Dealing with Catastrophic Property Loss

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Introduction

Hurricane Sandy reminds us that there are inherent disaster risks, even for those living in a city or highly urbanized area. Although disasters usually strike without warning, there are measures you can take both before and after they strike to protect your property and your finances.

What disasters are likely to strike your community?

While hurricanes may be on our mind, the majority of catastrophes are fires. Residential fires occur frequently in the United States. Although your risk of experiencing a natural disaster depends on where you live, every state has experienced some type of natural disaster. Floods and flash floods are the most common, occurring in all 50 states. Although hurricanes primarily damage islands and coastal areas, they can move inland, spawn dangerous thunderstorms and tornadoes, and produce rain that can cause massive flooding. Tornadoes occur most commonly in Texas, Florida, and throughout the Southeast and Midwest, but they can strike almost every state. California is prone to earthquakes, but since the turn of the 20th century, earthquakes have occurred in 38 other states and caused damage in all 50. To find out what disasters are most likely to strike your community, contact FEMA office or American Red Cross chapter.

How to prepare now to reduce catastrophic property losses in the future

Buy adequate insurance

Although you can’t prevent a disaster from destroying your home or possessions, you can prevent it from destroying your finances by purchasing adequate insurance. If you own a home, you’ll need to buy a homeowners policy that offers replacement cost coverage or guaranteed replacement cost coverage. While a standard homeowners policy pays only for the actual cash value of your home, replacement cost coverage will rebuild your home up to the limits of your policy, regardless of its actual cash value. Guaranteed replacement cost coverage provides further protection and will pay to rebuild your house regardless of policy limits, even if it costs more to rebuild your house than it did to build it originally, as a result of increased material and labor costs and building code changes. It may be a good idea to opt for replacement cost coverage for your personal possessions as well. The drawback is that this coverage may be significantly more expensive than standard coverage. In addition, consider specialized types of coverage that will insure your property specifically against various types of natural disasters that are likely to occur where you live.
Tip: Don’t wait to buy specialized types of insurance until hurricane season or until you hear on the news that flooding is imminent in your area. Your insurance carrier will likely refuse to underwrite the policy until a waiting period is over.

Flood insurance

Homeowners policies don’t cover damage from flooding. However, you can purchase flood insurance separately. The cost of flood insurance depends on many factors, including the type of occupancy (e.g., single family, nonresidential), the amount of coverage, and the location, design, and age of the building. Currently, the average annual premium for $100,000 of flood insurance coverage is approximately $542. (Source: FEMA, 2009)
If you have a mortgage on your home, it’s likely that your lender required a flood hazard search on your property at the time you obtained your mortgage in order to comply with federal standards. If your home turns out to be in a flood hazard area, you will be required to purchase flood insurance. However, even if you own your home outright or don’t live in an area that lies in a flood plain, consider purchasing flood insurance to protect your property. Flooding doesn’t happen only along the banks of rivers, lakes, or other bodies of water; it can also occur in other low-lying areas or in areas where drainage is poor, or it can result from heavy rains, melting snow, and backed-up sewers, among other things.
Tip: If your insurance company doesn’t sell flood insurance, call the National Flood Insurance Telephone Response Center at (888) 435-6637 for a list of insurers that do sell flood insurance policies. If your area was recently struck by a flood and you have difficulty purchasing flood insurance, you may be able to purchase coverage through a state or federally operated insurance pool, although you’ll pay more for coverage.

Earthquake insurance

Homeowners and renters policies do not cover earthquake damage, so if you want to insure your property against this type of natural disaster, you’ll need to purchase earthquake insurance. Unfortunately, earthquake insurance is expensive. Premiums vary widely from state to state depending on many factors such as the type and age of the structure and its proximity to fault lines, and you usually have to satisfy a high deductible before your policy will pay for damage. Most earthquake policies cover only the actual structure, so contents may have to be insured separately. However, if you live in an area where earthquakes are common, you should consider purchasing this insurance despite its expense.

Take measures to reduce your risk

You can do several things to reduce the likelihood that a fire, storm, or other natural disaster will destroy your property and possessions. First, before buying, building, or renting a home, evaluate the structure’s location. Is it in an area at high risk for some type of natural disaster? If so, consider living somewhere else if you want to reduce your risk. If you are building a home, make sure that it is constructed according to the existing building code, and have a building inspector, architect, or fire department inspector suggest ways to protect the house from certain hazards. If you already own or rent a home, you may be able to improve it substantially without spending a lot of money. For instance, you may want to bolt tall furniture to the walls and install latches on cupboards to prevent damage and injuries that can occur when your possessions fall during an earthquake.

Make a record of your property and personal possessions

Videotape, photograph, and/or make a written inventory of your property and personal possessions, then either give it to a friend or relative or store it in a safe place away from your home. If catastrophe strikes, you can use the inventory to refresh your memory and provide details about the property and possessions that were damaged or destroyed, making it much easier and less traumatic for you to support your insurance claim.
Tip: Have antiques, valuables, and unique items appraised, and keep the appraisals with your home inventory.

