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In general,
we do a terrible job of assessing the risks we face in everyday life.
But let’s not be too hard on ourselves. After all, recent research
indicates that much of this is due to our genetic hardwiring. We’re
simply predisposed to miscalculate the odds that this or that event will
occur. And I suppose if we sat around all day trying to imagine what
horrible disaster was lurking around the next corner, we’d never get
much of anything accomplished anyway.
One of my
biggest professional challenges as an insurance consultant and attorney
is to try to get individuals and organizations to understand that the
main purpose of insurance and risk management is protection against
financial devastation NOT merely financial irritation (having to come up
with $500 may be irritating but coming up with $500,000 would be
downright devastating). Since this article deals with homeowners
insurance, I’ve illustrated my points by examining the potential
financial devastation wrought when people make three huge and all too
common mistakes when purchasing this type of coverage.
Confusing real estate value with replacement cost
According to
Marshall & Swift/Boeckh, a worldwide provider of building cost data, 58%
of all homes are undervalued by an average of 21%. I believe this is
due primarily to neither the general public nor many in the insurance
industry understanding how to properly estimate the replacement cost of
a house. The problem is exceptionally egregious where an older home’s
real estate value may be, for instance, $200,000, but to rebuild the
home would cost much more than that.
To go a step
further and illustrate the financial hardship this could ultimately
cause, let’s assume that your house is insured for $200,000 (because you
figure you could sell it for that amount). If it is one of the 58% that
is underinsured by 21%, you have an uninsured exposure of $42,000.
Therefore, if your house burns down, you get a check for $200,000
instead of the $242,000 required to rebuild. I don’t know about you but
coming up with an extra $42,000 qualifies more in the catastrophe
category than the irritant category. And even if you have a guaranteed
replacement cost rider on your house, there is still a very good chance
you will not be fully reimbursed due to other policy penalties for being
vastly underinsured.
Trying to save money by buying minimum liability limits
Let’s be
honest, the chances of you getting sued for a million dollars (or more)
are pretty remote. Unfortunately, few folks ever ask themselves what
would happen if they did and how much would it actually cost to protect
them from this possibility?
Do you have
a pet? Consider that almost 1/3 of all homeowners claims come from dog
bites. Have a pool? Approximately 45,000 people a year are injured in
swimming pools. The trouble with liability claims is that they are so
difficult to quantify. Until disaster strikes, you have no idea how
much you may be sued for. Despite the fact that the risk may be remote,
your potential exposure is unlimited. My advice is to buy as much
liability insurance as you can. Won’t that be expensive? Heck no! One
major insurance company in Pennsylvania charges only $10 a year more for
a $1,000,000 limit than for a $500,000 limit.
The most
common objection I hear is that people feel they will somehow become a
target of an unscrupulous plaintiff’s attorney if they “over insure”.
Believe me, you’re already a target. That’s why you need to create as
big of a buffer zone as possible between your insurance limits and your
personal assets. This is NOT the place to skimp.
Insisting on a low deductible
Let’s take a
few steps back and revisit what I wrote earlier. Insurance is meant to
protect you from financial catastrophe not financial inconvenience.
Your deductible allows you to save money by self-insuring against small
losses while still protecting yourself from financial oblivion. Yet
there are a significant number of homeowners who for some reason want a
$250, $500, or even a $1000 deductible.
My rule of
thumb for choosing a deductible is simple; if you had a loss tomorrow,
how much difficulty would you have in coming up with the money to cover
your deductible. If the answer is none or very little, you need to
raise your deductible.
For many
years this didn’t make as much sense as it does today. The savings
associated with raising your deductible was relatively minor compared to
the number of claims you could submit with no negative repercussions
from your insurance company. However, as more and more homeowners
figured that out, the insurance companies wised up too. Recently, most
companies have begun surcharging your policy after 1 or 2 claims, no
matter how small.
OK. That
stinks but it’s really not devastating. Not until you try to get a
quote on homeowners insurance for that new house you want to buy. If
you’ve had multiple claims, your current company may use this as an
opportunity to dump you. Now you’re forced to scramble to get coverage
before the deal falls through. And if you are able to get coverage, you
may find yourself paying 5-10 times what you planned on. While maybe
still not devastating, it’s certainly traumatic.
The three
instances I pointed out in the paragraphs above are hardly an exhaustive
list of all the mistakes I’ve seen made over the years. However, they
are certainly some of the most common, dangerous, and avoidable.
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