Anyone who has bought a house or has shopped for one knows that homeowners insurance is a fact of life – some might call it a necessary evil; others peace of mind in times of crisis. And while most people are persuaded by banks to purchase home insurance, few people understand exactly who to trust, what their policy does, when to make policy changes, where to shop for it, why it is priced the way it is or – most importantly – how they can take control of the process.
What is Homeowners Insurance and How Does Home Insurance Work?
Homeowners insurance, sometimes referred to as “hazard insurance” or simply “home insurance,” is property insurance designed to cover private homes and their contents.
Homeowners insurance is a multi-line policy, meaning that the premiums, or regularly scheduled payments made to the insurer, cover both property and liability insurance. The premium is usually determined by the replacement cost of the home and its contents.
There are three major reasons to buy homeowners insurance:
- To provide property coverage: Homeowners insurance covers the physical structure of your home and your personal property if it gets damaged or destroyed.
- To provide liability coverage: If someone who isn’t covered under your policy is injured or killed, or their property is damaged or destroyed while they’re on your property, your homeowners insurance policy will cover your personal legal responsibility. This coverage extends to cases where damage or injury happens adjacent to your property, such as when the limb of a tree on your property falls on a parked car on the street.
- To satisfy your mortgage lender: To get a mortgage from a bank, most lenders insist you have insurance as long as you have a mortgage; you also have to list the lender as the mortgagee on the policy.
Additionally, your policy generally covers such expenses as staying in a hotel or renting an apartment during the period when your home is being repaired following a disaster. In most cases, it requires that at least one of the individuals named on the policy actually live on the premises.
Types of Home Insurance
The best homeowners insurance will cover all perils except for those that are specifically excluded in the policy language. Here are the types of policies offered:
- Basic Homeowners Policy, HO-1: This is a basic policy that protects the homeowner against 10 basic perils such as fire or smoke, explosions, lightning, volcanic eruptions and damage from aircraft.
- Broad Form Policy, HO-2: The Broad Form policy covers all the 10 perils in the basic policy, plus a few more, like accidents from electric currents. Your structure, your personal belongings, and your personal liability are covered.
- Special Form Policy, HO-3: This policy covers everything in the Broad Form policy, plus more. This policy covers you if you damage someone’s property or injure them.
- Tenant’s Form, HO-4: Tenant’s form is for renters and is commonly known as renters insurance. It covers your personal belongings and personal liability.
- Comprehensive Form, HO-5: This policy is comprehensive because it covers more perils than other policies. This policy is similar to the Special Form policy in that it can financially protect you from all perils except for ones specifically stated as not covered in your policy.
- Condominium Unit Owners Form, HO-6: This is for owners and/or occupants of condominium units. It insures your personal property and your walls, floors, and ceiling against all of the perils and also extends coverage for damage to additions and/or alterations that the unit owner may have made, up to specified limits. Usually, this coverage for alterations kicks in only after any insurance limits are reached by policies (if any) that are purchased by the condominium association.
- Mobile Home Form, HO-7: This is similar to the Special Form policy, but it is specifically for mobile homes. Mobile homes don’t have the same coverage as regular homeowners insurance.
- Older Home Form, HO-8: This is for older homes where the cost to rebuild is greater than the market value. It covers the same set of perils as the Basic Homeowners policy.
- Dwelling Fire Form: This policy only covers your dwelling and only for a few specific perils. It does not cover your personal property, personal liability or medical payments. This coverage is a popular option for vacation homes. It’s also the kind of limited policy your mortgage lender will purchase for you if you let your homeowners policy lapse.
If you own a townhouse, you may insure it through an individual homeowners policy or an association policy – sometimes referred to as a group policy.
What is Covered
Your coverage will not kick in unless you experience a loss that is caused by a specific peril, or reason for loss, that your policy covers. For most policies, the list of covered perils includes:
- Fire, smoke, wind, hail, lightning, explosions.
- Theft or vandalism.
- Trees and other falling objects.
- Weight of ice, snow, and sleet.
- Damage from an aircraft, car or vehicle.
- Water damage caused by a ruptured pipe.
