Homeowners Insurance

For many people, their home is their most significant asset. Yet it can be easy to overlook that the "standard" policy required when first taking out a mortgage may not always offer all the protection you may need. Like any insurance, choosing appropriate homeowner's coverage requires ongoing attention and adjustment.

Homeowner's insurance protects against loss due to disasters, theft, and accidents. Most policies include:

• Coverage for the structure of your home.
• Coverage for personal belongings.
• Liability protection for coverage against lawsuits resulting from accidents.

In addition, most policies offer coverage for the cost of living away from home if it's uninhabitable due to a covered disaster.

So, if your mortgage lender approved your policy, it must be sufficient, right? Not necessarily. Underinsurance, coverage for personal possessions, and liability limits can leave you responsible for unexpected losses.

Underinsurance: All Too Common

According to the Insurance Information Institute, an estimated two out of every three homes in the country are underinsured by 20 percent or more. That means the homeowner's insurance coverage limit is less than the actual cost of rebuilding after a catastrophic event - leaving the homeowner responsible for the difference. 

One reason for underinsurance is that labor and materials costs can increase significantly after a policy is purchased. So, if the coverage limits are never updated to reflect the actual cost of rebuilding, the property becomes underinsured.

Another reason for underinsurance includes home renovations. For example, if someone builds an addition, renovates their kitchen, or makes other significant updates, the cost of the new parts of the home couldn't have been considered when purchasing the original policy.

It's also important to note that just because coverage for a particular event wasn't required doesn't mean it can't damage your home. Most standard policies don't include coverage for flood damage, for example. With "500-year" floods occurring all too often, knowing how your policy treats flood damage - and water damage from in-home plumbing - can be an important part of protecting your home's value

Cash Value Versus Replacement Value

Homeowners' policies often allow a choice between replacing damaged personal items at actual cost or cash value. Imagine having to replace every piece of clothing and furniture in your home. Then imagine your budget is limited to whatever you'd get by selling everything in your home at today's used-market prices - accounting for age and wear. That's the reality for policyholders with cash value coverage.

Cash value (also called Actual Cash Value) refers to the value of your property at the time of the loss, considering depreciation. Depreciation is the decrease in value due to age, wear and tear, and other factors. In other words, cash value compensates you for what your property was worth before the damage occurred, not what it would cost to buy new.

Replacement value coverage compensates you for replacing your damaged property with new items of like kind and quality without deducting for depreciation. This coverage aims to restore your home or possessions to their condition before the loss, up to the limits of your policy. But remember that some valuables, like jewelry, art, and collectibles, may be subject to special limits unless you specifically purchase additional coverage.

Liability Coverage Limits

Liability coverage is a critical component of homeowners insurance because it protects the policyholder from financial loss if they are found legally responsible for injuring someone or damaging their property. Without sufficient coverage, homeowners could be faced with paying out-of-pocket for legal fees, medical bills, and other damages, which can be financially devastating.

The standard limits for homeowners liability coverage, the amount the insurer would pay for injuries that occur on your property or due to the actions of the homeowner's family, often range between $100,000 and $300,000. But in today's litigious society, it's not out of the question that an injury could result in damages beyond those standard limits.

Enhancing Your Policy

In the context of financial planning, asset protection is critical. Understanding your homeowner's insurance limits and considering whether they're sufficient can be helpful when making your financial plan. So, where to start? Here are some ideas to consider: 

• Review and Update Your Policy Regularly - Your home's value and the cost of rebuilding change over time. Reviewing your policy periodically can help keep your coverage closer to your home's current value and rebuilding costs. Some insurers also offer "enhanced" or "extended" policies that build in potential increases in construction costs.

• Understand Policy Limits and Exclusions - Knowing what's not covered is as crucial as knowing what is. For instance, most standard policies do not cover flood or earthquake damage, so it's worth checking your own policy language.

• Consider Insuring for Replacement Cost Over Actual Cash Value - Replacement value policies often cost more. Whether the broader protection fits your situation can depend on things like your premium budget, the age and condition of your belongings, and your coverage limits.

• Inventory Your Personal Belongings. Keeping a detailed inventory of your possessions with receipts, descriptions, and photos can help speed up the claims process and support your claim, though what an insurer pays depends on your policy terms and coverage limits.

• Consider Special Coverage for High-Value Items. Standard policies limit coverage for certain items like jewelry, art, and collectibles. If you own high-value items, consider additional coverage to protect their total value.

• Explore Personal Liability Coverage Limits. The minimum liability coverage may not be sufficient to protect your assets in the event of a lawsuit. Consider increasing your liability coverage or getting an umbrella policy, which provides additional liability coverage beyond your homeowner's insurance limits.

As you plan long-term, consider how changes in your life might affect your insurance needs. After renovations or significant purchases, a policy review may be worth considering to see whether your coverage limits still line up with your situation. As your net worth increases, liability limits become increasingly important.

The Takeaway

Homeowner's insurance is about more than protecting your house - it's a key part of protecting your financial future. Keeping your coverage up to date is one of the more straightforward ways to reduce the risk of a major unexpected expense.

If you need clarification on how much coverage is appropriate for your situation, please consult a qualified professional.