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I live in a state with stupidly expensive state-sponsored earthquake insurance. To get a 5% deductible, I basically have to buy 1/10 of a house over my lifetime... but the chance of losing my home to an earthquake over that timeframe is only 1/500. But then I noticed that for half the cost, I could buy a policy with a 20% deductible on the full value, and then a second policy with a 20% deductible on 20% of the value. To effectively get a 4% deductible.... at almost half the cost. Because of the lower deductible, the premium on the first policy drops by half. The second policy is 1/5 of that.

The payout with these two new policies is as good as one policy with a 4% deductible. For example, if the home is destroyed, then I collect 80% of the home value from policy 1, and another 16% of the home value from policy 2. So, in total, I get 96% of the value, just as in a 4% deductible plan. Neither policy is paying out any more or less than it would have if I had just one of the two new policies. So I am not causing any harm to either insurer by having the other one. Right?

Generally speaking, double-insuring things is legal. For example, I can insure stocks or mortgages that I don't own, and I can have 15 life insurance policies. Nonetheless, I have to ask: is there any potential legal issue with doubling up on earthquake insurance? Is it somehow illegal to attempt to avoid getting ripped off by the state?

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    I don't think you can insure something that you don't have an insurable interest in (like stocks or mortgages you don't own). I'm also not sure how your deductible math works out... – Ron Beyer Jun 19 at 4:38
  • @Ron Beyer I've added an example to illustrate the math. You can definitely buy put options without owning underlying stocks. It's a common way to short stocks. And there are credit default swaps (a la The Big Short) for mortgages. – personal_cloud Jun 19 at 4:56
  • @personal_cloud Those aren't insurance. They are governed by different laws most everywhere. – Yakk Jun 21 at 3:22
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    Also note that if the earthquake only causes damage to your house to an extent of e.g. 20% of the value of your house, your combined insurances will pay out nothing, while the original would have paid 15%. This should explain the difference in price. – Rasmus Faber Jun 21 at 5:05
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It would depend on the law of that state, and the insurance policy. Here is a sample policy from the California Earthquake Authority. §8 on Other Insurance says

a. If there is other insurance that covers earthquake loss to the dwelling or other property covered under this policy,we will pay our share of the covered loss or damage. Our share is the proportion that the applicable limit of insurance under this policy bears to the combined limits of insurance of all policies that cover the same property.

As you can see, they anticipate the possibility of having multiple insurance policies, so it's reasonable to conclude that it's not illegal to have two earthquake insurance policies, at least in this case.

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  • Ah. OK. I guess this technically does answer my question. So they might ask about Other Insurance if I file a claim, and then exclude some amount that went to the deductible on the Other Insurance. I guess that defeats my strategy. So they have a very clever system to enforce their monopolistic pricing scheme. I wonder if the insurance companies are behaving legally here. – personal_cloud Jun 19 at 5:17
  • Thanks for honing this down. I've posted a new question to get to the bottom of the bigger question -- whether my strategy can work to defeat monopolism. – personal_cloud Jun 19 at 5:28
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Looking at this and your other question, I think the thing you're missing is what if your house is merely damaged and not completely destroyed. You've focused on the probability your home is completely lost to conclude the policy is too expensive, but the insurer is also worried about the probability everyone's home is slightly damaged and they have to pay out billions of dollars for a gazillion cracked patio claims.

The reason why a policy with a 5% deductible is so expensive is because there's a much higher risk that your home will be damaged and need costly repairs even if it's not a total loss. The California Earthquake Authority was created in the wake of the Northridge earthquake in 1994, which nearly broke the solvency of some insurers due to the number of homes that were damaged. Most homes in that earthquake had less than $50,000 in damage.

So the high deductible reduces premiums by ensuring that the insurer doesn't have to pay out anything on damaging but not catastrophic claims. But you're trying to have it both ways. You want the lower premium of a 20% deductible—a low premium the insurer is only willing to offer you because you're agreeing to bear the risk yourself of all costs less than the deductible—yet want to combine policies so you get the coverage of a much lower deductible.

Consider your two example policies with a $500,000 home value. Your 20% deductible policy on the full value covers no damage under $100,000. If the earthquake does $75,000 worth of damage, the insurance company wishes you good luck and pays you nothing (though you may have separate coverage for personal property or loss of use). But your 20% deductible policy on 20% of the value, if you were allowed to have such a thing and I'm understanding your scenario right, that policy would cover any damage greater than $20,000. Now that same earthquake costs the insurer $75,000-$20,000=$55,000.

You want a 4% deductible at almost half the cost, and the insurer doesn't want to sell that to you because it underprices the risk they'll have to pay out on claims that involve significant but not catastrophic earthquake damage, and those happen to be the most likely claims.

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