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| The Basics | Do you really need disaster insurance?
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Many who live in flood- or quake-prone areas choose to 'go bare,' reasoning that the remote risks aren't worth the cost of pricey and limited coverage.
By Liz Pulliam Weston
Software engineer Roopesh N. Sheth paid for earthquake insurance when he bought his first home last year. After all, he lives in California.
This year, though, he let the policy lapse -- joining the vast majority of homeowners who go bare when it comes to some aspect of catastrophic coverage.
The decision not to buy insurance for earthquakes, floods, hurricanes and other natural disasters isnt always conscious: Some homeowners dont realize theyre not already covered. But many others, faced with high premiums and policies with limited coverage, gamble that they wont need insurance help to rebuild after a disaster.
Theres a pretty high deductible (on an earthquake policy), and the contents coverage was really low, said Sheth, 28, who lives with his wife in San Diego. We decided we would just take our chances.
So is going bare a smart choice, or a dangerous one?
Oh, I wish I could offer a concrete yes or no. Usually I'm a hardliner when it comes to insurance. As I've written before -- in columns such as "3 costly myths about insurance" -- insurance is best used to protect ourselves against uncommon but financially devastating events, and natural disasters certainly qualify.
But in this case, the cost/benefit analysis is trickier than usual. Sometimes the price of catastrophic insurance is chokingly high, while the risk remains remote. My husband and I, living in Southern California, have struggled mightily with this issue ourselves.
The answer for us, and for anyone, depends on three factors: your location, your financial situation -- and your comfort with risk.
The key is to make an informed choice. And Im here to help you with that.
Know your insurance policy inside and out
First, you need to know what disasters your homeowners insurance does and doesnt cover adequately. A review of your policy and a chat with your insurance agent should alert you to any gaps.
Then, where you can buy extra coverage depends on the location of your home and the particular catastrophe youre trying to protect against. This is where things get a touch complicated. Earthquakes and floods, for example, arent covered by standard homeowners policies. If you live in an area thats prone to other natural disasters, such as hurricanes, tornadoes or hail storms, your homeowners insurance may not cover damage from those calamities, either.
Heres where you can get the more common types of disaster coverage:
Earthquake coverage in most states can be purchased from your homeowners insurance company. In California, most policies are sold by the state-run insurance pool, the California Earthquake Authority (CEA), although a few private companies also sell earthquake coverage.
Flood insurance is typically provided by the National Flood Insurance Program, which is run by the federal government. A handful of private companies also write policies through a special arrangement with the feds. In states prone to floods your mortgage lender may require that you buy the coverage.
Hurricane and other windstorm insurance varies by state, and sometimes by county. Several states, including Alabama, Florida, Louisiana, Mississippi, North Carolina, South Carolina and Texas, offer windstorm coverage pools for people who cant get private coverage. Residents of some coastal counties in Georgia and New York can get wind and hail coverage through FAIR (Fair Access to Insurance Requirement) plans, which are high-risk pools run by insurance companies. Your insurance agent or state insurance department will have more details.
Owners may still say 'no dice'
Once they find coverage, homeowners still may forgo it. The most common reasons are these:
"Its too expensive." Disaster coverage can indeed be pricey. The annual premium for flood insurance is $382 a year for an average coverage amount of about $137,000. A windstorm policy in South Carolina costs $461 for $100,000 of coverage. Earthquake insurance can range from a couple of hundred dollars to several thousand dollars a year.
"The deductibles are too high." This is particularly the case for earthquake insurance, which typically has a 10% to 15% deductible. That means you have to pay the first $20,000 to $30,000 of damage on a home insured for $200,000 before your coverage would kick in. Deductibles are usually 2% for windstorm coverage (or $4,000 on the $200,000 home), although they range from 1% to 15% of the insured value of the house. Federal flood insurance comes with a much lower deductible, $500 to $1,000.
"The coverage is too limited." Bare-bones CEA earthquake policies -- the kind Sheth had in San Diego -- cover only $5,000 in damage for all the contents of your home and dont cover swimming pools, landscaping or outbuildings. Additional coverage can be purchased for a higher premium.
