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Homeowners Insurance 101

There are a wide variety of reasons why purchasing homeowners insurance is a must for most people:

Two of the major reasons are:

Required by your mortgage lender:

As long as you have a mortgage balance on your home, your lender will require you to have a homeowner’s insurance policy that lists them as mortgagee.  Essentially, this establishes that any loss to the mortgaged property is payable to the lender/mortgagee named in the policy.  If the coverage is cancelled for any reason, the lender/mortgagee will have your home insured at your expense, likely at a substantially higher cost than a normal policy.

Asset protection:

For many people, their home represents their most valuable asset.  Homeowners insurance will cover the structure of your home, your personal belongings, as well as any liability you might have to others and/or to their property while they’re on your property.

Generally, all homeowners’ insurance policies provide protection against financial loss due to:

Five of the most common financial losses are:

Damage to the physical structure of your home:

In the event of damage due to a named peril covered by your policy, such as fire, windstorm, vandalism, lightning, explosion, vehicles etc, your insurance company will cover the costs of repairing or rebuilding your home up to the limits of your policy, minus your deductible.

Loss or damage to personal belongings:

Contents of your home, such as furniture, appliances and clothing, will be repaired or replaced if they are damaged or destroyed by a peril covered by your policy. There is a limit for this coverage and it is typically a percentage of your dwelling coverage. If your home is insured for $500,000, you can expect personal belongings coverage to be  30-70% of that amount.  The question then becomes, “Is that enough?” If you have a home inventory, and you should, it will give you the answer. (“Why should I have a home inventory list”…read more) Be advised that if you have uniquely valued items such as art, jewelry and furs, you might want to purchase a separate “floater policy” for adequate coverage.

Loss of use:

If your home is damaged by a covered peril an is uninhabitable, Loss of Use coverage provides reimbursement to you for replacement housing in the form of a rental or a hotel stay until your home can be repaired or rebuilt. Additional personal expenses approved for reimbursement include meals and other incidental costs. However, oftentimes there are daily limits for these items.

Personal liability for damage or injuries caused by you or a family member:

This coverage provides liability protection for you and your family members against claims arising from accidents to other individuals or their property. With a few exceptions for specific accidents such as boating and auto, this is a “blanket type” liability policy that follows you wherever you go.  In the event that you decide that your policy limit is inadequate, you can increase the coverage by purchasing a separate umbrella policy.

Medical bills for people injured by you, a family member, or your pet:

This coverage provides protection against medical expenses incurred by someone other than an insured as the result of a claim arising from injury caused by you, your family members and/or your pets. This coverage is not limited to claims occurring on your property and coverage is provided regardless of legal liability.

There are several basic types of homeowners insurance policies, each providing a combination of property and liability coverage, as well as coverage for loss of use resulting from damage:

Below are common classifications:

HO-1: This is often referred to as the “basic” homeowners policy and provides coverage for damage done to your home and personal belongings by a very limited number of perils. A peril is an insurance term that simply means “cause of loss”, such as fire or vandalism. It is important to know that personal liability protection is not covered in an HO-1. For this and other reasons, this coverage is rarely written. The ten perils covered by a HO-1 policy are:

  1.   Fire or lightning
  2.   Wind Storm or Hail
  3.   Explosion
  4.   Riot or Civil Commotion
  5.   Aircraft
  6.   Vehicles
  7.   Smoke
  8.   Vandalism or Malicious Mischief
  9.   Theft
  10. Volcanic Eruption

HO-2: This is often referred to as the “broad” homeowners policy and provides coverage as indicated in the basic HO-1 policy, with a few important enhancements. It offers personal liability protection and adds six additional perils to coverage.  Similar to the HO-1 policy, this coverage is rarely written.  The sixteen perils covered by a HO-2 policy are:

  1.   Fire or lightning
  2.   Wind Storm or Hail
  3.   Explosion
  4.   Riot or Civil Commotion
  5.   Aircraft
  6.   Vehicles
  7.   Smoke
  8.   Vandalism or Malicious Mischief
  9.   Theft
  10. Volcanic Eruption
  11. Falling Objects
  12. Weight of Ice, Snow or Sleet
  13. Accidental Discharge or Overflow of Water or Stream
  14. Sudden & Accidental Tearing Apart, Cracking, Burning or Bulging
  15. Freezing
  16. Sudden & Accidental Damage from Artificially Generated Electrical Current

HO-3: This is often referred to as the “special” form homeowner’s policy. It has become the most popular of homeowner’s policies. It insures your home and detached structures from all perils except for those specifically excluded from the policy. However, personal belongings are treated a bit differently. They are only covered by listed perils, typically those found in an HO-2 policy. Here is a list of perils that are typically excluded from coverage:

