Whether you own a single-family home, a town home or a condominium, home ownership comes with pride and responsibilities.
No one wants to buy a home twice, which is why we purchase home insurance. Unlike car insurance – where the state, by law, dictates the parameters of auto policies – home insurance policies are designed by each insurance company, then approved by the state. Thus, it is not easy to compare home insurance policies.
Insurance companies design home insurance policies using some basic forms: HO-1, HO-2, HO-3, and HO-5. It is understood in the insurance industry that all HO-5 policies provide more coverages than HO-1 polices. So if you want to compare policies, start by asking an insurance agent which form policies they offer.
A form HO-5 has the broadest coverages in the industry. At first, it seems simple to compare policies, but then come the endorsements – insurance company-created additions to policies that can increase or limit coverages. Some insurance companies have determined that the market desires more coverages than the HO-5 policy provides, so they add endorsements to their HO-5 policies. Other companies have determined that the HO-5 policy provides more coverage than necessary, so they add endorsements to limit coverage.
For example, there are endorsements that limit coverage for theft of jewelry. Some companies have added endorsements that limit the amount of jewelry covered for theft, while others have endorsements that increase the amount of jewelry covered if stolen. In addition, some endorsements are automatically part of the policy, while other endorsements are optional.
The first, and most important, step to insuring your home is choosing the appropriate amount of dwelling coverage. It protects the most costly item – your house. The two terms people confuse most are “market value” and “replacement cost.” Market value is the price a person would pay for your home today. Replacement cost is the cost to rebuild your exact home in the same spot today.
These terms help to determine your appropriate dwelling coverage.
Insuring your home for its replacement cost will help you return to the life you had before your claim. Also, if you choose to underinsure your home, there are clauses in most policies called coinsurance that will penalize you at claim time, which results in you paying more if you want to replace your house.
Most insurance companies provide tools that can determine the cost of replacing your home. It is important that you and your insurance company agree up front that your home is properly insured.
It also is important to keep your replacement cost up to date. Home policies may provide protection for inflation – ask whether your policy does. Then, ask how.
Some companies use a simple interest rate, while others use construction indexes for the area in which you live. You may go 20 years without a claim, and if your policy does not keep up with inflation, you may be disappointed with your settlement.
Older homes may have higher replacement cost than market values because of their age or location. Even newly built homes can cost more to replace because the first contractor lowered the price to get the first sale. I can assure you that some contractors offer few discounts when they know you have to rebuild.
Last, your mortgage may determine the amount of dwelling coverage you must carry. Your lender will require you to have the same amount of dwelling coverage as the amount of your loan.
Your loan, however, may include the amount of land or location of your home, and this may put the replacement cost of your dwelling at odds with the demands of your lender. If you believe this may raise a problem, such as over-insuring your dwelling, discuss the issue with your lender and insurance agent.
Next to insuring your ability to earn money, your home insurance will be your most important insurance. I will continue to discuss all the possible home insurance coverages.
Bob Hollick is a State Farm Insurance agent based in Washington.
To submit columns on financial planning, investing or business-related matters, email Rick Shrum at email@example.com.