Do clients have the energy to deal with coastal property?
Bonnie A. Hughes, a certified financial planner,
fought mother nature for five years, trying to maintain a
home-financially and emotionally-on the coast of North Carolina, 20
miles south of Wilmington. After six hurricanes roared through the
area, she and her family admitted defeat and retreated to lakefront
property, agreeing to visit the ocean beaches once in awhile in rented
property and then leaving so that others had to deal with the aftermath
of hurricanes and flooding.
Her experiences have been multiplied many times over by the devastation of Hurricane Katrina on the Gulf Coast, where many people, rich and poor alike, may never be able to return home. The unprecedented magnitude of the storm and its damage have left the insurance industry reeling, and predictions of what may happen to the price or availability of coverage are pure speculation.
"There is nothing 'usual' about Katrina, so anyone who is telling you what affect this will have on the industry is guessing or just throwing darts," says Julie Rochman, senior vice president of the American Insurance Association, the trade organization for property and casualty insurers.
Much of the loss-impossible to calculate as this article was being written-will be covered by reinsurers of the insurance carriers. Much of the loss is attributable to flooding, which will be covered by national flood insurance, rather than from wind, which is covered by the insurance companies, she says.
"All of those things impact losses and losses impact the bottom line for insurance companies, and the bottom line is related to rates," Rochman says. Companies do not know their total losses yet from Katrina, so they don't know what it will mean for rates, she adds.
Losses from four hurricanes that struck the Florida area in the summer of 2004 resulted in some increases in rates, she says. But for financial advisors, there will be nothing to do but wait until the results of Katrina are assessed by the industry and property owners finally see what they have left before they can offer any specific advice.
For Hughes, the experience of dealing with much smaller, but still traumatizing events, taught her that there are more than strict financial considerations to look at when contemplating investing in oceanfront property, and the same would apply to homes in the California hillsides, in earthquake-prone areas, in tornado alleys or along the Mississippi River. Financial planners with personal experiences in preparing for and cleaning up after hurricanes, floods and other natural disasters feel they are most qualified to advise clients of the risks involved.
The most obvious consideration, adequate insurance coverage, may be the easiest issue to deal with, several financial advisors say, although all stressed that many clients and advisors forget to plan thoroughly for insurance costs and coverage. The emotional issues, as well as tax considerations, also should be brought to the attention of clients before they invest in first or second homes in disaster-prone areas, the advisors say.
"Every financial advisor needs to ask clients if they have the energy to deal with coastal property," says Hughes, a sole practitioner in the firm of A&H Financial Planning and Education Inc. in Chattanooga, Tenn., and Kennesaw, Ga. "They probably do for the first event, but when nature hits again and again and again, they may finally throw up their hands, like we did."
Some residents of the southern United States were put in that position this past summer, as one hurricane after another threatened or struck the area. Dealing with the aftermath, even when insurance coverage and tax refunds can help ease the financial burden, does not solve the many other problems, all of which can cost money because of time and energy lost that ordinarily would be spent earning a living.
"Planning for casualty losses is important and can save lots of headaches after an event," Hughes says, "but a check in hand won't make you whole. If people have a choice, I'd advise they steer clear of coastal areas and flood zones. It's one thing to have insurance-we did-and another entirely to deal with the aftermath."
Financial planners, and particularly those who consider themselves "life planners" for their clients, should warn clients that they need to consider whether they will have access to property following a disaster, something that is often banned for days or weeks.
"Then they need to be ready to deal with subcontractors and to deal with the cleanup that no contractor can or will do," Hughes advises. "They need to deal with the reality of a changing landscape when dunes and trees disappear and with the psychological challenge of having valuable property wrecked."
Clients need to be aware that a major disaster often triggers escalating fees and assessments for cleanup work, the potential of being taken advantage of by unscrupulous contractors and the need for litigation when things go wrong, Hughes warns. All of which can mean lost time and money in other areas of life.
"Before buying property, clients should be advised to look at the beach as a changing landscape. If they decide they should purchase, they should price those potential changes into what the property is worth when negotiating a buying price," Hughes says. "If the property involves a homeowners association, potential buyers should be advised to look at the homeowners association members, who are sometimes volunteers. Those are the people who will be buying your insurance and negotiating with contractors, so you need to know what those people are like. None of this will dissuade the truly possessed (from buying beachfront property,) but it is food for thought."