  1.   Earth Movement
  2.   Ordinance / Law
  3.   Water Damage
  4.   Power Failure
  5.   Neglect
  6.   War
  7.   Nuclear Hazard
  8.   Intentional Loss
  9.   Government Action
  10. Collapse
  11. Theft from a Dwelling Under Construction
  12. Vandalism or Malicious Mischief
  13. Mold, Fungus, or Wet Rot
  14. Wear & Tear, Deterioration
  15. Mechanical Breakdown
  16. Smog, Rust & Corrosion
  17. Smoke from Agricultural Smudging & Industrial Operations
  18. Discharge, Dispersal, Seepage of Pollutants
  19. Settling, Shrinking, Bulging or Expanding
  20. Birds, Vermin, Rodents & insects

HO-4: While part of the homeowners policy group, this insurance policy is most commonly referred to as a renters policy, but also as a tenants policy, or as a Contents Broad Form policy. If you rent a home, townhome, condo or apartment, and want to be protected, this is the policy you should have. The main purpose is to insure personal belongings (content), but also to provide coverage for personal liability and medical payment to others. Like the HO-2 policy, the sixteen perils covered are:

  1.   Fire or lightning
  2.   Wind Storm or Hail
  3.   Explosion
  4.   Riot or Civil Commotion
  5.   Aircraft
  6.   Vehicles
  7.   Smoke
  8.   Vandalism or Malicious Mischief
  9.   Theft
  10. Volcanic Eruption
  11. Falling Objects
  12. Weight of Ice, Snow or Sleet
  13. Accidental Discharge or Overflow of Water or Stream
  14. Sudden & Accidental Tearing Apart, Cracking, Burning or Bulging
  15. Freezing
  16. Sudden & Accidental Damage from Artificially Generated Electrical Current

HO-5: This is an “open perils” policy, meaning it provides coverage against all perils unless they are specifically excluded in the policy. This is similar to the HO-3 policy, but differs as to how personal property is covered. The HO-5 policy covers both home and personal property from all perils, unless excluded, while the HO-3 policy only covers the home this way and personal property on a “named peril” basis. The HO-5 policy is generally offered on newer properties or older properties that have been well-maintained. It is considered to be the premier homeowner’s policy. Here is a list of typical perils that are excluded from coverage:

  1.   Earth Movement
  2.   Ordinance of Law
  3.   Water Damage
  4.   Power Failure
  5.   Neglect
  6.   War
  7.   Nuclear Hazard
  8.   Intentional Loss
  9.   Government Action
  10. Collapse
  11. Theft to a Dwelling Under Construction
  12. Vandalism or Malicious Mischief
  13. Mold, Fungus, or Wet Rot
  14. Wear & Tear, Deterioration
  15. Mechanical Breakdown
  16. Smog, Rust & Corrosion
  17. Smoke from Agricultural Smudging & Industrial Operations
  18. Discharge, Dispersal, Seepage of Pollutants
  19. Settling, Shrinking, Bulging or Expanding
  20. Birds, Vermin, Rodents & insects

HO-6: This type of policy is commonly referred to as condo insurance. Like the HO-4 renters insurance, its main purpose is to insure personal belongs (content) and provide coverage for personal liability and medical payment to others. However, unlike a renter, a condo owner is usually responsible for the space from the wall studs in. This means appliances, flooring, fixtures, any enhancements and/or alterations made to the interior of the condo, etc. need to be protected. An HO-6 policy does that. Like the HO-4 policy, the sixteen perils covered are:

  1.  Fire or lightning
  2.  Wind Storm or Hail
  3.  Explosion
  4.  Riot or Civil Commotion
  5.  Aircraft
  6.  Vehicles
  7.  Smoke
  8.  Vandalism or Malicious Mischief
  9.  Theft
  10. Volcanic Eruption
  11. Falling Objects
  12. Weight of Ice, Snow or Sleet
  13. Accidental Discharge or Overflow of Water or Stream
  14. Sudden & Accidental Tearing Apart, Cracking, Burning or Bulging
  15. Freezing
  16. Sudden & Accidental Damage from Artificially Generated  Electrical Current
  17. Fire or lightning
  18. Wind Storm or Hail
  19. Explosion
  20. Riot or Civil Commotion
  21. Aircraft
  22. Vehicles
  23. Smoke
  24. Vandalism or Malicious Mischief
  25. Theft
  26. Volcanic Eruption

HO-8: This type of policy is one of the most basic available to homeowners. It provides coverage for your home, your personal belongings (content) and coverage for personal liability and medical payment to others. It is commonly used to insure older properties that might have a replacement cost value much higher than current market value.  Attempting to repair or replace an older home using antiquated materials and methods could prove to be prohibitively expensive. This type of policy provides coverage based on the cost to repair or replace the property using common construction materials and more efficient construction methods. By limiting the coverage in this way, insurance premiums are much more affordable. The ten perils covered under an HO-8 policy are:

  1.   Fire or lightning
  2.   Wind Storm or Hail
  3.   Explosion
  4.   Riot or Civil Commotion
  5.   Aircraft
  6.   Vehicles
  7.   Smoke
  8.   Vandalism or Malicious Mischief
  9.   Theft
  10. Volcanic Eruption

In order to be reimbursed for damages to your property, your loss must have been caused by a covered peril. A peril is an insurance term that simply means “cause of loss”, such as fire or vandalism.

