Should I purchase earthquake (or other disaster) insurance?

Question

We recently purchased a home. The other day we sat down with our insurance agent to go over our coverage and make sure we were happy with it. Insurance for most disasters (fire, flood) have to be purchased as separate clauses. Most of them are a reasonable cost or we don't live in an area where we could expect to have that disaster. Then we got to earthquake insurance.

We live along a mountain range and a known fault line. So we asked about earthquake insurance, since it seems a reasonable risk. The deductible for earthquake in insurance in our area is 10% of home value. That seems like a huge amount. On the other hand, it is less than total replacement cost.

So, I guess what I'm trying to ask is: How do you evaluate how much disaster recovery is likely to cost, so it can be compared to the deductible? This is a good policy if damage would likely cost upwards of 50% of home value. It would not be worth so much if it's likely under 10%.

I'm hoping this is generally phrased, as different areas likely have different prime disasters with higher costs. I'm also curious if this is typical of earthquake coverage, while other disasters have lower deductibles.

Answer 1

It depends on you. When people try to score risk, the "formula" is usually something like:

risk score = probability of incident * severity of incident

Your tolerance for risk depends on a number of factors, like:

• Likelihood of a major covered loss
• Likelihood of a minor covered loss
• Likelihood of a related covered loss (ie. earthquake that triggers an avalanche)
• Exclusions.
• Impact of deductible on losses
• Financial ability to sustain losses (ie. how big is your "rainy day" fund)
• Worst case scenario impact. If your only assets are your home and retirement, bankruptcy is an option.
• Your abilities. Are you capable of replacing windows and making repairs?
• Special circumstances (ie. do you have a special needs child or other dependent whose care is expensive)

If you live in an area with a high risk of earthquakes that will damage your home and can afford it, insurance is probably a good idea. But you need to be careful -- insurance salespeople usually focus on the worst case scenario. Figure out whether the coverage is going to cover more mundane scenarios like foundation cracking or shattered windows.

When we moved into our house, I thought about getting flood insurance (strong earthquakes aren't a risk in my area) Ultimately, I decided against flood insurance because my home was in an area with marginal risk -- the primary vector for a flood is the sewer system, and I found out the sewers near my home are reasonably modern and don't typically flood. A likely flooding scenario for me would be a basement sewer backup. That is a really unpleasant prospect, but the cost to remediate is probably $3-5k -- not worth an insurance claim in my book!

If you are leaning towards buying the coverage, make sure that you understand it fully from a covered/not covered standpoint. Ask lots of questions.

Answer 2

You can potentially get coverage with a smaller deductible but the price is likely to be substantially higher.

The idea of the coverage you are being presented is a lot like a major medical plan with a high deductible. It's designed to cover you if the house is really thrashed beyond some cracked plaster and stuff falling off shelves. At the same time it protects the insurance company from a ton of little tiny claims from a LOT of people, because of course earthquakes impact a fairly large geographic area, and can thus result in 5 or 6 digit figures of affected policy holders. By excluding the more minor 'expected' damage of stuff falling and getting broken, cracked plaster and broken glass, the company can have a much smaller reserve that is focused on making whole the people who's houses are greatly damaged and need major repairs.

In terms of value, I'd look at it from the perspective that you are buying it to prevent an earthquake being a 'disaster' to you. Having to replace up to 10% replacement value of your house and contents is annoying yes, but it's also more in the 'large pain in the rear' category compared to the 'disaster' category of having to replace the entire house if it's so badly damaged you can't live in it.