Ask the grumpies: whether or not to purchase insurance

H.I.P. Person (Home Insurance Purchasing Person) asks:

How do you decide if you need insurance for something? We are updating our home owners coverage and they are peddling the following:

1) service line coverage –  up to $10,000 per event
2) systems coverage (a/c, hvac, water heater, furnace, and the like) – up to $50,000 per problem
3) sewer back up (?? not sure of max coverage)

We live < 75 miles from the coast; <20 miles from two major water coastal inlets but  not in a flood zone. What hurricane related insurance should we own? The policy comes with wind/water but not flood and they don’t really want to sell us flood (they are offering #3 instead).

Are any of these worth it?  What price point would make them worth it or not?

DISCLAIMER:  We are not financial advisors.  Get advice from real professionals or do your own research before making important monetary decisions.

So in economics, you purchase insurance when the expected utility of the insurance is greater than the cost of the insurance.  So, assuming you knew how your utility function was shaped (the important part for this purpose is that you know your coefficient of risk aversion, in this case specifically how much you hate the possibility of loss), and you know the probability of a bad thing happening, you just multiply that probability by your expected utility plugging in the amount you’d be out if the bad thing happens and then add the probability that the bad thing doesn’t happen and multiply that by your expected utility plugging in the amount you’d have if the bad thing didn’t happen.  Problem is… in reality, we usually don’t know the probabilities of these negative events occurring (or even what those negative evens could be!) and we definitely have no clue about what our utility functions look like.

So how does one decide what to get insurance on in reality?  Well, if you have rough ideas of probabilities, you can look at the expected value of something happening.  Expected value is like expected utility, but it tells you what the break-even point is assuming you have no emotions.  You’re neither a gambler nor risk averse.  But risk averse you can look at those numbers and think to yourself, “How do I feel about this calculation?”  In general, the insurance company is out to make money, so they’ll be charging more than the expected value of the thing happening, but does the amount more that they’re charging seem reasonable to you?

If you don’t know the probabilities of something bad happening, you can still play with worst case scenarios:  If the bad thing happens, what would you have to pay out of pocket to fix it without insurance?  What would you have to pay out of pocket with their insurance?  Is the peace of mind for the difference between those two numbers worth what they’re charging?  (And again, if you have rough ideas of how probable these events are, you can factor that in as well).

Another thing to do is to google around, preferably with reputable sites, to see what kinds of insurance are usually a good idea and what kinds are generally scams.  You can ask people around you too, though people often do things that don’t make sense if there’s good marketing on the part of the insurance company or if they’re more credit constrained or risk seeking than you are.

An important thing to note is that you want insurance to insure against risk.  You don’t want it as a pre-payment for things you’re going to pay for eventually.  You don’t want a high monthly cost if you can avoid it by sharing some of the pain should disaster strike through a higher deductible.  The goal isn’t to save money, it’s to smooth your consumption over good and bad states of the world.  Don’t try to beat insurance– in the best states of the world you give them money and they never give you money.  But you want it there when disaster strikes if you can’t handle the disaster on your own.

If it were me, I’d definitely eschew the service line coverage unless it was really cheap– we can afford a 10K emergency.  Since the limit is capped, it is not actually useful insurance unless paying up to 10K would be devastating.  (Capped insurance is often a red flag– if they stop paying after a certain amount is spent you may be better off self-insuring because if something really terrible happens they’re not going to be much use, and self-insuring means you’re not paying for the additional administrative costs of going through them.)

Systems coverage again, we probably wouldn’t pay… replacing a/c, hvac, water heater, furnace etc. is all stuff that has to get done some time anyway (and none of these should cost 50K, unless that’s including the damage after a water heater explodes or something) so paying them is like pre-paying for bills you’re going to have, but it is likely you’re going to have less choice about how to make those replacements and you’ll be paying their administrative costs over what you’d be paying if you did these things yourself.  And, again, it’s capped.  This is unlikely to be good insurance.

Sewer back-up is the only one of these that doesn’t sound 100% scammy.  Check all your other insurances to see if this is covered under them.  Estimate how much a sewer backup could destroy.  Make sure that it’s unlimited covered and not capped and there are no other strings attached.  Think about the probability of this happening.  Look at how much they’re charging for it.  Then go with your gut.