Even with good insurance coverage, property owners should be warned that they may face substantial financial losses for a number of reasons, say advisors who have been through the process personally. Obviously, the best preparation is videotaping the contents of the home and describing all valuable property, and buying adequate insurance to cover its loss. However, if there are unforeseen losses or if the policy has a high deductible, such as most earthquake insurance, property owners have options. If the property owner itemizes deductions, the loss can be taken as a deduction for income tax purposes, minus some adjustments based in part on gross income, according to the Financial Planning Association.
If an area is declared a national disaster area by the president, property owners can take the loss deduction in the year that it occurred or in the previous year. Declaring it in the previous year would give the homeowner the advantage of receiving the tax refund quicker, rather then waiting until the spring of the next year when current year taxes are filed, explains Julie Welch, CFP, CPF, of Kansas City, Mo.
If the income in the previous year was substantially less than the current year, the adjustment based on gross income will be less and more of the loss can be used as a tax deduction, but the property owner needs to consider his or her tax bracket. If the property owner opts to take the loss deduction for the year in which it occurred, withholding amounts or estimated tax payments can be lowered in order to receive some of the money immediately, according to the FPA.
"None of these situations have an easy answer. You really need to run the numbers and see which is more advantageous," says Welch, a member of the firm of Meara, King and Co. Any part of the loss covered by insurance, whether or not the property owner decides to file an insurance claim, has to be deducted from the loss. Any insurance reimbursements for living expenses have to be documented or they may be considered income for tax purposes. In addition, casualty losses for home offices and for offices in office buildings are figured differently, she warns.
"If a person receives a financial gain from an insurance payment, he or she has an extended time to reinvest in property before having to pay capital gains tax, if the property was in a national disaster area," Welch says. "The new property does not have to be in the same area as the old, if the client decides not to risk disaster hitting again."
Hidden costs in replacing a home also can strike clients if insurance has not been calculated correctly in advance of a disaster, warns Elaine D. Scoggins, CFP and Chartered Financial Consultant, who is the founder of Scoggins Financial LLC in Tampa, Fla. Scoggins also learned about the potential problems for clients firsthand, when Hurricane Charlie threatened to send flood waters surging in the mouth of Tampa Bay last year. The hurricane did not directly hit that area, but prompted Scoggins to re-evaluate insurance and what should be brought to the attention of clients.
"I am amazed at the number of people who are underinsured," Scoggins says. "People get a false sense of security because their insurance policy has an inflation rider, but that does not mean the cost of new home construction is going to go up at that same rate. Here in Florida, the cost of concrete, copper and lumber is rising faster than inflation, and that is critical."
Building codes also are in constant flux, and when a new home is being constructed are likely to be stricter then they were when the destroyed home was built.
"There is an 'ordinance and law clause' in insurance policies that covers that, but this also leads to a false sense of security because it can have a percentage limit. Clients may not be able to bring their homes up to code without paying money out of their pockets," Scoggins warns. "Financial advisors or their clients need to talk with realtors and builders to find out total construction costs and then take that times the square footage of the home. That is the number you are after. All of this applies, whether you are working with a client with modest means or one that has a million-dollar-home."
Another Florida financial planner, G.M. "Buzz" Livingston III, also had personal experience prompt his re-evaluation of risks and concluded that underinsuring property, even with the advice of a financial planner, is more often a problem than most advisors might suspect. A sole practitioner who works with the Garrett Planning Network under the name Livingston Financial in Santa Rosa Beach, Fla., Livingston says the most frequent mistake is not having insurance converge keep pace with skyrocketing home prices.
"People buy a vacation home and its value doubles or triples, but they do not increase insurance. At the same time, advisors have to consider how much the property itself is worth, if it is bayfront or beachfront property, versus how much it would cost to rebuild the home on the property. Sometimes the property itself is worth $2 million, but the home by itself is not nearly as valuable. I do not know how many advisors are well versed in construction costs," Livingston says.
Some property, such as patios and gazebos, are not insurable for hurricane damage, and hurricane deductibles can vary by company, he warns.
"Also, just because an area has not flooded before, does not mean it will not flood in the future. More development means more runoff, which causes floods. Some insurance policies have high deductibles for lower premiums, but if a client has a 2% deductible on a valuable piece of property, that can be a huge deductible," Livingston says. "Even people who are very well off often overlook their insurance; 75% of my clients, where I do comprehensive planning for them, are underinsured. Our job is to educate the client, including advising them that the cheapest insurance is not necessarily the best. That is the value financial advisors bring to the table."