Why pay for insurance?

Question

I've been dealing with insurance companies and am convinced this is the biggest scam in the world. Every year the premiums go up and if you have the audacity to ever make a claim, they raise your rates and try to pay you far less than the actual damages. I just learned from my bank that they dont require full replacement value and as long as the insured amount covers the loan, they are okay with it.

So here is my plan: Tell me if I am crazy.

1. I am dropping my coverage to the value of what I paid for the home or a little more. That satisfies the bank and covers me if the house burns to the ground.

2. I currently have a portfolio of 8 homes and plan to get up to 25-30 by the end of this year. Once the homes are paid off (plan is to do it in 7-10 years) I would carry only liability insurance. The way I figure is this: I am paying at least $600 per home per year. If I have 20 homes thats 12K per year in insurance. Each home average buying price is $50K. So in 4-5 years of premiums, I could buy a home. Now I figure the chances of 1 home burning to the ground every 5 years is really small. Why wouldnt I just self insure and put the $12K aside in a reserve fund for 5 years and then forget about it? I would just pay for all repairs out of pocket and still come out far ahead.

Am I nuts or does this actually make sense? I know math is approximate and I will still pay for liability so cost is not zero but still..

Eric Belgau · Answer

I'm an insurance guy, and I actually don't think you're crazy.  Insurance is a financial tool, which I believed should be used intelligently like any other financial tool.  If you have the financial strength to act as your own insurance company, you can save money, just as you can save money by acting as your own bank.

In my opinion, self-insuring requires a significant amount of liquidity.  It's not as simple as looking at premiums through the narrow lens of an unwanted expense (although I agree it's tempting!) because there are real-world issues to consider.

For example, the liability insurance that comes with a property policy is cheap, but you won't find those rates without a property policy.  If you buy a liability policy without property coverage, you'll realistically cut your savings in half.

Also, reducing the valuation of your property has to be done carefully.  Replacement cost policies carry a coinsurance clause (normally 90%), meaning that the property has to be insured for at least 90% of the cost to replace it.  If it's insured for less, even a partial claim will be reduced.  (If you insure for 50% and a claim is adjusted at $10,000, you'll get $5,000.)

And because partial claims are far more common (and realistically routine with a large portfolio) I would encourage you to dig a little deeper into the numbers and look at what a smaller claim ($20,000 for the sake of argument) will do to your cash flow.  Can your business model absorb that on a regular basis?

Rather than throwing the baby out with the bathwater, I would encourage you and other investors to arm yourself with the knowledge that will enable you to use the insurance tool well.  Find an agent who counsels as well as sells and who isn't afraid to sift through exposures so that you can pick and choose the risks to retain.  Read a couple of books (like "From Good Hands to Boxing Gloves") so you can understand the machinations of the industry and be prepared to deal with them when you have to.

I notice that much of the distaste for insurance companies comes from the unfortunate fact that many of them do minimize claims payouts.  There are two strategies for dealing with this.  One is to research the claims service of the companies that supply quotes and to work with one that has a reputation for settling well.  Another is to make friends with the best public adjuster in your area.

Michael Seeker · Answer

Anish Tolia - I completely agree with the reasoning.  Self-insuring, assuming you have the reserves becomes more advantageous as you own more property.

If you have 20-30 properties and own them outright (i.e. no property insurance requirement from lender) then insuring them yourself may very well make sense.

The main downside I see to self-insuring is that you're susceptible to catastrophic claims.  Just about every part of the country experiences freak accidents (hurricanes, mudslides, tornadoes, hail storms, etc.).  While it's unlikely that you'll suffer a complete loss on a high portion of your properties, do you want to be left holding the bag if a wild-fire or mudslide wipes out 10 of your 30 properties?

My approach thus far has been to go for the highest deductible possible.  Not only do the banks not complain about this (at least not yet), but your premiums are greatly reduced.  If you aren't already doing so, check out what annual premiums would look like with a $5K deductible or see if the ins. co. would do an even higher deductible than that.

As a side note, I'm a practicing actuary in the health insurance field and worked for a P&C insurer in college.  I can absolutely confirm that self-insuring is a good idea if you have a large, diverse portfolio so that risk is spread around.  If you own 30 properties within a 10 mile radius, you're looking at a very focused risk that is susceptible to high volatility.

John Rooster · Answer

I don't have hazard insurance on most of the houses I own free and clear. I talked about this in a thread from about three months ago. My logic is simple, half the money I pay the insurance company goes to claims, the other half goes to everything else (sales, overhead, profit, etc...). I don't pay the premiums, I pay the claims out of my own pocket, I profit to the tune of 50% of the claims that would have been paid.

Ronnie Sparrow · Answer

I am really upset at what insurance is costing me on my latest rental property. All my other properties are from $850 to 1,000 per year. This last property is $2,300 per year. My insurance guys are telling me its because the property is over 30 years old. I was built in 1973. This is going to kill my cash flow. What can I do to lower my premium?

Andrew Syrios · Answer

Self insuring is an option as long as you carry sizeable cash reserves, but banks will have none of that (nor will private lenders generally speaking). There is also a risk of something catastrophic happening to the entire area (think Joplin or New Orleans) that could ruin your whole business.

Donald Stevens · Answer

If you are thinking about self insuring your first move should be to increase your deductibles which will also lower your rates. The old way of thinking is a $500 or $1000 deductible but many companies offer higher options like $10,000 or $50,000. That way you self insure for the smaller claims and the insurance company pays out if its catastrophic. Just an idea.

Bill Gulley · Answer

Residential has had an 80% co-insurance clause for years, mine is, company specific, so check your policy before you self insure.

Another point, what your loan officer tells you may change when it gets to servicing and hits the insurance department bunch who deal with coverage. They are aware of co-insurance clauses and so are compliance types as well as examiners. I suggest you bump coverage a tad higher as hitting the coverage at the co-insurance limit will put you under in time as replacement or repair costs increase to the time of a loss. Then review that coverage carefully each year. :)

Elizabeth Colegrove · Answer

@ANISH TOLIA

How much are you paying for insurance premiums. For my 4 houses I pay a total of $3,700 a year for property worth over $580,000 (combined). There is no way that 4-5 years of premiums would allow me to save enough to buy another house.

While insurance companies are a "for profit" institute and they bring in more than they pay out. They are also one of the leading "institution" investors in real estate. So they make alot of money from investing in other capital sources!

Once house is worth $125,000 and I pay $1,200 a year. It would take me 104 years of premiums to buy a new house! Personally I would not recommend getting rid of insurance. I do recommend shopping around and making sure you have the best product at the lowest price!

Justin E. · Answer

Insurance companies would not be in business if they didn't take much more in then they pay out. Ever ask yourself why there are so many insurance company commercials all the time, that costs a pretty penny?I have payed thousands and thousands in insurance, and have not received a cent in return. Its a government scam, like extended warranties.

Account Closed · Answer

@David Krulac

1. Of course. I understand the need for liability.

2. Yes, but at some point thats the same as self insured while still giving money away!

3. Yes but why should I care? I am really not going to erect a new building anyway. If I get my investment back plus years of rent collections, I am happy to sell the land for whatever I can get and walk away!

Why pay for insurance?

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