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