Buying home insurance can be somewhat perplexing because risk insurance is not so easily understood. Insurance companies apply a lot of different factors in determining what level of risk you present to them, and the same factors are used to determine the amount of premium they will charge. To complicate matters further, each insurance company has their own pricing formula, and those can change from region to region, or even from neighborhood to neighborhood. The bottom line is you need to understand how homeowner's insurance coverage works in order to determine whether you are paying the right amount of premium.
The Mechanics of Homeowner's Insurance
Your home: The standard policy for most residential homes is an H0-3 which insures your home against all perils except natural disasters and war. The amount of coverage is determined by you. You can insure for up to 100% of your home's replacement cost or, you can insure for less if you think that your home is not likely to be totally destroyed. 100% of your home's replacement value is recommended.
Perils/Risks: These are the events or circumstances that result in damage or loss that are covered by your insurance policy. Most policies cover perils such as fire, windstorms, theft. Some policies are issued with "named perils" which lists the specific perils that are covered. Perils not listed are not covered. In an "all perils policy" all risks are covered except those listed in the policy. For example, in certain states policies might exclude coverage for floods or earthquakes. For many excluded perils, additional insurance can be purchased to cover them. This is perhaps the most important consideration when designing your policy, so, if you don't know exactly what's covered, you need to ask.
Personal Property: This describes all of the property other than the actual building and land that the policy covers in the event of loss or damage. It usually includes such things as furnishings, automobiles, personal items, jewelry and pets. Although most policies provide coverage for valuables, their limitations may not cover yours if they are valued higher than the limits of the policy. Consider adding a rider for your valuables.
Personal Liability: This is coverage that reimburses the homeowner for costs incurred through litigation or claims made against any member of the household as a result of injury or property damage that occurs on the covered property. Check the limits of your coverage and consider adding an additional umbrella liability policy for added protection.
Important Considerations for Your Homeowner's Insurance
Actual Cash Value (ACV) vs. Replacement Cost
With ACV, the insurer determines the value of items or property lost or damaged based on what it is currently worth. For example, if a three-year old computer is stolen, the replacement value is based on its original cost less any depreciation. Obviously this makes it more difficult to replace items as prices tend to increase or similar versions of the item are no longer available. Policies with ACV are generally less expensive than policies with Replacement Cost coverage.
With replacement cost, the reimbursement amount of a claim is based on the cost of replacing a lost or damaged item with one at current prices. So, the three-year old computer could be replaced with a brand new computer of similar make and quality. Replacement cost coverage is preferred by homeowners; however it is more expensive than ACV.
Most policies cover the cost of replacing your home at their present value. It is recommended that you add a replacement guarantee that will provide replacement coverage based on a rate of inflation or a schedule of increased coverage. Many policies cap the increase at 120% of your original purchase price, but that should provide sufficient coverage. Also, make sure your contents are covered for their replacement value.
This is the amount of money the insurer expects you to pay towards a claim before it will pay its portion. For example, if you agree to a $1,500 deductible in your insurance policy, and you incur $3,000 in covered damages or losses, you will need to pay $1,500 before the insurer pays the remaining $1,500. The deductible amount you choose will affect the amount of premium you pay with a higher deductible resulting in a lower premium amount. It is often recommended that you choose the highest deductible you can afford to pay out of pocket in order to reduce your premium cost. The savings in premiums can then be used to buy a personal umbrella liability policy or added to an emergency fund.
Know the Limits of Your Policy's Liability Coverage
The liability protection available in a homeowner's insurance policy is typically limited to around $300,000, which probably wouldn't cover the medical costs of a serious head or back injury that occurred on your property. For just a few hundred dollars a year, you could add a one million personal umbrella liability policy that can coordinate with your homeowner's liability coverage (and your auto insurance liability coverage).
Natural Disaster Coverage
If you live in a natural disaster area, you should consider buying separate coverage for such events as floods or earthquakes. These types of policies are available through the state agencies that manage disaster relief for these events.