On a recent episode of the Animal Spirits podcast, my colleagues, Michael and Ben, had an interesting conversation about homeowners insurance rates in Florida. The average homeowners insurance premium in the state is over $9,000/year. Ben asked Michael if there’s a certain level of premium where it makes sense to forgo insurance coverage. As I am nodding my head yes, Michael fiercely suggested that no one should buy a home if they cannot afford the insurance. It dawned on me that neither live in storm or fire-prone areas, where the thought of self-insuring a home might make sense.
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For many homeowners, forgoing insurance isn’t an option. If there is a mortgage on the property, the bank will require an insurance policy to protect the loan. This makes homeownership more expensive for those who live in areas prone to natural disasters. When putting together financial plans, I often do a double take when investors in the Midwest quote their homeowners premium to me. I might even clarify: is that an annual or a monthly number? Insuring homes in safe areas seems so cheap compared to my $9,000 annual insurance premium. Insuring a multi-million home for a few thousand bucks a year shocks me. Likewise, my sky-high insurance costs are unfathomable to them.
But homeowners who don’t have mortgages can choose to self-insure. While that seems insane, allow me to walk through the economics of such a decision.
I met a retired woman in New Orleans who bought her house in the 1960s for $68,000. The mortgage was paid off 20 years ago. Today, she could sell the house for over $300,000, and an insurance company estimates it would cost $250,000 to rebuild the home after a total loss, which is probably a low estimate. She lives on a fixed income from Social Security and a small retirement savings account. Her annual homeowners insurance premium is now over $6,000/year. This cost doesn’t fit in her modest budget.
She decided to cancel her homeowners insurance policy. In the event of a named storm, her deductible would have been $12,500, or 5% of the coverage amount. She’s paying $6,000 year after year, and coverage doesn’t kick in until there are losses greater than the deductible. She plans to invest the savings from canceling her insurance to build a slush fund for potential storm damage.
Is she crazy? I say no. She knows the ultimate risk, that a major storm event will cause a total loss of the home. If that happens, she will sell the lot and move on. If you’ve never lived somewhere where this is a real possibility, I understand it can be hard to comprehend. But many New Orleanians feel this way. We saw people walk away from their homes after Katrina. We are willing to do the same if it comes to it. We pray that doesn’t happen. We might come out ahead financially by self-insuring and accepting this risk.
The first time I heard about self-insuring a home was during my first year living in New Orleans. A fellow advisor was deciding on whether to cancel her insurance. The premiums were inching above 2% of the insured value. Her thought process was: If I pay for a new home every 50 years through insurance premiums, why not save and invest the premiums to cover future losses? After processing these economics, I understood how self-insuring could make sense. Of course, the risk is that a loss happens in the early years without insurance. That’s a risk she was prepared to take.
In my case, even if I didn’t have a mortgage, I would maintain insurance on my home today. I recently bought the home and need to protect my equity. My children are in school, and I’m not keen to uproot them to move to another city at this stage. If we are unable to live in our home, I need to be compensated to live elsewhere. But 20 years from now, when the mortgage is paid off, and the kids are grown, I may feel differently.
Nor do I think it’s a bad financial decision to maintain insurance coverage on a home in a high-risk area like New Orleans. There are beautiful historic homes in this city. If I owned a historic Garden District home, I would feel obligated to maintain costly features such as plaster and intricate wood mouldings. And for many, the thought of moving away is unthinkable. Treating such an emotional decision like a spreadsheet to be optimized isn’t the always the right path.
High insurance costs are likely here to stay. Storms, fires, and natural disasters are happening more frequently and continue to cause record-breaking financial damage. The reinsurance market is starting to thaw after a few calm hurricane seasons. But price has information. The market is gently letting us know, that some places may not be inhabitable in the long run.
If forgoing homeowners insurance could destroy your financial plan, then there’s no question you must maintain insurance. But if you can afford to take a loss and are willing to accept the consequences, self-insuring is sometimes a viable option, as crazy as that sounds.
