Should You Invest in Disaster Insurance?

Living in an area prone to natural disasters can be risky. Going without insurance to help pay for damage can be even riskier.

But there are ways to take on the responsibility of covering repairs without flirting with financial disaster. Hikingware.com asks you to consider the following background and information on this subject of importance to all homeowners.

Most homeowners carry basic insurance, which covers damage from fires and routine bad weather, and lenders often require borrowers in high-risk areas to purchase additional coverage for certain catastrophes.

Yet as premiums rise, many homeowners who do have a choice are opting not to buy coverage specifically for floods, earthquakes and other major disasters.

Only 13% of U.S. homeowners had flood-insurance policies last year, according to the Insurance Information Institute, a trade group. That is down from 17% in 2008, despite alarming reminders of the threat from superstorm Sandy in 2012 and other recent devastating events. Flood coverage is mandatory in most cases if you are applying for a mortgage on a home in a high-risk area.

In California, only 10% of homeowners with basic insurance carry separate earthquake coverage, which is excluded from standard policies, according to the state's insurance department. Coverage isn't mandatory, even if the homeowner has a mortgage.

In addition, some homeowners in coastal areas who own their homes outright exclude coverage for wind damage from basic homeowner policies.

The savings can amount to thousands of dollars over many years, and considerably more for homes that are more expensive to insure.

Premiums from the federal government's National Flood Insurance Program—by far the most common source of flood policies—averaged $695 as of March, up nearly 7% from a year prior and up 24% from 2009. The California Earthquake Authority, the state-managed earthquake insurer, charged an average premium of $789 in March, 2014; up 6% from 2013. Deductibles can be high as well, leaving homeowners to bear more of the risk.

Financial writer AnnaMaria Andriotis says: "Many homeowners in vulnerable areas who don't buy coverage are essentially betting that their homes either won't sustain serious damage or that they will have the financial resources to pay for any necessary repairs." 

One way to manage the costs is to set aside a certain amount of money each year specifically to pay for damages. But be alert to the risk that disaster could strike before you have a chance to build up much of a reserve, says Spencer Houldin, president of Ericson Insurance Advisors, an independent firm based in Washington Depot, Conn.

You also need to be able to avoid the temptation to tap the funds you set aside for other reasons, says Alex Soto, senior partner at Miami-based InSource, an independent insurance firm. It can be tempting to use savings intended for home repairs to cover everyday expenses or big-ticket purchases, especially if a long period passes without an incident, experts say.

Some states offer tax breaks for this kind of savings. Alabama and South Carolina, for example, allow residents to save cash in so-called catastrophe savings accounts, whether they are insured for disaster losses or not.

Interest on the accounts generally isn't subject to state income tax as long as it remains in the account or is used to cover repairs or losses on a primary residence from certain catastrophes. These are typically savings or money-market accounts that homeowners can open at banks.

A home's location also is crucial. Consider reviewing the history of natural disasters in your area, as the past can provide a useful guide to the types of events that may be more likely to occur, even if there is no way to be sure what will happen in the future.

Also, think about what you can do to bolster your house and make it less susceptible to damage. The Insurance Institute for Business & Home Safety, a research group funded by the property-insurance industry, recommends steps homeowners can take on its website, disastersafety.org.

There also is a middle-of-the-road option: Split the risk with the insurance company by signing up for a policy with a high deductible. The larger the deductible, the lower the premium, typically. Just be sure that you can afford to cough up the deductible if disaster strikes.