If your home were destroyed, is your insurance policy enough to rebuild and replace your possessions? (image via Delaware state fire school)

When was the last time you looked at your homeowner’s policy If you are like most homeowners, you looked at it when you bought it and then you filed it away in your filing cabinet or fireproof box for safe keeping.  But like the other insurance policies you have to protect you, you need to review and reassess your homeowners policy on a regular basis.  June is Home Safety Month which provides a great opportunity to review everything related to the safety and security of your home, including your homeowner’s policy.

Start by reading through your policy to make sure you understand all the terms and conditions and any exclusions.  Don’t hesitate to ask your insurance agent to explain anything that is unclear or answer any questions that come up during your review.  One of the most important things you need to understand about your policy is the type of replacement coverage that it provides.  This makes a big difference in determining the amount of coverage you need and explains how the insurance company will assign a value to your home and its contents if you experience any losses.

There are two primary types of replacement coverage, actual cash value and replacement value.  If your policy provides actual cash value for your losses, the insurance company will value your possessions and your home at the actual cash value minus any depreciation.  If your policy provides replacement value coverage, the insurance company will value your possessions and home at the current cost to replace them.  Understanding the difference between these two types of coverage is critical to understanding how much protection your homeowner’s policy is actually providing.

Let’s look at how the amount the insurance company would pay differs for the same loss under each of these coverage types.  There is a fire in your home that causes damage to the kitchen and the living room.  Both rooms have extensive damage and will require significant work to repair.  The fire destroys your stove, refrigerator, television, couch, and an antique desk.  Here is how the payout would differ.

If you have actual cash value coverage, the insurance company would use the value of the home to calculate the value of the portion of the house that was damaged.  Once that value was established, any depreciation would be subtracted from that value and that is the amount the insurance company would pay out for the damage to your home.  If your policy provides replacement coverage, the insurance company would get an estimate from a contractor on the cost to repair the damage and the payout would cover the cost of the repairs regardless of the value of the home or any depreciation.

The same process would be applied to the possessions damaged in the fire.  If your policy provides actual cash value, the current value of your stove, refrigerator, television, couch and antique desk would be determined and if appropriate, any depreciation would be subtracted in order to determine the payout.  If your policy provides replacement value, the cost to purchase comparable items to replace those that were destroyed would determine the amount of the payout.

As you can see from these examples, if your policy provides actual cash value coverage, you may not receive enough money from the insurance company to repair your home or replace your possessions.  Since most people don’t have the cash on hand to make up the difference in costs, most homeowners should consider having a policy that provides replacement value coverage.

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Homeowners Policy Mistakes

Is your homeowners insurance enough to replace your home and possessions? image via Flickr

Homeowner’s insurance can be the best money you have ever spent if fire destroys your home or a home invader takes some stuff and trashes the rest.  But many homeowners’ make critical mistakes when purchasing their policies that only become apparent after a loss, when it is too late to do anything about them.  Mistakes like these can cost a lot of money and may leave you with an unpaid mortgage, an unusable house, and nowhere to call home.  Make the most of the protection homeowner’s policies offer by avoiding these 5 common mistakes.

1.     Not Reading the Policy Documents

This can be a costly mistake as the policy document outlines exactly what is covered and not covered by the insurance company.  The discussion you have with your agent may leave out important considerations and it is likely that you believe you are covered for things that are not actually covered by your policy.  Before buying a policy, ask the agent for a sample of the policy documents that mirror the policy you are considering.  This will give you the chance to read through the policy and ask any questions you need answered before you are committed.

2.     Not Scheduling High-Value Property

Another very costly mistake that many homeowners make is not scheduling property that falls outside the individual property limits of their policy.  If you are surprised that your policy has limits on specific kinds of property, you haven’t read your policy.  Almost every homeowner policy includes limits on the loss of specific types of property like computers, jewelry, stamps, coins, and firearms.  If the value of your property in that category exceeds the policy limit, you need to ensure that your policy has a rider that will cover the excess value if there is a loss.

3.     Not Understanding the Difference Between Actual Value and Replacement Cost

This mistake can leave you with a mortgage on a house you can’t live in and can’t afford to rebuild.  According to the National Association of Insurance Commissioners Consumers Guide to Home Insurance, actual value will only pay for your loss, which is the value of your house and property at the time of loss and includes considerations for age, wear and tear.  This means that if the value of your house is less than what it would cost to rebuild it, you will have to come up with the difference on your own.  It also means that if the actual value at the time of the loss is determined to be less than your mortgage, you will still owe the mortgage company that difference.  Replacement cost, on the other hand, pays to replace the house and property, regardless of the actual value at the time of loss.

4.     Not Having Coverage for Specific Perils

Many people think that their homeowner’s policy covers damage to their house no matter what causes that damage.  Unfortunately, this is not true on most homeowner’s policies, as any homeowner who has survived a hurricane only to find out that water damage is not covered, can attest.   While it is common knowledge that floods are not covered by homeowner’s insurance, many people don’t understand that flood and water damage are generally considered the same thing.  Unless you live in California, it is unlikely that you know that most policies exclude damage from specific perils like earthquakes, nuclear accidents, and war.  The best way to protect yourself and your property is to understand what your policy covers and purchase additional coverage for perils that could happen but are excluded.

5.     Underestimating Everything

Another costly mistake is underestimating things like how long it would take to rebuild your house, the value of your personal property, or the value of your home.  In the event of a loss, all these can seriously impact your financial well-being.  If your policy only provides for a year of additional living expenses and it takes 18 months to rebuild your house, you will have to pay for the additional 6 months out of pocket.  If you underestimate the value of your personal property, you may be unable to replace what is lost.  If you underestimate the value of your home, you may be saddled with mortgage debt for a house you can’t live in and can’t afford to repair while paying to live somewhere else.

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