is 100% safe. There are floods, forest fires, tornados, earthquakes, volcanos, hurricanes, meteors and terrorist attacks that could strike at any moment.

I'd like to hear everyone's ideas.


tl Commented on September 15, 2005

MrOpine:

I wouldn't pay off the mortgage if you have a rate below 6%. If you're in a 25% tax bracket and itemize, with inflation running at 3% the cost of borrowing approaches zero, particularly if you live in a state with an income tax. If inflation picks up, you'll get a better return on government bonds than you're paying in interest on your mortgage.


mm Commented on September 15, 2005

Interesting discussion ... seems there are more risks we need to seek protection. I was once considering earthquake insurance too (http://www.pfblog.com/archives/600_earthquake_insurance.shtml).

To Mr Opine: I don't think paying off mortgage earlier is a risk. Even if you don't pay off, you are still liable if the liquidated value of your house is less than the mortgage balance. Still, in case of a nuclear disaster, presumably insurance company will pay at least the rebuild cost (even if you don't have the inhabitable land to build a house on).

TL: I don't see how inflation can play a role in deciding whether you should pay off mortgage earlier. Regardless of inflation, the decision should be solely based on the after-tax value of prepaying vs after-tax opportunity cost of holding the money. You either consider inflation in both cases or none.


MrOpine Commented on September 15, 2005

MM,

I agree I'd still be liable for the mortgage but my main concern was having the extra cash to start over in a worst case scenario. I could easily start a new life in a new city if I had 100k to 150k in cash with me. I could put down a down payment for a new house, buy a car and live off savings for a while until I found a new job.

On the other hand, if I take 100k+ and pay off my mortgage and have an asset worth 150k that becomes worthless then I'm in trouble. Perhaps I need to review my insurance policy with my agent and ask about what truly is covered or not. I was under the impression that they wouldn't pay anything related to radiological damage.


jc Commented on September 16, 2005

Most insurance doesn't cover "acts of war". I wouldn't count on your homeowners policy bailing you out in the case of a major terrorist attack.

The sentiments expressed above really ring a bell with me. I know this sounds unorthodox, but I don't like owning houses. I've done my share of homeownership and I realize that I'm just not cut out for it. I hate dealing with the maintenance and insurance and hassle of it all. So I rent. If something goes wrong, I don't have to fix it. Sometimes I think of all the money I don't have to spend at Home Depot and it just makes me giggle. I live in a fine home that I can rent for an "out-of-pocket" price that is far far less than an equivalent purchase.

Thus, I can keep all of my substantial assets working for me in a well diversified portfolio. If an obnoxious neighbor moves in next door and makes too much noise or has a barking dog or just lets his place go to hell, I don't have to stress over it. I can just move. No strings attached! If a major disaster struck my area, I can easily relocate and pick my life up where I left off in a better and more desireable location.

Am I throwing money away? I don't think so. I get something tangible and very valuable for my rent dollars. I get a fine place to live. By the way, the rental market for upscale homes is typically much tighter than for less expensive ones. You can get incredible deals. Yes, if I bought a home with a large mortgage and committed to live in it for many years, I would probably end up with more money. But I don't think homeownership is for me.

It spares me the trouble outlined above. I know it goes against the conventional wisdom, but an alternative is to simplify by doing away with homeownership altogether. If you have the discipline to invest the money you save on homeownership prudently, you can end up with more money and a more hassle-free, carefree lifestyle. I say "good riddance" to homeownership.

At least it's an option. Works for me.

JC


tl Commented on September 16, 2005

mm:

The after tax value and the after tax opportunity cost of holding the money are both affected by inflation.

If I have a 5.5% mortgage and mortgage rates go to 9% it will most likely be because of inflationary pressure in the economy. I'm still not only making use of cheap money, the value of that money keeps getting cheaper as inflation rises. However, paying off the cheap money mortgage not only increases the illiquid portion of my portfolio, but the opportunity of earning a better "real" return in the market lessons because markets usually don't perform well during periods of higher inflation.

If rates fall to 3%, then I simply refinance and have a lower payment, with the freedom to invest the rest.

There's nothing wrong with paying off a mortgage early, or owning a house free and clear, as long as it doesn't represent the majority of your overall portfolio. But to be house-rich and cash poor increases one's financial risk.


Some Girl Commented on September 17, 2005

First, I recommend checking out this unscientific story on Slate which illustrates that there is really no risk-free place to live: http://www.slate.com/id/2126321/?nav=ais

Second, does anyone have any suggestions for on-line resources of how to make sure you are adequately insured. If it helps, I own a condo, but I would be interested in knowing how to make sure that the condo building itself is also adequately insured.

Thanks


Stephen Commented on September 21, 2005

I enjoyed reading the link you gave above as it justify the saying that there is really no risk-free place to live.


mropine Commented on September 21, 2005

I'm in Texas and it looks like Rita is heading right for us! I couldn't find a hotel room anywhere 200 miles west or north of here (Houston). The Katrina evacuees had already taken most of the hotel rooms and now they're all booked! So even if you have money, it doesn't necessarily mean that it'll do you any good!

News reports here say the oil refineries will take a hit so expect fuel prices to rise back again to $3+/gallon.


mropine Commented on September 22, 2005

What a nightmare! Last night I drove from Houston to Austin. It took 4 hours to get out of houston. What should have taken 2.5 hours total ended up taking 7 hours! And there were no gas stations that actually had gas! There were many cars pulled over overheated and many ran out of gas.

I took some emergency cash but it did little good; I would have gladly paid $10/gallon for gas but none was available. This disaster has been a real eye opener at how helpless we can all become in a crisis. Having money didn't make any difference - no flights, no gas, no hotels for miles!


Samuel Commented on October 12, 2005

That's very sad to hear but this is life. Life is uncertain, having money didn't make any difference, moreover it can happen with anyone.


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