homeowners insurance

Homeowners Insurance – Do You Have the Coverage You Need?

Homeowners insurance is another type of must have policy. But many homeowners are required to purchase it regardless. Any time you have a mortgage on your home, the lender will require you to insure their collateral. As such, unless you own your home free and clear from any loans, you will likely need to insure it. But if homeowners insurance is optional for you, it is best to be safe than sorry.

For most individuals, a fire or other substantial damage to their home would cause all sorts of problems. Being displaced from your home is one thing. But then not having the financial means to replace or repair the home is even worse. What if someone is injured on your property? A lawsuit can also potentially result in financial distress. So don’t pass on homeowners insurance even if you are not required to carry the coverage.

Homeowners insurance has two major components. It insures against damage to property, and it also insures against liabilities arising from lawsuits or other claims.

Anything that can cause damage or loss is a peril. Examples include fire, theft, and wind. Policies are either “named peril” or “all risk.” “Named peril” policies only protect you from the perils listed on the policy. With “all risk” policies, the insurer generally covers you from all perils unless specifically excluded.

Types of Claims – Actual Cash Value vs Replacement Cost

Homeowners insurance claims are generally settled based on one of two valuation methods. Actual cash value (ACV) is equal to replacement cost minus depreciation. However, this is not the preferred method for the insured. ACV will typically necessitate the insured to go out of pocket to replace the exact property which was lost.

A better option for the insured is the replacement cost method. This type of claim is based on the cost of replacement, without a reduction for depreciation. For real property, replacement cost value is based on the size of the property, and the cost of materials and labor required to replace it.

Most policies offer coverage for structures at replacement cost, and content coverage at actual cash value. However, you can purchase replacement cost for contents as well, albeit at a higher premium.

Even with replacement cost however, the policy may limit personal contents coverage for specific valuables on a per item basis. Examples include jewelry, electronics, silverware, and firearms among others. You can purchase additional coverage for such items.

How much homeowners insurance do you need?

A coinsurance clause in many policies generally requires you to purchase enough insurance to cover at least 80% of the replacement cost value of the property. In the case of a total loss, your insurer will cover you up to the policy limits.

If you don’t meet the coinsurance clause, you may be subject to less than full coverage in the more common case of a partial loss. The coinsurance penalty allows the insurer to reimburse you for less than the full cost of replacement or repairs.

The fraction of reimbursement is the amount of coverage divided by the 80% of the replacement value of your property. So if the replacement cost value of your property is $450,000, 80% of the value equals $360,000.

If your insurance coverage is only $300,000, your reimbursement fraction will be $300,000 divided by $360,000, or 83.33% in this example. In this scenario, a partial loss costing $50,000 to repair will only net you a claim payout of $41,667 ($50,000 x 83.33%). You would be responsible for paying for any repairs above this amount.

Cover 100% of the Replacement Value

Regardless, many experts generally recommend that you cover your dwelling for 100% of the replacement value. This way, the policy guarantees the insurer will pay for the full cost of replacement, less any applicable deductibles.

You will also have a 20% cushion to meet the coinsurance clause. Otherwise, inflation, or other variations or opinions of the calculation of replacement value can cause you to have limited coverage.

Your replacement cost may seem low in comparison to the market value of your property. However, keep in mind that you are insuring only the structures on the land, not the land on which they are built.

Replacement cost can change over time. You should review your coverage on a regular basis to ensure that you have sufficient coverage.  You can also purchase a “guaranteed” replacement cost policy. Such policies, however, generally limit the excess  paid over the policy limit to about 20%. An inflation protection endorsement may also be available. This type of protection increases the replacement value coverage each year by an estimate of inflation.

Homeowners Insurance Deductibles

As with other types of insurance, insurers use deductibles to pass some of the risk back to you. A deductible is the amount you must pay before the insurer pays out any portion of the claim. Deductibles therefore also act to reduce premiums.

What Property Do Homeowners Insurance Policies Cover?

Homeowners’ policies typically cover three categories of property. These are generally classified as follows:

Coverage A –  Insures your home or dwelling and attached structures. This includes the physical structure in which you live. Some landscaping coverage may also be available.

Coverage B – Covers structures on your property which are not attached to the main home. This may include a detached garage, shed, deck, or fence. Insurers generally limit the coverage for other structures to 10% of the coverage for your dwelling (Coverage A).

Coverage C – This part protects your personal property such as furniture, clothing, and appliances. Insurers generally do not cover animals, vehicles, and business use property. Coverage C is usually no more than 50% to 70% of Coverage A.

