Do you really need disaster insurance?

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.

How medical insurance works

When you purchase health insurance, the money you pay (your "premium") is combined with the premiums of others to form a pool of money. That money is then used to pay the medical bills of participants who need health care. Your coverage remains valid only as long as you continue to pay your premiums.

Once you purchase insurance, the insurance company will give you an insurance identification card for you to use when you seek care from a hospital or doctor.

The insurance company will also provide written instructions for reporting and documenting medical expenses ("filing a claim"). The insurance company will evaluate any claim you file and make the appropriate payment under your policy. In some cases the insurance company pays the hospital or doctor directly; in others the company will reimburse you after you have paid the bills.

Types of insurance

Any risk that can be quantified can potentially be insured. Among the different types of commercially available insurance are:

• Automobile insurance, known in the UK as motor insurance , is probably the most common form of insurance and may cover both legal liability claims against the driver and loss of or damage to the insured's vehicle itself. Throughout most of the United States an auto insurance policy is required to legally operate a motor vehicle on public roads. In some jurisdictions, bodily injury compensation for automobile accident victims has been changed to a no fault system, which reduces or eliminates the ability to sue for compensation but provides automatic eligibility for benefits.
• Aviation insurance insures against hull, spares, deductible, hull war and liability risks.
• Boiler insurance (also known as boiler and machinery insurance or equipment breakdown insurance) insures against accidental physical damage to equipment or machinery.
• Builder's risk insurance insures against the risk of physical loss or damage to property during construction. Builder's risk insurance is typically written on an "all risk" basis covering damage due to any cause (including the negligence of the insured) not otherwise expressly excluded.
• Casualty insurance insures against accidents, not necessarily tied to any specific property.
• Credit insurance repays some or all of a loan back when certain things happen to the borrower such as unemployment, disability, or death.
• Crime insurance insures the policyholder against losses arising from the criminal acts of third parties. For example, a company can obtain crime insurance to cover losses arising from theft or embezzlement.
• Crop insurance "Farmers use crop insurance to reduce or manage various risks associated with growing crops. Such risks include crop loss or damage caused by weather, hail, drought, frost damage, insects, or disease, for instance." ^[3]
• Defense Base Act Workers' compensation or DBA Insurance insurance provides coverage for civilian workers hired by the government to perform contracts outside the US and Canada. DBA is required for all US citizens, US residents, US Green Card holders, and all employees or subcontractors hired on overseas government contracts. Depending on the country, Foreign Nationals must also be covered under DBA. This coverage typically includes expenses related to medical treatment and loss of wages, as well as disability and death benefits.
• Directors and officers liability insurance protects an organization (usually a corporation) from costs associated with litigation resulting from mistakes incurred by directors and officers for which they are liable. In the industry, it is usually called "D&O" for short.
• Expatriate insurance provides individuals and organizations operating outside of their home country with protection for automobiles, property, health, liability and business pursuits.
• Financial loss insurance protects individuals and companies against various financial risks. For example, a business might purchase cover to protect it from loss of sales if a fire in a factory prevented it from carrying out its business for a time. Insurance might also cover the failure of a creditor to pay money it owes to the insured. This type of insurance is frequently referred to as "business interruption insurance." Fidelity bonds and surety bonds are included in this category, although these products provide a benefit to a third party (the "obligee") in the event the insured party (usually referred to as the "obligor") fails to perform its obligations under a contract with the obligee.
• Health insurance policies will often cover the cost of private medical treatments if the National Health Service in the UK (NHS) or other publicly-funded health programs do not pay for them. It will often result in quicker health care where better facilities are available.
• Disability insurance policies provide financial support in the event the policyholder is unable to work because of disabling illness or injury. It provides monthly support to help pay such obligations as mortgages and credit cards.
• Liability insurance covers legal claims against the insured. For example, a homeowner's insurance policy will normally include liability coverage which will protect the insured in the event of a claim brought by someone who slips and falls on the property, and brings a lawsuit for her injuries. Similarly, a doctor may purchase liability insurance to cover any legal claims against him if his negligence (carelessness) in treating a patient caused the patient injury and monetary harm. The protection offered by a liability insurance policy is twofold: a legal defense in the event of a lawsuit commenced against the policyholder and indemnification (payment on behalf of the insured) with respect to a settlement or court verdict. Liability policies typically cover only the negligence of the insured, and will not apply to results of willful or intentional acts by the insured.
