We all have stories of people we know who had trouble getting insurance companies to pay out for damages but lately I've also been hearing a lot about systematic insurance company behaviors to pay claimants less than they're owed, contract changes requiring arbitration and conflicting water/wind damage clauses designed to grind the claims process to a halt, and industry-sponsored legislation that strip the legal rights from consumers or make it impossible to sue.
The YT channel Building Integrity summarizes these issues in a Florida context:
https://www.youtube.com/watch?v=T5xPijaGYWAhttps://www.youtube.com/watch?v=-SetRwR_or0Meanwhile, even as the odds of getting a fair payout for damage seem to be declining, the cost of homeowners' insurance is
increasing at double-digit rates per year, far out-pacing any argument about inflation, rising fraud, or particular disasters.
Of course, most homeowners and landlords have no choice but to pay whatever the insurance companies quote them. They are not wealthy enough to self-insure and they have mortgages which require the coverage. Yet Mustachian homeowners or small LL's with modest-sized properties can conceivably think about paying off their mortgages and self-insuring. MMM reported he was doing this years ago. For us, there will be some threshold at which we decide the insurance market isn't worth it, and it may be time to start evaluating that threshold.
In addition, all the people I hear about who are getting 6%-7% mortgages are prioritizing paying down those mortgages. If rates never go back down in a significant way, we might see a lot more people directing a firehose of cash at paying off their houses. If many of them pay off their mortgages early, insurance will become optional.
Here are some specific thoughts I've had about the consequences and choices we may need to make if insurance becomes "a scam" with low odds of getting a fair payout and high annual premiums:
1) We can reduce our exposure to rising insurance costs by owning smaller, cheaper houses with mortgages small enough to kill in a few years if necessary. 2) We can reduce our risk of going without insurance by building houses that are less fragile. E.g. tougher roofing materials, better resistance to high winds, termite-proof and waterproof materials, fire-resistant design, and design features that make it cheap and easy to DIY swap out components like windows. Such construction techniques are common in other parts of the world, but Americans tend to buy stick houses with fragile asphalt shingles because that delivers a cheap price and because insurance has been affordable in the past. Unaffordable insurance tilts the decision in favor of spending extra to have a tile roof, concrete construction, better materials, etc. Usually this would require we custom-build.
3) We can also reduce our risk of going without insurance by not living in areas prone to hurricanes, wildfires, floods, or earthquakes.
4) A decision about paying off one's mortgage needs to factor in the option value of self-insuring. E.g. a 5% mortgage might seem good enough to keep forever, but if you are a millionaire living in a house with $200k net replacement cost* and $5k per year insurance premiums and you don't believe they'd actually pay you if you had a claim, then it's worth considering if the actual cost of your mortgage is a lot more than the interest rate. This is sorta like the people who are pleased with their low mortgage rate, but are paying PMI! No, the actual amount you pay to have that loan is through the roof and it's because of insurance!
5) If homeowners' insurance is becoming an uneconomical, duopolistic racket, then the overall price of homes is too high. I.e. if we violate the assumption that insurance expenses will continue to be affordable, then the true cost of home ownership will be higher than people currently expect. The result per supply and demand theory should be a "deadweight loss" like taxes which should reduce the price of the item. Whether prices actually change probably involves a lot more factors, but unaffordable insurance *should* be a factor reducing prices.
6) The way we understand sequence of returns risk (SORR) for self-insured individuals needs to separate and calculate the risk of an adverse market from the risk of an uninsured six-figure loss to the value of their RE. That is to say, we need to think about if we can afford to stay uninsured after a market SORR event, and we need to think about whether we can stay FIRE'd after a... uninsured house fire. Then we need to consider what happens if both occurred at the same time. Bonus!... one does not get to escape this calculation by staying insured, because one cannot count on insurance to provide a fair payout when disaster strikes. So the insured Mustachian needs to consider what happens when insurance refuses to cover the true cost of damages or they have to lawyer up (per the 2nd video, a new Florida law makes lawyer feeds un-recoverable in most cases when suing your insurance company). Flipside!... Self-insuring might improve portfolio resilience to SORR events because (a) there is no chance of the insurance company ripping you off for a net-worth-reducing five or six-figure loss, (b) annual expenses and thus WR's are lower and immune to the risk of premium hikes, (c) there is the option to spend the money in one's self-insurance account and to pay for insurance someday in the future - an option which might float a retiree through a SORR event, and (d) the self-insurance portfolio could in some scenarios grow faster than the cost of home replacement grows, thereby spinning off cash**.
7) An alternative response to high insurance costs and low insurance value would be to take the opposite approach as described in #2 and build disposable houses instead of more durable houses. E.g. If you're going to live in Florida or California, why not buy a $75k mobile home for cash, leave it uninsured, and if it gets destroyed just walk away and buy another. The insurance savings alone would cover replacement if you can go maybe 10 years between disasters, and you don't have as much money at risk as you would with a site-built home. Owning the lot under the mobile home would reduce one's housing expenses to just taxes, utilities, and occasional home replacement. Your main risk would be losing mobile homes at a faster pace than expected (e.g. back-to-back hurricanes, fires, or floods), in which case repairing a durable site-built home might have been more economical in hindsight. Still, it's hard to argue risk when you have so much
less money tied up in a disposable home, and your self-insurance portfolio only needs to be five figures. Really the only option that doesn't work in any scenario is to continue to site-build still-expensive fragile homes.
8) Returns on a self-insurance account could be attractive and inflation-resistant if you calculate it correctly. A self-insuring Mustachian might put the net cost of replacing* their home in a separate account or portfolio allocation and invest it conservatively to avoid the risk of overlapping SORR and home losses. The yield on such a portfolio might be very attractive, because it would be the sum of investment returns plus the insurance premiums one avoided. For example, a person with a $200k net replacement cost home and $3k per year premiums could instead build a $200k portfolio of treasuries, agency bonds, and CDs yielding 5%. Such a portfolio would yield $10k in cash from the investments, plus $3k per year in avoided insurance costs, for a total yield of (13/200=) 6.5%. That's enough to keep up with property appreciation in most places and in most years that aren't 2021 or 2022. So inflation probably won't run up the cost of replacing one's house beyond what the portfolio can generate to grow itself.
What are your thoughts about a potential future scenario where insurance is uneconomical?
Footnotes:
*Insurance considers the replacement cost of a house to be the cost of constructing a whole new house in its place. Mustachians will note that in many markets, the actual cost of replacing a 1970s ranch house is actually the cost of buying another 1970s ranch house, minus the resale value of the land on which the old house stood or its salvage value. This way of calculating our actual replacement cost can be a lot less than the full retail price of a brand new house. In other markets (e.g. HCOL and restricted) the cost of rebuilding might be cheaper than swapping.**E.g. in a deflationary recession like the Great Depression or 2007-2009, a self-insurance portfolio of treasuries would spin off cash while the replacement cost of your house* declines.