There are generally considered to be three types of peril coverage, Named Peril, Multi-Peril and Open or All Peril:

Named Peril:

This applies to a policy that covers damage to an insured property only when caused by one of the specifically listed perils. For example, your insurance policy may be written to cover only losses due to fire, explosion, burglary and vandalism…all other perils would be excluded.

Multi-Peril:

This is Named Peril coverage, but applies to a policy that covers all types of damage to an insured property except those caused by perils specifically listed in your policy. Your policy might read:  “We insure for direct loss to the property by a peril listed below unless the peril is specifically named in the Exclusion section of your policy”. In that section of your policy, you might find exclusions for earthquakes, floods, war and terrorism.

Open Peril or All Peril:

This applies to a policy that covers damage to an insured property caused by all types of perils. The premiums for this type of coverage are so prohibitively high that they are rarely written these days.

Examples of Homeowners Insurance

Each example is formatted to describe and provide the following as each relate to a specific homeowners insurance claim incident:

  • What Happened?
  • What Was Covered?
  • Explanation

Example #1

What Happened?: Electrical fire

    • Caused $40,000 damage to dwelling
    • Destroyed $5,000 of personal property

What Was Covered?:

  • Dwelling loss covered $40,000 minus deductible of $1,000 = claim paid of $39,000
  • Personal property covered $5,000 minus deductible of $1,000 = claim paid of $4,000
  • Explanation: In both cases the losses were within the policy limits and as such, claims were paid minus the policy deductible amounts.

Example #2

What Happened?: Explosion and fire

  • Total Loss $575,000
  • Destroyed $5,000 of personal property
  • Family was displaced for 6 months during rebuilding

What Was Covered?:

  • Dwelling loss covered $500,000 minus deductible of $1,000 = claim paid of $499,000
  • Personal property covered $75,000 minus deductible of $1,000 = claim paid of $74,000
  • Family received a per diem amount of $250 for lodging, meals and incidentals

Comparisons of Homeowner’s Insurance

What’s The Relationship Between Increasing Coverage And Annual Premium?

While the obvious relationship is that the higher the coverage the higher the premium, this needs to be put in to perspective.

The premium differential seems to be relatively insignificant with respect to the increased coverage, there does not seem to be any rationale for having too much coverage.  Granted, a 10% increase in coverage will cost only $57, but there may be a better use for $57 annual savings:

  • You can use it towards the purchase of a $1,000,000 umbrella policy that would provide needed coverage, versus too much coverage.
  • It could be used to purchase a decreasing term insurance policy designed to pay off your mortgage in the event of an untimely death.
  • It could be applied to your regular monthly mortgage payment, thereby reducing the remaining term of your mortgage payoff.
  • It could be used for enhancing your investment portfolio, including retirement planning…FYI— Did you know that investing $57 per year ($4.75 per month), with an annualized return of 6%, will grow to $2,194.69 at the end of 20 years?

Again, the key factor is to determine the proper amount of insurance needed. Then, secure the best policy that provides the required coverage.

 

What’s The Relationship Between Deductible Amount And Annual Premium?

By increasing your deductible from $500 to $2,500, you can reduce your annual premium by approximately 1/3rd. This savings is substantial, particularly when you think of insurance as a way to protect against catastrophic losses, as opposed to minor losses. It’s as though the insurance company is giving you $421 a year just to assume a bit more responsibility for an event that may never occur. Here are a few thoughts on how you might use the savings of $421:

  • It would be enough to purchase an umbrella policy.
  • It could be used to purchase a decreasing term insurance policy designed to pay off your mortgage in the event of an untimely death.
  • It could be applied to your regular monthly mortgage payment, thereby reducing the remaining term of your mortgage payoff.
  • It could be used for enhancing your investment portfolio, including retirement planning…FYI— Did you know that investing $421 per year ($35.08 per month), with an annualized return of 6%, will grow to $16,209.93 at the end of 20 years?

What’s The Relationship Between Cost And An Umbrella Policy?

Oftentimes, this type of insurance is referred to as the “best buy in the insurance industry”. There are a few requirements before securing coverage. Basically, the insurance company will want to write both your auto coverage and your homeowners policies before agreeing to write an umbrella policy for you.

Conclusion:

It does seem like the cost for coverage is very low, and it is. However, keep in mind that it usually begins coverage only after the limits of your auto insurance and/or homeowner’s insurance have been exhausted. The key here is to properly determine your personal financial net worth, then match coverage to protect that amount.