Loss of Use Coverage

Included in the property aspect of homeowners insurance policies is Coverage D – Loss of use. This type of coverage is protection for not being able to use the property. If the damage is severe enough, you may have to move out of your home temporarily.

This coverage essentially reimburses you for living expenses while you repair or replace your dwelling. Insurers typically limit this coverage to about 20% of coverage A.

Liability Coverage

Homeowner policies also include a liability (casualty) component in addition to the property coverage. The different parts of liability coverage are as follows:

Coverage E – Protects you against liability arising from injury or property damage of others due to use of your property. Most policies provide a minimum of $100,000 in coverage per occurrence. Many experts, however, often recommend that you purchase $300,000 or more in coverage.

Coverage F – Covers medical payments for others. The limit is usually $1,000 per person, but as with E you can purchase more.

Types of Standard Homeowners Insurance Forms

There are several different types of standard homeowners insurance policies available. All these policies generally include a property as well as a liability component. The type of dwelling you live in generally limits the types of insurance available to you. Your mortgage lender may also require a specific type of coverage.

HO-1

This is the “basic” form. It covers loss or damage to the dwelling, other structures, and contents from the following named perils:

  • Fire or smoke
  • Lightning, wind, or hail
  • Damage by aircraft or vehicles (other than your own)
  • Explosion
  • Riot or civil disturbance
  • Vandalism or malicious mischief
  • Volcanic eruption
  • Theft

Insurers rarely offer this type of coverage today as most homeowners insurance policies offer more comprehensive coverage.

HO-2

This is the “broad” form and is also a named peril policy. It includes protection of the dwelling, other structures, and contents from all the perils covered by HO-1, plus the following:

  • Damage from falling objects
  • Weight of ice and snow
  • Water damage from plumbing issues
  • Freezing of plumbing, air conditioning, heating systems, or appliances
  • Sudden or accidental tearing apart, cracking, burning, or bulging of pipes or other air conditioning or heating systems
  • Accidental or sudden damage from an artificially generated electric current
  • Burglary damages

HO-3

This is the “special” form and is an “all risk” policy. It’s also the policy insurers issue most commonly, along with HO-5. It covers all perils for the dwelling and other structures, except for those specifically excluded. Coverage for contents is usually the named perils covered with HO-2. The excluded perils for dwelling and structures under HO-3 are as follows:

  • Flooding
  • Earthquakes
  • War

HO-4

This is insurance for tenants. Coverage does not include structures protection. Protection is only for contents and liability. Perils covered are generally similar to the HO-2 broad form.

HO-5

This is an all inclusive or comprehensive type of policy which generally includes the “all risk” coverage of HO-3 on both structures and contents. It is also therefore more expensive.

HO-6

Those who own condominium units may look at this type of policy. It covers the interior of the unit, and personal property such as furniture. It also provides liability insurance as do all other HO policies.

HO-8

Insurers especially design this type of policy for older homes. It is a named peril policy which covers structures and contents. Perils covered are usually the same as those under HO-1. With older homes, the replacement cost may exceed the market value substantially. As such, replacement or repairs are essentially done on an actual cash value basis. Materials used may be similar and usually less expensive than the originals used in the home. The overall cost is therefore more reflective of the current value of the home.

Flood Insurance

Homeowner policies do not cover damage caused by floods. Such coverage is generally available from the National Flood Insurance Program (NFIP), which is managed by the Federal Emergency Management Agency (FEMA). You must purchase coverage through insurers who participate in the NFIP.

Flood insurance can be very expensive, depending on your property’s proximity to bodies of water and low lying areas. Lenders generally require it if you are within a flood zone. Obtaining an Elevation Certificate can help you to reduce premiums.

Conclusion

Homeowners insurance is important not just in protecting your dwelling and related structures. It also provides coverage for your personal belongings, as well as liability protection.

It pays to review your policy regularly to make sure you have adequate coverage. Also make sure your insurer is financially sound. Financial stability ratings are provided by companies such as A.M. Best.

Finally, it’s wise to shop around as premiums may vary among different insurers. You may be able to get lower premiums if you buy policies for home and auto from the same insurer. You can obtain quotes online or over the phone. Well known insurers include Liberty Mutual, State Farm, and Allstate.

One comment

  1. You are not required to purchase insurance from the company your lender recommends. There are a number of unbiased sources available to find out what different insurers charge for identical products and services, including your state insurance department, consumer publications and your public library.

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