HomeHow Much is Enough?
Determining Insurance Protection for your Home
by L. Allen Perille, AAI
Congratulations! Your new home purchase will be one of the most rewarding and somewhat confusing financial decisions you'll face in your lifetime. Aside from qualifying for and selecting a mortgage from the varied programs available, you will also be dealing with an attorney/title agent, Realtor and insurance agent in the hope that all the pieces will fall into place and you will close as scheduled. But how much do you insure your new home for?
Why is there such a difference between what you paid for your home and what the insuring value is? And finally, how do you keep yourself from being over or underinsured?
To begin with, mostly all homes made of modern materials will qualify for "Replacement Cost Coverage." In short, this type of coverage is based on a formula arrived at using a construction cost index suitable to your zip code or region that determines what the actual cost to rebuild your home would be should you suffer a loss. Factors such as construction quality, square footage, style of home, features and amenities all go into the mix to determine what your home's individual replacement cost would be. These base costs are then compiled and put through a formula to obtain a final number.
What is not included in determining replacement cost is just as important as what is. The land which your home sits upon is not included for one simple reason: You can't burn dirt! In other words, land and its location can not be destroyed. Second, since a fire will usually not destroy your home's foundation, the cost associated with pouring a new foundation is normally excluded as well. This does not mean that certain coverages do not apply to your landscaping or foundation, but, as the standard disclaimer states, it's always best to check your own policy for limitations or exclusions.
What happens if you do not want replacement cost coverage? A home buyer may prefer not to select replacement cost coverage because he or she actually paid less for the home than what the replacement is valued at or they only want to cover the mortgage amount. Mortgage lenders require that a home buyer obtain insurance coverage equal or greater to the amount of the mortgage. Any amount above that is technically optional for the borrower.
Although the majority of single family homeowners do not consider compromising the insurance value of the home they occupy, there are situations that arise with investment properties and some areas that have suffered a sharp decline in market value over time that may have their owner questioning why he or she has to carry such high limits.
By electing to carry limits lower than what would reasonably be the replacement cost, a property would be subject to several reductions in how a property loss would be settled. The first would be that your property loss would be adjusted on an "actual cash value" basis, which is equal to replacement cost less depreciation. For example, a home owner who suffers the loss of a roof that is 10 years old and would cost $5,000 to replace after the loss may only receive $2,000 to $2,500 when putting in a claim under an actual cash value basis. Owners are also often put into the position of negotiating with their insurance company over the actual cash value of hundreds of items after suffering a major loss.
The next peril you may face with the election of lower limits is what is called a "coinsurance clause." I won't go into the formula detail here but most companies will require you to carry at least 90% of your home's replacement cost to qualify for full coverage. If coverage falls below those percentages, there may be a penalty at the time of loss that takes into account the shortage of insurance compared to value of the property. A $200,000 home insured for only $100,000. would not likely recoup the $100,000 when subject to this coinsurance penalty.
When you consider the investment of time and money that goes into purchasing real estate, it really serves you well to insure your property correctly and at adequate limits. Most home buyers will find little difference in the cost between a policy that fully insures a property and one that covers the minimum required. No one expects a loss to their home. Taking the advice of an insurance professional on what limits to properly insure your home at will make any loss more bearable and enable you to restore your property and life as quickly as possible.
L. Allen Perille, AAI, is with Lamburt Corporation in Stratford, Connecticut