Perpetual Home Insurance is quite a rare option that a homeowner would choose over and above traditional home insurance. This policy is written to have no term, or date, when the policy expires. From the effective start date, the coverage exists for perpetuity.
The insured deposits money, called a deposit premium, with the insurer. It is many times larger than the cost of a non-refundable annual premium for a traditional home insurance policy. When you no longer need the coverage, the deposit premium is returned to you.
The deposit required for perpetual home insurance is usually 15 – 20 times the annual cost of a traditional insurance. The perpetual home insurance company invests the deposit. It uses the proceeds of investments (interest and dividends) to cover claims, administrative costs and of course profits. Since the insurance company has your deposit, you lose the ability to invest in alternatives like stocks bonds and savings accounts.
The best reason to choose a perpetual home insurance policy is for the tax benefits.
Payments for traditional home insurance are not deductible. That is to say, if you pay $1000 per year for insurance and you are in a 25% marginal tax bracket, you must earn $1, 333 to pay the insurance plan. (25% of $1, 333 is $333 – the portion that is taken by the government). The non-cash insurance benefit from a perpetual home insurance company is, however, not taxed as income to the recipient.
All things being equal, a perpetual home insurance plan is the fixed rate? $1000 of insurance that often accompanies a perpetual home insurance policy. This allows you to purchase additional insurance as your property value increases at a predefined purchase rate.
WHAT ARE THE RISKS?
While it may at first seem that the $15, 000 deposit premium is the most significant component of the risk, it is not. As with any insurance decisions, the most important question is whether the company is prepared to pay in the event of a substantial claim.
This is the question that should be asked of all insurance companies, both traditional and perpetual. It would serve a purchaser well to investigate the company as well as its financial performance before signing up. Fortunately, in the United States, there are considerable capital retention regulations placed on most insurance companies where you are only at risk in the event of a claim. With a perpetual company you constantly have the deposit premium at risk.
Essentially you are gaining the tax and fixed purchase-rate benefits at the expense of increased risk.
EVALUATING PERPETUAL INSURANCE INVESTMENT PERFORMANCE
If we assume perpetual home insurance costs 16 times an annual insurance policy, that means an average tax-free return of 6.25%. If you are in the 25% tax bracket, this is equivalent to an 8.31% return.
You can then compare this with other taxed and tax-free options (like mutual bonds) to determine whether the investment makes sense. Of course, the 16 x assumption is important. If the number rises, say to 25 X, it may be better to invest in something else and simply buy the traditional annual option.
PERPETUAL HOME INSURANCE vs TRADITIONAL INSURANCE
Given that you are investing a sizeable lump sum of money into a single company, we think perpetual insurance makes sense only for the people who have:
More than $100, 000 in non-home, non-retirement investment assets;
Are in a tax bracket at least 25% (the higher the bracket, the bigger the advantage);
View their perpetual policy as a component of an overall coordinated investment strategy;
Have no high interest credit card or other debt;
Are willing to put in the effort to evaluate the insurance company.
As of the end of 2013, Baltimore equitable had assets of $156, 000 million, nearly all of it liquid, and liabilities of $47, 000 million in the form of deposits. It means they could refund every dollar of deposit they hold 3.3. times.
A few companies that offer the coverage: