When my brother and sister-in-law bought their first home, they were required by their bank to carry homeowners insurance to protect both the lender and themselves in the case of loss.
At first, this seemed like another added expense in a long list of expenses that new home owners have.
Because they were brand new homeowners, they didn’t truly understand the value a good homeowners policy could have.
Just six months after they moved in, however, they went away to visit family for Christmas. While they were gone, their house was robbed.
The thieves damaged the roof and drywall when they broke in, they took electronics and jewelry, and dumped out all the contents of all the drawers and cupboards.
Though the experience was undesirable and traumatic, they were able to replace everything that was stolen and repair the damage to their house without expense or stress.
Their homeowners policy covered all the losses and destruction of property, repaired our roof, and got things back to normal as quickly as possible.
Over the years we have had other friends who have experienced fires, or broken pipes, or storm damage to their homes. Again, because they had good homeowners policies, they were protected from liability and financial loss.
Homeowners insurance can be a valuable tool for protecting you from risk and guarding one of your biggest assets—your home.
This article will explain the components of a standard homeowners policy and be your guide to the many different types of homeowners insurance policies that are available and all the coverage options.
A Few Important Terms
Before we talk about types of policies, it’s important that you understand a few key terms that can be misunderstood by many homeowners. These will help you understand in greater detail exactly what your policy covers. Each of these terms has an important bearing on your coverage and any possible claims you might make in the future.
1Replacement Cost vs. Actual Cash Value
When you select a homeowners policy, you can choose to have the policy based on either replacement cost or a policy based on actual cash value.
Replacement cost is exactly what it sounds like. This is what it would cost to replace an item after a loss.
For example, if you are insured for replacement cost of personal property and your computer is stolen, the policy would cover the cost of replacing the computer.
On the other hand, actual cash value takes into consideration the age and condition of the insured items and in the case of a claim, only reimburses the homeowner for the current market value of the items, rather than what it would cost to replace the item new.
If we go back to our example with the stolen computer, if you have selected an actual cash value policy, and the computer is five years old, the amount covered would be the cost of the computer minus five years of wear and tear, and the amount paid out would be prorated according to what the computer was worth at the time of the theft, not what it would cost to replace the computer.
These terms apply to the dwelling structure covered in the policy as well as the personal property items. Let’s look at another example to make sure you understand how these terms apply to your policy.
Let’s say you bought a newly built home ten years ago. At the time of purchase, you decided to choose an ACV (actual cash value) policy rather than a replacement cost policy.
Now ten years, later, there is a huge hailstorm causing massive damage to your roof. The roof has to be replaced and is going to cost $30,000. You file a claim with your insurance company.
The insurance company reviews the claim and sees that you have an ACV (actual cash value) policy on your dwelling. This means that the roof is only covered for its current actual cash value.
The insurance company runs the numbers and determines that your roof is a third of the way through its useful life of 30 years.
Therefore, instead of giving you the full replacement cost of the roof, they settle your claim by subtracting ten years of depreciation, and write the settlement check for $20,000, the cost of the new roof minus ten years of depreciation. The rest of the roof repair will have to be paid out-of-pocket.
On the other hand, a RC (replacement cost) policy you would have provided you with the full amount to replace the roof with like kind and quality of materials. All in all, a much happier claim experience for most homeowners.
This is why it’s very important to understand the kind of policy you are selecting and determine what is the best option for you.
Named peril policies are policies that are designed to cover you for perils, or losses, that are only specifically listed and named in the policy.
Open peril policies, in contrast, cover your dwelling and personal property in every case, except those that are specifically excluded in writing. Today, most decent homeowners policies are open peril policies.
If you choose to have a named peril policy—one that only covers listed losses—there are usually 16 or 17 standard named perils. But this varies from policy to policy so you need to double-check your coverage. Many of the standard named perils include:
1Fire and lightning
2Windstorm or hail
4Riot or civil commotion
8Vandalism & Malicious Mischief
12Weight of ice, snow or sleet
13Accidental discharge of water
14Sudden and accidental tearing apart of water heater
16Damage from artificially generated electrical current
Remember, if you choose a named peril policy and your house or property is damaged by something not specifically listed, it will not be covered. If your kids open a game of Jumanji and a herd of rhinos comes running through the living room, your coverage will be denied.
If, on the other hand, you have an open perils policy, and it does not specifically exclude rhino stampede in writing, then everything will be covered, you will be able to file a claim and receive a settlement.
For your information, the usual things that are excluded in writing in most open peril policies are flood damage and earthquake or earth movement claims. Separate flood and earthquake policies can be purchased to fill these coverage gaps.
Depending on where you live in the country and your level of risk, these policy additions can be very helpful. Always check with your agent for any other specific exclusions from any open peril policy you choose.
Hopefully, you can see how much broader the coverage is in an open peril policy and the enormous benefit it would be to you as a home owner.
When property is insured on an open peril basis, when there is a claim, the burden is on the insurance carrier to show where the loss is excluded in the policy.
Alternatively, if the property is insured on a named peril basis, the burden is on you, as the insured, to prove the loss was caused by one of the covered named perils when you go to file a claim.
Standard Homeowners Policy Coverages
Now that we’ve established a few important terms, we will talk about the coverage provided in a standard homeowner policy. As you think about this coverage, you can evaluate if your property is properly protected.
Make note of questions or concerns you have and then get in touch with your agent to make sure your policy is set up the way you want it with adequate coverage for your home and property.
For most people, their home is one of their greatest investments and assets. Beyond the financial investment, your home is also the place where you have raised your family, strengthened your relationships, and built a life.
It’s hard to underestimate the role your home has played in creating and supporting your life and your lifestyle, and you want to be properly insured for both financial and personal reasons.
A good home owners insurance policy protects your home from perils or risks that can cause loss or damage. There are five basic sections (coverage A-E) of your home owner’s policy to be aware of:
The “dwelling,” of course, is the main structure of your home—your living space and the materials that create it.
When deciding how much coverage you need for your dwelling, most insurance carriers require an agent to run a replacement cost calculation to determine the value or the amount it would cost to replace the building’s structure.
The calculated replacement cost includes everything that would be needed in order to rebuild the home in case of a complete loss. This would include demolition, debris removal and cleanup, ordinance and legal fees, the cost of labor and materials for rebuilding.
The replacement cost is the amount the home needs to be insured for. Replacement cost is often stated in a per square foot formula, like $150 per sq. ft, for example.
You are required to keep your home’s insurance amount within 80% of the calculated replacement cost value. If you don’t maintain this 80% limit, there are clauses in your policy called “insurance to value clauses,” that can kick in, affecting the way any claim is settled.
In order to be fully covered for losses, you are required to have the correct amount of insurance on the property to meet the replacement cost of the home.
Most insurance companies now also have an automatic inflation guard built into most homeowners policies, usually about 4% every year. This makes it so the coverage on your dwelling automatically increases every year to keep up with inflation.
Obviously, as inflation increases, the costs of goods, building materials, and construction services rise, which also raises the replacement cost of your dwelling. By building an automatic increases in coverage into the policy, it greatly decreases the possibility of not being “insured to value” at the time of a claim. This protects you as a homeowner.
Of course, this means your premium may also increase by a small amount each year due to this automatic inflation guard protection. If you ever feel your home is over-insured, you should talk to your broker or insurance agent. An underwriter can even be hired to see if an adjustment is necessary.
Keep in mind that the insurance value is much different than the market value of your home. This can be confusing for some people.
Home owner’s insurance is insuring against the cost to rebuild your home, not covering what your home is worth on the real estate market. Also, homeowners insurance does not cover the land on which the structure is built because, theoretically, the land cannot be destroyed.
So, this means that in depressed housing markets, the insurance value on the dwelling may actually be more than the home is worth on the market. But, the opposite is true as well. In areas where housing is booming, the insurance value may be considerably less than the market value. In either case, the home only needs to be insured to replacement cost.
It’s important to remember that if you ever make changes to your home, such as putting on an addition or doing a remodel, you need to call your agent to let them know that you have made improvements to your structure. Then the appropriate replacement cost changes can be accounted for.
Upgrades in building materials or additions to square footage need to be documented so that you have the correct insurance to value ratio. If your home is not insured to replacement cost, you will not be completely covered in the case of loss or damage.
2 OTHER STRUCTURES OR COVERAGE B
“Other structures” in a homeowners policy include every other kind of structure on the property that are not directly connected to your dwelling.
Examples of other structures include a detached garage, a swimming pool, fencing, gazebos, driveways, walkways, or storage buildings.
The limit for other structures in your homeowners policy is determined by an automatic and simple calculation, usually 10% of your dwelling coverage.
The amount will be listed in your policy. For example, if your home’s insured value is $300,000, you will automatically have $30,000 coverage for other structures.
Consider if this standard coverage is enough for your personal situation. Every property is different. If you spend more than $30,000 putting in a spacious detached garage, or a full-sized sports court, then the $30,000 limit may not be sufficient coverage for your property and you will need to raise the limit of insurance for other structures.
This is usually done by underwriting on the backside after the policy is issued, but talk to your insurance agent about your needs and concerns and they can help you get adequate coverage.
3 PERSONAL PROPERTY/CONTENTS OR COVERAGE C
The simple way to understand what qualifies as personal property is anything not permanently attached to your dwelling.
In other words, if you turned your home upside down, whatever happened to fall out, is clearly not permanently attached to the structure itself, and most likely falls under the category of personal property.
This part of your policy is also usually based on an automatic calculation taken as a percentage of the dwelling’s insured value.
This percentage varies from carrier to carrier and from policy to policy, but it is usually at least 50% of the dwelling’s insured value and is most often around 70-75%.
Remember the terms we learned at the beginning of this article? Unlike the dwelling and other structures coverage, the personal property section of the policy is more likely to be written as ACV (actual cash value) rather than RV (replacement value). This means that at the time of a claim the settlement would be based on the age and condition of the personal property, not on what it would cost to replace the item.
The same applies in terms of open peril and named peril. While most dwelling coverage is open peril, when it comes to personal property, the coverage is usually named peril, meaning that it is only covered if it was damaged by a specific threat on the peril list.
Let’s look at one claim to understand how this works.
In this case, a claim was made by some homeowners who had been gone one day when their dog went into the bedroom and tore the waterbed apart, creating a huge mess and water damage on both the first and second floors of the house.
Although the home had open perils dwelling coverage and the water damage was covered, the personal property had been written on a named perils basis. Remember the 16 named perils? It turns out that a misbehaving dog was not one of them. So, the waterbed and other personal property that had been damaged were not covered.
This was a scenario the homeowners never could have anticipated. You never know what can happen. It is worth considering purchasing open perils and replacement cost coverage on your personal property and contents.
4 ADDITIONAL LIVING EXPENSE OR COVERAGE D
Additional living expense is another important part of a homeowners insurance policy.
Think about what would happen if your home became inhabitable because of damage, like in the case of a fire or a severe water loss?
If you can’t live in your house and have to wait for repairs, you will need alternative living arrangements either in a hotel or rental home.
That, of course, creates additional expenses. Who pays for that? Your homeowners policy will cover these costs. In some policies, This additional living coverage is written as “actual loss sustained for 12 months,” while in others, it is a dollar amount equal to 30% of your dwelling coverage.
For those policies that provide “actual loss sustained,” it does not mean you can rent any house you want or live wherever you want. If you were living in a 2800 sq. ft home with an $1,400 mortgage, you could not run out and rent a 12,000 sq. ft home with rent of $5,000 a month and then expect your insurance company to cover it. You would be able to rent a similar-sized home as your insured home and have it covered.
It is not unusual for people to be displaced from their homes for a long time, especially in the cases of major destruction such as in a flood or fire. It’s is critical to have adequate additional living expense coverage to allow you to recover and rebuild without significant financial hardship and additional stress.
5 LIABILITY OR COVERAGE E
The final coverage provided on most standard homeowners policies is liability coverage, also called coverage E. Personal liability on your homeowners policy covers the costs and legal responsibility for the insured and anyone in the household for both property damage and bodily injury.
