WE are into the second week of the 2002 hurricane season. It is fair to say that based on the devastation and wide-scale flooding-out of householders in a number of parishes in Jamaica, there is need to protect your assets in the event of hurricane, earthquake or flooding brought on by sustained and heavy rainfall as occurred within the last two weeks. Prudent personal financial management speaks not only to maximising investment earnings but eliminating financial losses. Sound personal financial planning then is incomplete unless appropriate insurance policies are factored as an integral component in the mix.

Insurance is based on two essentials. These are risk reduction and loss sharing. When you purchase insurance you are exchanging the uncertainty of a potentially huge financial loss with the certainty of a smaller fixed insurance payment (known as a premium) in an effort to reduce your risk. Insurers also utilise a concept known as the law of large numbers. The concept states that predictions about the behaviour of a group of persons become increasingly accurate the larger the group becomes. Taken to its logical conclusion, it follows that the levels of uncertainty and therefore risk decrease the larger the group.

We take an example. The parish of Clarendon seems to have borne the brunt of the heavy rains of the last two weeks. If we assume that there are about 100,000 households in Clarendon then based on the reports of flooding in that parish, we might assume that about 500 households were flooded out. That would make a one in 200 chance that a household will be flooded the next time we have prolonged heavy rain in that parish. This is a .005 per cent chance. If we were to focus on just say 10 or even 100 households in Clarendon, we really could not predict with any great accuracy whether a flood will strike a household next time. In other words, some villages in Clarendon might encounter severe flooding with several homes washed out while other villages might have no flooding at all. Where we combine all of these households together however, we can predict with more accuracy that approximately 500 families will be flooded out of their homes next time the rains come.

Because of these principles anyone who purchases insurance, in this case property and/or homeowners insurance, benefits whether a loss is suffered or not for the simple reason that the reduction of risk is itself a benefit. Think about it. What if there were no risk coverage for driving your car, or owning a home with the real probabilities of fire or flooding occurring?

There are many rules for properly engaging in insurance but we highlight just two of them here:

Never risk a lot for a little. By that is meant you should not allow a large potential loss to remain uncovered by paying a smaller premium than necessary. The dollars you save here could turn out to you being “penny wise and pound foolish”.

Never risk more than you can afford to lose. This one is particularly poignant especially as we start the hurricane season. Some householders have argued that they simply cannot afford the cost of property insurance and have opted to build up their own private reserve in the event of “loss”. The obvious question here is, can this reserve that is built up cover the cost of replacing the loss? Can the magnitude of the loss be predicted? What if you, a householder, were to suffer a complete wipe-out in a fire? Can the reserve cover this? When asked these questions, these “risk takers” invariably answer that they are prepared to “risk” their chances. The simple response here is that this approach to risk management leans more closely to gambling than to responsible risk taking.

If you would engage in a responsible risk management programme, two of the fundamental requirements are to determine the coverage needed on your dwelling and determine the coverage needed on your personal property. Some otherwise rational individuals take out coverage on their dwelling but ignore coverage on their household items. But this has to be a function of how much value is placed on the latter. Where property insurance is concerned the average clause principle makes it absolutely essential that you do regular appraisals on your property and that you are never under-insured. Some persons go to the other extreme and over-insure their property to counteract this average clause principle that in simple layman’s jargon denies you full value on your claim once it is established that your property was not insured for its full market value.

On the other hand while some persons are prepared to “grin and bear” the additional cost of premiums necessary to insure their property at full value, they are completely sanguine about insuring their household effects. If you fall into this category you may be abrogating those two rules above of either risking a lot for a little or risking more than you can afford to lose. How do you determine the coverage needed on your personal property?

The first step is to make an inventory of and place a value on all the contents of your home. It is a time-consuming but crucially important task. Conduct this inventory for each room, attic and basement (if you have these), garage, yard, workshop and anywhere else in which you store valuable possessions. The total value on these possessions will enable you to select the most suitable limits on your policy.

The table on previous page looks at some typical items from an average living room. Prepare similar checklists for each room in your home. It is a time-consuming and often mundane but very essential task.

The checklist speaks to you listing three estimates for the value of household contents. These are: purchase price, actual cash value and replacement cost. Over time the practice of insurers has been to pay what we term the actual cash price of items for which claims are made. By actual cash price is meant the purchase price of the item, less depreciation. They utilise a formula that you can use also:

ACV = P – {CA x (P / LE)}

Where P = purchase price of item

CA = current age of item in years

We have worked an example for you. The television in our checklist was damaged beyond repair in the recent floods (we are assuming a total life expectancy of 10 years for the television).

ACV = $9375 – {6 x ($9375/10)}

= $9375 – (6 x $937.5)

= $3750

Our investigations show that a modern 24″ television set with stereo features would now cost in the region of $23,150 inclusive of GCT, which is indeed a more realistic replacement cost for the television. Some policies carry a contents replacement-cost protection option as a part of their homeowner’s insurance policies. It could cost a higher premium, but think of the greater loss involved.

Please send comments and questions to: staubyn@colis.com

Hopeton Morrison is general manager of St Thomas Co-operative Credit Union Ltd.