• Marine cargo insurance covers physical loss or damage to property while in transit via sea or inland waterways. Marine insurance typically refers to coverage of physical damage to the transporting vessel. Many marine insurance underwriters will include "time element" coverage in such policies, which extends the indemnity to cover loss of profit and other business expenses attributable to the delay caused by a covered loss.
• Purchase insurance is aimed at providing protection on the products people purchase. Purchase insurance can cover individual purchase protection, warranties, guarantees, care plans and even mobile phone insurance. Such insurance is normally very limited in the scope of problems that are covered by the policy.
• Life insurance provides a monetary benefit to a decedent's family or other designated beneficiary, and may specifically provide for burial, funeral and other final expenses. Life insurance policies often allow the option of having the proceeds paid to the beneficiary either in a lump sum cash payment or an annuity.
  • Annuities provide a stream of payments and are generally classified as insurance because they are issued by insurance companies and regulated as insurance and require the same kinds of actuarial and investment management expertise that life insurance requires. Annuities and pensions that pay a benefit for life are sometimes regarded as insurance against the possibility that a retiree will outlive his or her financial resources. In that sense, they are the complement of life insurance and, from an underwriting perspective, are the mirror image of life insurance.
• Total permanent disability insurance insurance provides benefits when a person is permanently disabled and can no longer work in their profession, often taken as an adjunct to life insurance.
• Locked funds insurance is a little-known hybrid insurance policy jointly issued by governments and banks. It is used to protect public funds from tamper by unauthorised parties. In special cases, a government may authorise its use in protecting semi-private funds which are liable to tamper. The terms of this type of insurance are usually very strict. Therefore it is used only in extreme cases where maximum security of funds is required.
• Marine insurance covers the loss or damage of goods at sea. Marine insurance typically compensates the owner of merchandise for losses sustained from fire, shipwreck, etc., but excludes losses that can be recovered from the carrier.
• Nuclear incident insurance covers damages resulting from an incident involving radioactivive materials and is generally arranged at the national level. (For the United States, see the Price-Anderson Nuclear Industries Indemnity Act.)
• Environmental liability insurance protects the insured from bodily injury, property damage and cleanup costs as a result of the dispersal, release or escape of pollutants.
• Pet insurance insures pets against accidents and illnesses - some companies cover routine/wellness care and burial, as well.
• Political risk insurance can be taken out by businesses with operations in countries in which there is a risk that revolution or other political conditions will result in a loss.
• Professional indemnity insurance is normally a mandatory requirement for professional practitioners such as architects, lawyers, doctors and accountants to provide insurance cover against potential negligence claims. Non-licensed professionals may also purchase malpractice insurance, in which case it is commonly called errors and omissions insurance and covers a service provider for claims made against him that arise out of the performance of specified professional services. For instance, a web site designer can obtain E&O insurance to cover her for certain claims made by third parties that arise out of negligent performance of web site development services.
• Property insurance provides protection against risks to property, such as fire, theft or weather damage. This includes specialized forms of insurance such as fire insurance, flood insurance, earthquake insurance , home insurance, inland marine insurance or boiler insurance .
• Terrorism insurance provides protection against any loss or damage caused by terrorist activities.
• Title insurance provides a guarantee that title to real property is vested in the purchaser and/or mortgagee, free and clear of liens or encumbrances. It is usually issued in conjunction with a search of the public records performed at the time of a real estate transaction.
• Travel insurance is an insurance cover taken by those who travel abroad, which covers certain losses such as medical expenses, lost of personal belongings, travel delay, personal liabilities, etc.
• Workers' compensation insurance replaces all or part of a worker's wages lost and accompanying medical expense incurred because of a job-related injury.

A single policy may cover risks in one or more of the categories set forth above. For example, auto insurance would typically cover both property risk (covering the risk of theft or damage to the car) and liability risk (covering legal claims from causing an accident). A homeowner's insurance policy in the U.S. typically includes property insurance covering damage to the home and the owner's belongings, liability insurance covering certain legal claims against the owner, and even a small amount of health insurance for medical expenses of guests who are injured on the owner's property.

Potential sources of risk that may give rise to claims are known as "perils". Examples of perils might be fire, theft, earthquake,and hurricane, among many others. An insurance policy will set out in detail which perils are covered by the policy and which are not.