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 rewardingand somewhat confusing financial decisions you'll face in your lifetime.Aside from qualifying for and selecting a mortgage from the varied programsavailable, you will also be dealing with an attorney/title agent, Realtorand insurance agent in the hope that all the pieces will fall into placeand you will close as scheduled. But how much do you insure your new homefor?
Why is there such a difference between what you paid for your home andwhat the insuring value is? And finally, how do you keep yourself from beingover or underinsured?
To begin with, mostly all homes made of modern materials will qualifyfor "Replacement Cost Coverage." In short, this type of coverageis based on a formula arrived at using a construction cost index suitableto your zip code or region that determines what the actual cost to rebuildyour home would be should you suffer a loss. Factors such as constructionquality, square footage, style of home, features and amenities all go intothe mix to determine what your home's individual replacement cost wouldbe. These base costs are then compiled and put through a formula to obtaina final number.
What is not included in determining replacement cost is just as importantas what is. The land which your home sits upon is not included for one simplereason: You can't burn dirt! In other words, land and its location can notbe destroyed. Second, since a fire will usually not destroy your home'sfoundation, the cost associated with pouring a new foundation is normallyexcluded as well. This does not mean that certain coverages do not applyto 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 buyermay prefer not to select replacement cost coverage because he or she actuallypaid less for the home than what the replacement is valued at or they onlywant to cover the mortgage amount. Mortgage lenders require that a homebuyer 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 compromisingthe insurance value of the home they occupy, there are situations that arisewith investment properties and some areas that have suffered a sharp declinein market value over time that may have their owner questioning why he orshe has to carry such high limits.
By electing to carry limits lower than what would reasonably be the replacementcost, a property would be subject to several reductions in how a propertyloss would be settled. The first would be that your property loss wouldbe adjusted on an "actual cash value" basis, which is equal toreplacement cost less depreciation. For example, a home owner who suffersthe loss of a roof that is 10 years old and would cost $5,000 to replaceafter the loss may only receive $2,000 to $2,500 when putting in a claimunder an actual cash value basis. Owners are also often put into the positionof negotiating with their insurance company over the actual cash value ofhundreds of items after suffering a major loss.
The next peril you may face with the election of lower limits is whatis called a "coinsurance clause." I won't go into the formuladetail here but most companies will require you to carry at least 90% ofyour home's replacement cost to qualify for full coverage. If coverage fallsbelow those percentages, there may be a penalty at the time of loss thattakes 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 $100,000when subject to this coinsurance penalty.
When you consider the investment of time and money that goes into purchasingreal estate, it really serves you well to insure your property correctlyand at adequate limits. Most home buyers will find little difference inthe cost between a policy that fully insures a property and one that coversthe minimum required. No one expects a loss to their home. Taking the adviceof an insurance professional on what limits to properly insure your homeat will make any loss more bearable and enable you to restore your propertyand life as quickly as possible.
L. Allen Perille, AAI, is with Lamburt Corporation in Stratford, Connecticut