By FPA member Leslie T. Beck, CFP®, MBA
Last Updated: March 15, 2012
Homeowners insurance is an important, but often overlooked, part of any financial plan. Not only does it protect what for many is their largest investment, i.e. their home, but it can also provide protection from personal liability should someone be injured on your property, or should you injure someone else (non-auto related). But the terminology for homeowners insurance can be confusing, and many consumers, once they purchase their initial policy, rarely review it again unless they need to make a claim.
A full description of the ins and outs of homeowners insurance is beyond the scope of this article. However, the following is a brief description of homeowners insurance, and a checklist to use when purchasing or reviewing your policy. For more in-depth information, check your resident state’s Department of Insurance website or visit the National Association of Insurance Commissioners website.
Homeowners insurance typically provides a package of coverage, called a “form.” Each form covers losses caused by very specific reasons, known as “perils.” The standard form will cover losses on your home or “dwelling” based on a limit you select with other losses, such as on a free-standing garage, shed or personal property, covered as a percentage of the dwelling amount (10-70 percent, typically). Policies can be personalized by changing coverage limits and terms and adding additional peril coverage.
Know the Perils Included and Excluded from Your Policy
The most common types of homeowners insurance are the Broad form, which covers 17 specific perils, and the Special form, which covers all perils, including everything in the Broad form, as long as it is not specifically excluded by the policy language. The typical exclusions include losses due to flood, earthquake, war and nuclear accident, but there could be others as well. There are also forms for renters, condominiums, and older homes that may require custom work to replace — each has their own specific peril and coverage limits.
Consider Additional Peril Coverage
Damage from earthquakes and floods (and to some extent hurricanes) is specifically excluded from just about every standard homeowner policy. In jurisdictions prone to these natural disasters, additional insurance may be required to cover these perils in order to qualify for a mortgage. But all homeowners should consider whether they should add coverage for these perils, especially flood insurance. The so-called “100 year floods”, while statistically having only a one percent occurrence chance per year, can in fact occur much more frequently within any given time period, with devastating results. Flood insurance is not cheap, but it’s way cheaper than having to replace your flood-damaged home from your own pocket. Learn more about your chances of flooding.
Know Your Coverage Limits
Your dwelling coverage should equal the full replacement value of your home. “Replacement Cost,” in homeowners jargon, is the amount it would take to repair or rebuild your home in the case of loss. However, standard policies may place a limit on this amount, either by stating a maximum value for reimbursement, or a percentage of the replacement cost. “Actual Cash Value” may sound like the same thing, but in fact this type of coverage will pay you only for the value of your home minus depreciation due to age and wear and tear, and often will not provide you with enough coverage to fully repair or replace the home. Talk to a builder or your insurance agent about what it would cost to rebuild your home at current material and labor rates to ensure your coverage is adequate.
While it’s important to make sure your coverage will cover the full repair or replacement of your home, it’s equally important to realize that premiums are based primarily on this amount, so don’t over-estimate the amount of coverage you’ll need (such as adding in the value of your land), as you’ll be paying for more coverage than you’ll ever use.
Your policy will also have a deductible, which will be subtracted from the amount of any claim made. Personal property is covered as a percentage of your dwelling replacement cost and is also subject to the deductible.
Assess Your Personal Property and Liability Coverage
Most policies will cover personal property losses at some percentage of your dwelling coverage, but may also add specific limits on certain items, such as jewelry, antiques, computers, etc. These limits can often be raised through the use of personal property endorsements for an additional premium. It’s a good idea to make an inventory of your possessions, and check their value against the limits of your policy (this comes in handy should you ever need to make a claim, as well).
In addition to your property, most homeowners’ policies include coverage for injuries or losses incurred by others while on your property, or for non-auto related injuries and damage caused by you or your immediate family to others. Individuals with substantial assets may want to consider adding personal liability umbrella protection, for an additional premium, to increase or expand this coverage.
Finally, if you’re conducting a business out of your home, make sure you know what your policy will and won’t cover. Homeowners insurance is not designed to cover most business uses (including running a nursery or daycare center at home), so make sure you have the proper additional coverage.
While many insurance companies offer similar homeowners’ policies, the premiums can differ drastically. Make sure you’re getting the most coverage for your dollar. You can often save on premiums by raising your deductible, or insuring both your home and auto with the same company (but make sure you have the cash on hand to cover any deductible hit!). Theft and fire deterrents, such as home alarms and sprinkler systems, can reduce premiums. Some companies will charge extra if you have a pool, a large dog, or an “attractive nuisance” (such as a pond) on your property that could cause injuries. Your previous homeowners claim history, as well as the ever popular credit score, can also affect the premium you pay.
In summary, homeowners insurance is an important part of any consumer’s financial plan. Like all insurance, you hope you never have to use it. But making sure you’ve got the proper coverage can give you peace of mind should tragedy strike.
FPA member Leslie T. Beck, CFP®, MBA is one of the founders of Compass Wealth Management LLC, a fee-based financial planning and advisory firm based in Maplewood, NJ.