If someone slips and falls on your property, or if a pet injures someone or you or someone you live with causes an accident or injury to someone else, a homeowners policy protects you from liability.
This coverage can also include activities that happen away from the insured’s actual premises, such as a fight or altercation at a football game or concert. Anytime someone else is injured because of your actions, this portion of the homeowners policy will protect you.
Some insurance companies have even expanded their policy coverage to the areas of libel, slander, defamation of character, wrongful eviction, and invasion of privacy. If your particular homeowners policy doesn’t cover these situations, check with your agent to see about endorsing the policy to do so. It will give you much broader protection for very little cost.
This is especially important coverage today with the increase in social media usage. If you are sued because one of your children says something online, you could be held liable. You would need protection and you can get it for very little cost added to your policy premium.
Today, most policies include $300,000 as the standard minimum limit for liability, but, in reality, even this is probably too low for most people. It is recommended that you purchase as much liability as the carrier will allow you to buy.
It’s only a little bit more a year to max out the liability amounts on your policy. You should be able to easily purchase $500,000 and some carriers will allow $1,000,000 of coverage.
Other Types of Homeowners Policies
In addition to standard homeowners policies there are a few more types of homeowners policies to be aware of.
1Modified Coverage Form
This policy is designed for older homes, where the cost to repair or rebuild the structure is greater than the market value of the home. It usually has the same list of perils as a standard policy.
2 Condominium Unit Owners Form
Obviously, this kind of policy is for owners and occupants of condos. It insures your personal property as well as the walls, floors, and ceilings against the standard list of perils.
3Dwelling Fire Form
This type of policy only covers your dwelling. It also only covers a very small list of perils. It does not extend coverage to your personal property or cover liability.
Some people use this type of policy to insure a vacation home. It is also the kind of policy your mortgage lender will purchase for you if your homeowners policy lapses. This provides enough coverage to protect their asset from damage and loss.
Optional Homeowners Policies and Endorsements
There are catastrophic events that are not listed on your named perils or that are specifically excluded from an open peril policy.
But it is still possible to insure your property against these possible events. Sometimes it requires an entirely new policy to cover the peril and sometimes you can just add an endorsement to your policy, giving you extra coverage.
For homeowners in high risk areas, purchasing additional policies or endorsements should be a high priority.
If you live in a known flood zone you can get flood insurance from the federal government under the National Flood Insurance Program. Policies range from $600-$3000 a year, depending on where you live.
Inactive earthquake zones, some insurance companies sell separate earthquake policies or add an endorsement. In California where the risk is high, policies average about $700 per year.
Deductibles for earthquake policies are the biggest cost. They are often written as a percentage of the loss, rather than a dollar figure, and can range from 2-20% of the property’s replacement value.
In areas with specific and regular weather hazards, like coastal areas, a standard policy won’t have enough coverage and you will need to purchase additional endorsements.
4Guaranteed Replacement Cost Coverage
This endorsement pays to rebuild your house completely, even if the cost is above your policy limits. This costs about $400-$1000 more in premiums every year.
5 Personal Umbrella Liability Insurance
This endorsement increases your liability coverage above the limits of your primary homeowners policy. The umbrella coverage can extend to excluded coverages like slander and libel and can kick in after your primary policy limits are exhausted.
Premiums for this coverage are extremely reasonable at only $150-$300 a year for $1 million in coverage and between $50-$75 a year to increase coverage by another million after that, according to the Insurance Information Institute.
6Scheduled Personal Property
This endorsement covers high-value items like camera equipment, instruments, jewelry, stamps, coins, guns, computers, antiques, or other items that would exceed the personal property limits of your standard homeowners
In this guide, we have discussed the various coverages provided by a standard homeowners policy as well as explained other types of policies and endorsements that are also available. As you evaluate your homeowners insurance needs, the brokers at IPA are ready to help and assist you in designing the policy that is right for you.
Every homeowner needs a solid, complete insurance policy to protect their home and their property. So many important parts of life occur under your roof. It’s important to make sure you are well-protected and guarded against loss and damage and the financial repercussions of those losses.