We have no idea about hurricane insurance.  The internet has a bunch of pages about it, noting you should get wind and flood on top of home, but I’m not getting a good idea of what numbers you should be looking at or even how to make that calculation.  You may also want to look into the different deductibles they offer, because none of these sound particularly cheap, but it may be that if you have a high deductible the insurance cost will be more reasonable (assuming you can afford the deductibles).

Good luck!

Grumpy Nation, do you have any better advice for H.I.P.?

 

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10 Responses to “Ask the grumpies: whether or not to purchase insurance”

  1. Ali Says:

    Totally agree with the answer here. In addition to the points above about systems coverage, I have had multiple people tell me that coverage in those policies isn’t nearly as good as they anticipated when purchasing such insurance (items they expected to be covered aren’t, or amounts paid are prorated based on system age).

    On the flood insurance note, I’m not sure you can even get this if you aren’t in a flood zone since the only policies I’m aware of are underwritten by the national Flood insurance program. We are in a flood zone, but in a paid for house so we had the option of paying for it or opting out…we chose to opt out as we are in a low risk area and the annual rate was insane (more than our regular homeowners insurance), but had a high deductible and relatively low max amount of coverage (plus that didn’t even cover contents). It just made more financial sense to opt out given that we could “afford” the kind of loss we might see (would be painful, but could still afford).

    • Jenny F. Scientist Says:

      We used to live in WI where a lot of home sales would come with a systems-coverage type warranty – when we bought our house, it came with it- and the coverage was very not great. It was something like $75 per service call, and then they’d only replace parts or if the whole thing blew up or something, and they were not especially speedy about, say, replacing furnace parts, so you’d be out $75 *and* have no heat for ten days.

  2. chacha1 Says:

    Depending on the state and thus the topography, at less than 20 miles inland from two major coastal inlets, hurricane or flood insurance may not be a thing they could even get. Regardless, I would self-insure for all these risks – that is, set up a dedicated Touch Not savings account and make it as fat as possible as fast as possible, starting with a monthly contribution equivalent to what the additional insurance premium would have been. As you say, most of these “risks” are things a homeowner HAS to replace/repair eventually. No house lasts forever in its original condition.

    In view of the storm data over the past 10 years (and if we’re talking Gulf Coast or Atlantic Coast), I would assume the risk of significant, if not catastrophic, damage from a storm is in the 75-80% likelihood range in any given year at that distance from the coast.

    My parents live <10 miles inland from the Atlantic coast in St. Augustine, Florida – a city that has historically avoided major impacts from hurricanes, but which has been hit fairly hard twice in the past three years. They have hurricane shutters, hurricane glass, and get tree service every year to keep branches away from their power lines and roof. They also have a generator, their own well, and a septic system vs city sewer. So far their only significant damage has been to trees, not to the house, but they've had roof repairs done twice in about ten years.

  3. gasstationwithoutpumps Says:

    In California, the high-cost item is earthquake insurance—a very high premium for a high-deductible policy on a low-probability event. My house made it through the Loma Prieta quake with no damage (not even a cracked chimney flue, though all the neighbors lost their brick chimneys), so I decided to self-insure: the lifetime risk is small given the particular situation of my house (reinforced concrete construction, heavy clay soil, no damage in last major quake), but the insurance is priced based on “average” situations (flimsy construction, loose fill, never tested in a quake).

    In general, I view insurance as paying to reduce variance. It only makes sense if the variance is high compared to the average expenditure. For example, health insurance makes a lot of sense, as health expenses can get astronomically high, but on average are fairly low. Long-term care insurance makes no sense—the variance is pretty low compared to the average cost, so you are better off self-insuring.

    One exception, which is based more on the utility function is life insurance. There the devastating effect of loss of income on a family is the crucial factor. I had term insurance when I was younger, so that my wife and child would not be forced out of the house if they lost my income. Once we had enough saved that they could survive sort of comfortably without my income, then there was no advantage to life insurance and I discontinued it. At my age, life insurance would be very expensive and of very little utility—we have enough savings to live on well past our remaining life expectancies (even enough to handle likely scenarios for long-term care).

