Hidden Value in Homeowners Insurance

Insurance is for the mathematically challenged. Insurance companies have the largest buildings in town for a reason. What other company do you write a check to for a thousand dollars and get nothing more than a promise to cover some bills in the event of certain losses? Commissions to the salesperson can reach or exceed 100% of premiums in the early years of some life insurance policies. Many credit card companies offer free extended warranty insurance at no additional cost when you buy with their card. You can guess the real value of the extended warrantee offered at Wal-Mart on $88 headphones.

Warren Buffett built an empire funded by insurance premiums at Geico. Some insurance is required by law. In the U.S., auto insurance is required for liability. Health insurance is also required since the Affordable Care Act passed.

Insurance is about risk management. Insurance companies are masters at it. The goal for the insurance company is to bring in as much as possible in premiums and pay out as little as possible in claims. Insurance always has a built-in profit for the insurance company. This is the house advantage.

Most insurance claims are for stupid small stuff. The cost of insurance to cover claims under $10,000 is massive. The processing of a claim is expensive. That is why higher deductible can save so much. But even better is not buying insurance at all and pocketing the cash.

When Insurance is Important

Auto insurance is required on the vehicle itself if you have a loan on said vehicle. Required auto insurance is for liability only, regardless of loans. The liability portion of the auto insurance bill is small compared to the cost of collision. This should tell you something. Liability claims are rare. Most auto insurance claims are for fender benders. The reason liability insurance is so important is because when the rare occurrence arises, the claim gets really big.

A new trend is emerging among the FIRE (financial independence, retire early) crowd. To cut spending to the bone, these people pay off their mortgage and then forego homeowners insurance. I understand the concept, but worry about the consequences. Homeowners insurance runs from $500 a year into the thousands. As long as you have the financial resources to manage any physical loss the insurance is an elective, maybe.

I agree that all small claims should be handled without the help of an insurance company. Even a higher deductible homeowners policy doesn’t save all that much. Claims on a home are rare and the claims that do come in are related to smaller issues rather than a complete loss of the structure on the property. Still, homeowners insurance premiums have skyrocketed.

My office building is in a floodplain. Actually I am surrounded by a flood plain so I am considered an island and if I had a loan on the property I would be required to carry flood insurance. Flood insurance would set me back over $2,000 per year. Insane! My office building has no encumbrances and no flood insurance either. I have owned the building 21 years. That means I saved at least $42,000 in premiums. In the last 21 years there was only one incident where there was a flood. The sump pump died at the same time and some old books were destroyed. Value: $0. I did have an afternoon of cleaning out the office basement so I guess if you count my time as worth something there was some out of pocket cost in 21 years.

I still have insurance on my building, however. And that is where this story is going.

The Old Reliable HO-3

The HO-3 homeowners policy is the most commonly sold today and is required by most lenders. It covers all the things you would expect: fire, tornado, or any direct damage to the home or surrounding buildings. The insured is covered for replacement value without depreciation. There are a few notable exceptions to the HO-3. Flood and earthquake, for example, are not covered; additional insurance purchase is required to insure against loss from these events.

Having casualty insurance increases your costs. Many years ago I hit a deer coming home from work during tax season. Back then my attitude was to have collision coverage if the car was valued over $5,000. (Today I only carry liability regardless the value of the vehicle.) I filed a claim and started looking for a shop to repair my car. All the quotes kept coming in around $4,000 and I had a $1,000 deductible. This was crazy. Finally I decided to get a few more quotes and tell the shop I was uninsured. Now the quotes were all under $1,000! The final bill was $800 and the guy gave me a $50 discount for paying cash. It was the last time I had collision coverage on my autos.

All this is good and well. But, since you know the odds of making a major claim are small, bypassing insurance is a calculated risk insurance companies take every day. The cost of repairing or replacing a vehicle is rather small when you think of it. If you can’t afford to replace the car, you can’t afford the car. I have pocketed a small fortune since I dropped all but the liability coverage on my autos.

Back on the farm I have homeowners insurance. I have to. My only debt in the world is the farm mortgage and I could easily pay it off in cash, but I am reluctant since the interest rate is under 2 ½% and my investments do better than 2 ½. That isn’t a problem at the office. The office building is debt free and I still carry insurance. Why?

You are Liable

Life insurance commissions are huge! So where is the value to the policyholder?

The real value (the only value) insurance has is protecting you from the big one, the one that would destroy you financially. A $10,000 loss is an inconvenience; a multi-million dollar lawsuit could easily change your life for the worse. Even if you win the lawsuit, the legal bills to win could reach into the six figures. A family member was caught uninsured and paid over $75,000 to fight a lawsuit he eventually won. He was still out 75 grand. I’m a fast learner. Lawsuits are the real risk. Especially frivolous ones.

The office is covered by an insurance policy. No one requires I carry the insurance. There is no mortgage on the building. However, my office is on a corner where a lot of moms and kids cross my parking lot on the way to a park and beach. Drivers sometimes cut through my parking lot to avoid the stop sign. If a driver broke the law by racing through my parking lot and injured or killed one of those kids I would also be sued. In Wisconsin wrongful death is $500,000 for children and $350,000 for adults. That means even if I am not at fault, maybe it was just an accident or the driver’s brakes failed, I would be on the hook for a minimum of half a million dollars for wrongful death if a child is killed. Then the attorneys can get serious about getting the rest of my net worth.

The HO-3 policy covers liability. (Always check with your insurance company or agent to understand what coverage you really have. The blanket statements I make here are for illustration only. Also read your policy and ask questions if you don’t understand something.) That is the one reason why I recommend homeowners insurance even when you are not required to have it.

Piddly claims don’t concern me; I can handle those on my own. The big, take’em out behind the woodshed lawsuits, is what I want protection from. Even if I am so rich I can write a check and walk away, it isn’t that easy in a lawsuit. Lawsuits take time and money. It’s the time I have a limited supply of. Living without money is fine if it ever came to that; I grew up poor and am none the worse for it. But spending years fighting a mega-lawsuit would damage the one thing I value: time.

There are bloggers out there acknowledging they have no homeowners insurance because they reached FI and can easily handle a complete physical loss of their home. I agree on that part. Besides, it will cost the insurance company a lot more than it will me to rebuild my home. I disagree because of the liability protections involved. I never encourage a client to go without homeowners insurance. Extended warranty, auto collision, disability, and life insurance are all things you can take a pass on and still get my blessing. Not the homeowners insurance.

Frugality and responsible spending are quality traits. If taken too far it can cause more harm than good. At some point you cross the line from frugal into becoming cheap at the risk of spending serious amounts of time and money defending yourself.

Life is too short to fight those kinds of battles. A small amount of insurance assures you can keep living the quiet comfortable life you have grown accustomed to.