Question: My house insurance premium has gone through the roof. It will cost me $95,000 this year. That excludes GCT. Friends suggest that I should lapse the policy and put the money in a bank account to pay losses. In other words, I should assume the risks and not buy coverage. Does that idea make any sense?
- G.A., Kingston 7
Answer: Managing risks is a complex business. It is more than putting money into a bank account to earn interest.
On one hand, it entails a general awareness about risks, especially those that threaten your property. It also involves taking steps to ensure that self-insurance is not a big gamble - especially when the account balance is less than the asset value.
Your friends have over-simplified the matter. To prove my point: why do insurers need actuaries, accountants, economists, en-gineers, scientists, lawyers and other professionals to help them decide which risks to accept (or reject) and what prices to charge?
Risk appetite
There is another part to self-insurance. What is your appetite for risk? Some persons do not like risks and the stress of carrying them. Investment experts and economists call them risk averse.
Others are like some male drivers who use the public roads as race tracks. They get their 'kicks' from taking risks. Your position on the risk aversion/tolerance scale - high, low or in between - will determine how much you are likely to accept.
Local householders, like their counterparts in Florida, U.s., are looking very seriously at self-insurance. That is due to insurance price hikes this year.
However, before you tell insurers to 'beat it', I suggest that you consider the following:
Self-insurance may not be an option if you have a mortgage or are using the property as security for a home equity loan. Almost all lenders will require insurance.
How close is the premises to the sea/rivers/gullies? Has the property or nearby houses sustained damage from floods/storm surges/hurricanes during the last five years? What measures have been implemented to prevent a recurrence?
Can your house survive a category five hurricane (like 'Gilbert') or a serious earthquake? Is that opinion shared by an independent professional like a structural engineer or an architect?
What costs would be involved to replace the roof of your house assuming that it was damaged by a hurricane? Similarly, what would it cost to repair substantial earthquake damage (including retaining walls, if any)?
How much money can you realistically save to finance the cost of repairing hurricane, earthquake, flood and/or fire damage?
Does your house have any particular features (e.g., purpose-designed hurricane shutters) which are likely to lessen damage from hurricanes and earthquakes?
What would it cost to rebuild your house at today's prices, assuming that it was destroyed? Where would you live if your house was undergoing major repairs and what costs would be involved?
Assuming that the house was not rebuilt, what would be the value of the land if it was offered for sale?
What level of financial support could be expected from the government in the event of a major loss?
Since amounts in excess of $300,000 in bank accounts are not insured, what measures will be put in place to reduce the credit risks (?) when the self-insured fund exceeds that amount?
Will premium financing over a nine or 10-month period make the cost of traditional insurance more affordable?
A lot of work involved
Self-insurance is not a one time job. It means doing lots of work over a long period.
Many persons do not realise this. They take the easy way out. The focus is only on the premium avoided and the prospect of earning interest.
Self-insurance advocates can hedge their bets. After all, even insurers and reinsurers do this.
Carry some risk and buy insurance to cover the rest instead of assuming all of it. For example, a consumer could, (in the case of a house valued at $5 million), agree to retain five per cent of all losses (or $250,000) and insure the balance (95 per cent or $4,750,000).
That would be instead of carrying the compulsory two per cent ($100,000) excess (or deductible) for earthquake, hurricane and flood losses and insuring the balance (98 per cent or $4.9 million).
Self-insurance, in my opinion, should not begin with one giant leap of faith into the darkness, but rather with a series of small steps over time.
Cedric E. Stephens provides independent information and advice about the management of risks and insurance. If you need free information or counsel to help you solve a problem write to The Financial Editor or contact Mr. Stephens directly at aegis@cwjamaica.com.