  4. Debbie M Says:

    My homeowner insurance includes wind insurance, so that’s good. (My first mortgage company tried to tell me that I had to add wind insurance, which they picked out for me and added to my payments, but fortunately I had just read about my insurance; finally I sicced my insurance company on them and they withdrew this added coverage.)

    I also get flood insurance. When I was a kid, the houses six blocks away (next to the creek) flooded, and my mom researched flood insurance and decided it was super cheap for what you get, so I also got it when I bought a house. Later I learned that although my house is not technically in a 100-year flood plain (I checked before buying), my back fence is on the border of one, and the other side is nothing but asphalt and apartments, so I’m pretty sure that if they’re flooding, I’m also flooding. Yikes–next time I’ll check a map!

    I also get earthquake insurance. I understand that it covers almost nothing, but where I live, it’s super cheap because we don’t have earthquakes. Why do I get it? Because fracking causes earthquakes and politicians in my state love fracking, though we don’t have as much as Oklahoma yet.

    I never heard of sewer back-up insurance. I feel like this may be covered in regular homeowner insurance. I know that flooding from natural disasters is covered only in flood insurance but flooding for other reasons is not covered in flood insurance.

    I agree that service line coverage and system coverage sound like a bad idea–better to save up for these things yourself.

    My philosophy is that insurance is for big things. If you get it for little things and a little thing happens, they will pay, but then they will seriously raise your rates. Better to keep insurance companies out of it except to prevent bankruptcy. (This strategy really only works if you have decent cash flow. If you can’t keep from living month-to-month, this strategy might not be ideal.) Therefore, I like insurance with big deductibles and no caps or high caps.

    Another philosophy, which I learned from a finance book, is that insurance is a thing lots of people pay into so that which ones get hit with ridiculous costs are okay.

    I also agree with chacha’s (parents’) strategy of aiming finances at preventing damage when possible.

    • Jenny F. Scientist Says:

      One more comment with personal experience- my friend/neighbor had a sewer back up last year which destroyed their finished basement and the whole clean-up and re-do was, in fact, covered by their homeowners’ insurance. The insurance even washed the giant Lego collection that had gotten covered in sewage! (It was something like $5000 of legos, so cheaper to clean than replace, it turned out.)

  5. Seaglass Says:

    Re: Flood insurance. Flood is federal. Any agent who sells homeowner’s insurance can sell you the policy. If you’re not in a flood zone, it’s much less expensive. After working in the mortgage backoffice of a bank (taxes and insurance), and seeing how often areas get remapped into flood zones, AND how much flood insurance costs once any portion of the land or buildings (corner of a garage, part of driveway, half of a house) is in a flood zone… I got flood insurance. Once you are covered in a non-flood zone area, you’re grandfathered in at the non-flood rates. I have no doubt that with sea level rise and the fact that we’ve been evacuated at the last minute during the last two hurricanes here in northeast Florida, we’ll be remapped soon. We’re about 5 miles from the ocean, and 3 hurricane evacuation ‘zones’ in from the coast. However, we have all sorts of creeks and inland waterways around us. Commercial property was built in our sleepy residential area and it was built up with fill dirt, putting it about 5 feet higher in the air than we are. So basically, we’re in a hole now. :-/

  6. Revanche @ A Gai Shan Life Says:

    Since I don’t know all the numbers to plug into the proposed equations either, I simply do the math on whether or not we could pay for the worst case scenarios out of pocket: earthquake demolishes or even damages our primary home enough that we can’t live here, we could afford to repair most likely BUT we would wipe out our entire cash reserves and we’d still need to pay the mortgage. Not an acceptable cost, so we have earthquake insurance.

    We have primary insurance because if the house burned down, same answer.

    We had a free one year warranty from our agent when we bought this place that covered all our roofing and appliances and I’m considering if we want to buy another year’s warranty on them again but they’ve taken away the limited roofing coverage so that reduces the value of the coverage. We already have half our appliances under warranty for years, that leaves the roof, HVAC, furnace, and water heater that are old and not covered. Since the warranty doesn’t help us with the roof, I think we’d be better off saving the $600 a year and applying that directly to the things we’ll need it for: some roof repair, replacing the water heater with a tankless.

    That’s my long way of saying: I’d insure the really big stuff (like sewer backup) and not for the first two items.


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