Peril or self-insurance: The homeowner's dilemma

Insurance Helpline With Cedric Stephens

Question: My wife and I recently settled the mortgage on our house. In the past, the monthly payments to the building society included amounts for perils insurance. Now that the house is debt free, it seems unwise to be paying all that money for insurance, especially during these difficult times. Wouldn't it be better to put money into a bank account instead of paying it to an insurance company? We never made a claim under the building society's policy during the last 10 years. The house has concrete walls and is roofed with Decramastic tiles. Its floors are made partly of wood and concrete. The replacement cost of the building was estimated at $35 million last December. What would you recommend?

- S.D.P, Kingston 6.

HELPLINE: I am very thankful for your two questions. They give me a chance to show to one of this column's critics - an accountant and insurance company director, no less — that I write about things other than what he implied was the (boring and unimportant) subject of car crashes.

The questions also provide an opening for me to share things with readers like you that help them to make more informed decisions.

"The Caribbean is one of the most disaster-prone regions in the world." This was one of the quotations that columnist Ian Boyne used in his article, 'Beyond the Budget Debate', that was published in The Sunday Gleaner of April 7, 2013. It came from a paper, Caribbean Small States: Challenges of High Debt and Low Growth, which was released by the International Monetary Fund. I visited the IMF website and read the report because I was unfamiliar with it.

WHAT SOME EXPERTS SAY

The report stated that a 2006 study found that the six Eastern Caribbean Currency Union countries "rank in the top 10 most disaster-prone countries in the world when considering disasters per land area or population. The rest of the Caribbean is not far behind, with all the countries among the top 50 hot spots. Over the last 60 years, the Caribbean countries have suffered from 187 natural disasters, most of them tropical cyclones (usually hurricanes), and floods."

It said the frequency of disasters varies significantly with Jamaica and The Bahamas having 23.6 per cent and 20.2 per cent probabilities, respectively, of a hurricane striking in any given year.

Losses in excess of one per cent of Gross Domestic Product (GDP) have occurred annually during the last 50 years, the report also said.

Minister of Water, Land, Environment & Climate Change, Robert Pickersgill, according to a December 9, 2012 report in this newspaper, estimated that Jamaica has lost an annual average of two per cent of its GDP in damage and other losses associated with hurricanes, floods and droughts since 2001.

The total cost of the damage was put at US$1 billion. Scientific evidence indicates that climate change is leading to more frequent and intense hurricanes.

Geophysics professor Eric Calais of Purdue University, who visited the island recently over a four-day period as part of a mission with the United Nations Development Programme (UNDP), has urged "the government and various stakeholders to understand that the threat (of a major earthquake) is very real based on the area's history and active seismic activity."

According to recent media reports, he also said that "most scientists agree that Jamaica will most likely be exposed to a quake with a magnitude of 7 or 7.5. An earthquake of magnitude 7 on the Richter Scale is considered 'major' and is capable of widespread, heavy damage."

NOT WITHOUT RISKS

These opinions that we - as a country and as individuals - face should not be ignored when decisions are being made about how to handle risks. Placing money with banks to fund future losses does not provide any guarantee that the money will be available when it is required or foster peace of mind, especially since interest rates are at historic lows and are expected to remain there.

Would sufficient funds be available if a loss was to occur in the early years?

Also, banks, like other institutions, can fail. Though bank deposits are insured, the protection is limited to a maximum of J$600,000 per depositor per institution.

This kind of informal self-insurance strategy is not without its risks. It requires long-term commitment and expertise in many areas if it is to succeed. Transference of the risk to professional insurers may be a much safer bet in the long run.

Homeowners can reduce premiums by opting to carry more of the risks to which their property is exposed. Losses arising from earthquakes, hurricanes and flood for example, are subject to compulsory deductibles/excesses of two per cent of the insured values.

Using your house as an example, the loss would have to exceed J$700,000 before insurers would pay anything. This means that if a claim was submitted for J$1.5 million, you would be required to pay - or self-insure - J$700,000, and the insurers would pay J$800,000.

If the loss amounted to J$5 million you would pay $700,000 or 14 per cent while the insurers would pay J$4.3 million or 86 per cent.

Buying coverage with a deductible of say, five per cent instead of two per cent would result in savings because you would carrying a much bigger burden in the event of a claim.

There are other things that you can do to minimise the amount that you spend.

The more important include doing your homework - that is, researching information from reliable sources — and finding a good insurance broker to provide advice and to shop around.

To do anything less would be unwise.

Cedric E. Stephens provides independent information and free advice about the management of risks and insurance.

aegis@flowja.com

SMS/text message to 812-7233.