Keep important documents and valuables safe

You may want to keep most of your important documents and valuables in a safety-deposit box to ensure they are safe from fire and natural disasters. However, if you use these documents or possessions frequently, you may prefer to keep them in your home. No matter where they are stored, make sure they are readily accessible if you need them in a hurry when a disaster strikes. One way to do this is to store them in a box that can be carried out of your home quickly and easily. This evacuation box should be waterproof and fireproof and should contain marriage and birth certificates, insurance paperwork, titles, wills, passports, and a copy of the previous year’s tax return. You may also want to put a list of important phone numbers and addresses in the box, a list of your bank account and Social Security numbers, and copies of your safety-deposit box keys and car keys.
Tip: You may choose to keep some paperwork in a safety-deposit box and some in an evacuation box in your home. For instance, never store your original will in a safety-deposit box, because the box may be sealed at the time of your death. However, you may want to keep things in your safety-deposit box that take up a lot of space or that need special protection, such as jewelry, copies of photographs or negatives, appraisals of valuable items, copies of your written or videotaped home inventory, a list of credit card numbers, and copies of important paperwork.

Start an emergency cash fund

It’s important to have access to cash to help you survive the weeks or months following a disaster. First, even if you have insurance, you will likely have to pay a deductible before your coverage kicks in, and your insurance won’t compensate you for all of your increased living expenses if your home is partially or totally destroyed. In addition, people living in areas that experience severe damage may lose their jobs temporarily or permanently when businesses are unable to open because the business has been damaged or destroyed or because utilities are cut off. Although some disaster help is available from charities or from the government, it won’t be enough to cover all your expenses. You should aim to keep funds for at least three to six months’ worth of living expenses in an emergency cash reserve account (e.g., a savings account or money market fund) that can be easily liquidated.

What to do after a catastrophe strikes

Contact your insurance company

After a catastrophe strikes your property, call your insurance agent or company as soon as possible and ask that an appraiser be sent right away. Ask for advice about making emergency repairs, but don’t hire any contractors until clearing it with your insurance company. Find out if you are entitled to any money for living expenses under your insurance contract. While you’re waiting for an appraiser, take photos of damage to your property and gather records that you have, including your household inventory and receipts for expensive items that you might own. If you don’t have a household inventory, you’ll have to rely on your memory and old photos of your home to make a list of things destroyed. Providing as much information as possible about losses will help ensure that your claim is settled quickly and fairly. You should also keep careful notes of your conversations with the adjusters and check over all paperwork and supporting records to make sure the settlement is fair. If you believe it’s not, you can appeal the settlement offer to your insurance company or try to settle your claim through arbitration. After you receive your settlement, keep it in a liquid account, because you’ll need the money soon to replace, repair, or rebuild your property.
Find out what government, private, and nonprofit assistance is available to help you deal with the catastrophe
After you are struck by a catastrophe, you should seek information and/or financial assistance from one or more of the government agencies, private programs, or nonprofit organizations that help victims of natural and other disasters. If you have lost property in a fire, contact your local fire department or American Red Cross chapter for information on what assistance is available in your community. If you are the victim of a natural disaster, numerous other sources of help may be available. For instance, you may be able to apply for help from state and local government disaster relief programs, and you can also seek assistance from the Federal Emergency Management Agency (FEMA). FEMA can provide emergency housing or assistance to cover the cost of living expenses and hotel accommodations. You may receive a low-interest loan or a cash grant. If you don’t have insurance, or your insurance is inadequate, you may be eligible to receive a low-interest loan from the Farm Service Agency (FSA) or the Small Business Administration (SBA). You can also apply for a cash grant from FEMA if you don’t qualify for a loan. For more information on disaster relief programs, contact the American Red Cross or FEMA.

Income tax considerations

Deductibility of casualty losses

A personal (nonbusiness) casualty or theft loss is deductible if the loss exceeds $100 and your total casualty and theft losses in a year (in excess of the $100 per loss floor) exceed 10 percent of your adjusted gross income (AGI). However, for the loss to be deductible, you must file an insurance claim (if the loss is covered by insurance). The amount deductible is the lesser of the decrease in fair market value of the property as a result of the casualty, theft or the adjusted basis in the property before the casualty or theft, minus any insurance or other reimbursement received or that is expected to be received.

Special rule for residents of federally-declared disaster areas

If your residence was located in a federally-declared disaster area, you can deduct a casualty loss resulting from the disaster in either the year the loss occurred or the year preceding the loss.
Example(s): Lynn files her year-one taxes and receives a $200 refund. In year two, her home is damaged by a hurricane, and her county is declared a federal disaster area. Lynn elects to amend her year-one tax return because it would give her a higher deduction than one she could take in year two, thus giving her an additional refund for year one.

About Michael Bradley, CFA

I am an independent financial advisor in San Francisco. My wealth management practice is primarily composed of affluent individuals with a scientific or technical background.
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