"Its not mandatory." As noted, if you live in a flood plain, your mortgage lender will insist you buy flood insurance. (Ask to see the latest flood plain maps, though.) Otherwise, catastrophic coverage typically isnt a requirement for getting a home loan.
"The government will help us out." After a major disaster, the Federal Emergency Management Agency (FEMA) provides grants for emergency repairs and temporary housing, while the Small Business Administration (SBA) offers low-interest loans for rebuilding.In fact, if you have insurance, your ability to get government help may be limited. Grants are usually reserved for those who are uninsured, and loans are restricted to amounts that your insurance doesnt cover.
After Northridge (the big quake that struck Southern California in 1994), we made a lot of loans covering just the deductibles, said SBA public affairs officer Ken Shuman.
Time for a reality check
So why would anyone pay for coverage? Several reasons, including:
The government might not step in. The president has to declare a major disaster before FEMA and SBA can step in to help. If the damage is limited, that might not happen -- even if you personally suffer a catastrophic loss. The vast majority of floods, for example, are not declared major disasters.
The help might not be enough. FEMA grants may be limited, and SBA loans for home repairs top out at $200,000. (You can expect repair costs to soar after a disaster, by the way, because every available contractor will be working overtime.)
You may be adding considerably to your debt burden. SBA loans are just that -- loans. Youre required to pay the money back. So, between your mortgage and your SBA loan, you could end up owing a lot more on your property than its worth.
Now that you've considered some pros and some cons, ask yourself the following questions:
Do I live in a high-risk area? Most homeowners tend to downplay the risks they face, even if theyre living directly above an earthquake fault or on the beach of an East Coast state.
Coastal states from Texas to Maine are most at risk for hurricanes, as is Hawaii. People who live west or just east of the Rockies are at earthquake risk, as are those in Alaska, New England and the New Madrid fault area along the Mississippi River. Floods can happen just about anywhere.
Have I really weighed the potential costs? To be flip: It only takes one natural disaster to ruin your whole day -- and your finances.
Insurance is designed to protect you against financial setbacks you couldnt easily recover from on your own. Clearly, most people couldnt pay for a new house out of pocket.
Have I set up an emergency fund? If you can get your hands quickly on a lot of cash, you may decide to forgo insurance.
Sheth set up a home-equity line of credit in part to help pay for earthquake repairs that might be needed in the future. He knew that the time to get such loans is before anything happens.
The appraisal may not go so well after the earthquake, he chuckled.
Have I invested in mitigation? Homes both new and old can be fortified substantially with some special construction measures. And truth be told, this is what many earthquake experts do, rather than pay expensive premiums for earthquake insurance.
The type of home you have affects your risk. One-story homes that are "tied together" -- with the roof bolted to the walls, and the walls to the foundation -- tend to survive earthquakes and windstorms better than multistory homes that aren't. Likewise, houses with big openings, such as plate-glass windows or large garage doors, fare worse than ones without those features.
The Institute for Business and Home Safety has a Fortified For Safer Living" program that specifies building techniques that can help homes better withstand disaster. The institute estimates these safer-building methods add about 10% to the construction cost of a new house. But the price may purchase much less damage if disaster strikes.
Am I prepared to walk away? If you dont have much equity in your home, and you have no ethical qualms about reneging on your mortgage, you could simply plan to hand your house keys back to your lender if a natural disaster leaves your home a pile of rubble.
Thats the option many homeowners took in hard-hit Northridge. As is typical after a disaster, foreclosures spiked in the area after the 1994 quake damaged thousands of homes (and, ultimately, many credit reports as well).
If you have lots of equity, though, and your home represents a big chunk of your net worth, the scales start tilting heavily toward the need to pay up for extra insurance coverage.
Thats what my husband and I ultimately decided to do. Living in California, weve seen firsthand what an earthquake can do to a home. We dont enjoy writing that check for earthquake insurance every year, but it does buy us something of substantial value: peace of mind.
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