[ExI] a note on economy of scale

[spike at rainier66.com]

You can buy a new Honda Accord or Toyota Camry off the assembly line for
about 50k, but if you were to get the parts list, buy the all the parts from
the dealer, hire an expert mechanic to assemble the thing, you would be damn
lucky if you could drive away with an investment of half a million bucks,
and even if you did, the car would be not nearly as good as the one
assembled at the factory, for your expert mechanic doesn't have all the
special assembly tools they have at the factory.  The factory is banging out
a thousand units a day with highly specialized assembly lines, your expert
mechanic is building one.

 

OK then.  Imagine you have a house and you have insurance on that house for
as much as the insurance company will allow: approximately its resale value.
Insurance companies are reluctant to insure any house above its resale value
for a perfectly understandable reason: they don't want to incentivize a
homeowner to "accidentally" torch his own home for the insurance money.
Furthermore, they avoid incentivizing the homeowner to have an "accidental"
fire by writing the contract such that the owner must build back what he had
to start with.  If he doesn't rebuild, the insurance company doesn't pay.
If he builds something vastly superior to what he had, the insurance company
does not pay, for that too would incentivize "accidental" fires.  If the
homeowner chooses to not rebuild, but sells the empty lot, the insurance
doesn't pay.

 

I was not aware of this.    I am damn aware of it now however.  I assumed it
was analogous to car insurance, where the company declares your car a total
and gives you the depreciated value of the car.  But home insurance doesn't
work that way.  The owner must rebuild the house as it was, to get the
insurance settlement.  That's the only way to get the insurance company to
pay.  

 

However.

 

If your house burns down, you can't rebuild it for a cost anything near what
it cost to build in the first place, if you live where plenty of us yanks
do: in housing tracts, where the homes were built a hundred at a time, which
gave the contractor economies and efficiencies of scale.  If you have a
tract home which was build 35 years ago and is worth 400k, good chance it
will cost about 800k to rebuild it from the ground up.

 

The insurance company will pay about 400k of that.  When you finish, your
new house will be the same design as the original house but everything in it
is new, so it will be worth. about 500k.  So you put in 400k, and if all
goes well and the contractors don't overrun or screw up, you might come away
with 100k profit, but no guarantee.  You might lose money on the deal: the
resale value of the new house might not be enough to cover what you put in,
after the insurance company pays their share.  The original builder had
economy of scale, you the homeowner do not.  Result: many (possibly most)
home fire victims will not be able to rebuild or will judiciously choose to
not do so.  Result: the insurance company gets out of a lot of expense.

 

Conclusion: your fire insurance is mostly an optical illusion.  If one is
fully insured, one is not really all that much better off than the guy who
had no insurance at all.

 

spike

 

 

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