What is Not Covered
Some common perils occur with such frequency and predictability in certain areas that they are subject to exclusion from basic coverage. The most notable excluded perils include:
- Floods or sewers that back up into the home.
- Land movement, including earthquakes, landslides, and mudflows.
- Damage from pets, birds, rodents or insects.
- Pollution damage.
- Deliberate damage to the home.
- Normal wear and tear.
Most of these are fairly clear-cut perils, but many people get confused by the types of water damage perils, as defined by insurance companies. They make a clear distinction between sudden water damage caused by a ruptured pipe (covered) and gradual water damage caused by rising floodwaters that seep into a home (not covered).
How Much Coverage Do You Need?
To decide how much coverage and policy limits you need, you’ll need to understand the importance of replacement costs vs. actual costs:
- Actual cash value (ACV) – This method would reimburse you for your lost or damaged possessions only after accounting for the age of each item and discounting for the wear and tear – or the depreciation – that has occurred over the years to lessen its value. Usually, the ACV is lower than the market value, but premiums tend to be cheaper.
- Replacement cost value (RCV) – This would replace your possessions with similar items at their current market value, so it does not factor into depreciation. The downside is that the annual premiums for RCV policies tend to be about 10 percent higher than ACV ones. To make sure you get enough for reimbursement, your coverage should equal the full RCV of your home.
The market value, which includes the price of your land, depends on the real estate market. If your dwelling coverage drops below 80 percent of the RCV of your home, your insurance company may reduce the amount it will pay on a claim.
As you shop for a quote, the agent or online app will ask for some basic information about your house, such as:
- Where it’s located.
- The square footage.
- When it was built.
- The type of construction.
- Roof type and age.
- Number of bedrooms, bathrooms, and stories.
- Garage type (if any).
- Foundation type.
- Whether it has security systems, such as burglar alarms and smoke detectors.
- Type of heating and air-conditioning systems.
Be consistent during your search, and be sure to get rate quotes and key information in writing. When you get quotes, it’s crucial that you ask for the same coverages and limits and give the same information to each agent or company. That way, you can get a much better apples-to-apples comparison of rates.
While you shop for bargains, this is also a good time to assess the insurer’s customer service skills and ability to handle problems. Go to your state insurance department and see if they have a “complaint index.” A complaint index measures how many complaints your state insurance department receives, relative to the size of the company, and then gives you an idea of how well each insurer responds.
The Cost of Homeowners Insurance
How much is home insurance, and what is the average cost of homeowners insurance? There is no one specific answer as insurance policies come in many different shapes and sizes. The same is true for insurance companies and agents, which can charge wildly different rates for essentially the same coverage. It’s always in your best interest to shop around for the best deals and to ask the right questions in an effort to know what you’re actually getting.
The NAIC came up with a list of good questions to ask an agent while you’re shopping around for quotes. Use this handy checklist the next time you chat with an agent about shopping for a homeowners policy:
- What is the claims history of the home I am considering?
- If I submit a claim, how will it affect my premium when I renew the policy? Could it end up costing me overall?
- How will my credit history affect my premium?
- What does the policy cover? What doesn’t it cover? What are the limits to the coverages?
- How much coverage do I need for my personal property?
- How much liability coverage should I buy?
- Should I buy flood insurance or earthquake coverage? Can an agent help me determine how much risk my home is at?
- What types of water damage are not covered? Is mold damage covered?
Check with your state insurance department or consumer agency to see if it publishes premium comparison guides for homeowners insurance. To make sure all prospective insurance companies are financially sound, check their health by using evaluations from independent rating agencies such as Standard & Poor’s, A.M. Best and Moody’s.
How Insurers Determine Your Premium
Many factors affect the underwriting process, which determines the premiums you pay. Different insurance companies charge different premiums for similar coverage. Decisions you make about how much insurance coverage to buy also affect your premium. Some of the other things that are likely to affect your premium include:
- The cost to rebuild your home: this is not the same as the purchase price, which includes the cost of the land. Your insurance agent might help you estimate replacement cost using information about your home and its contents
- Whether your home is made of brick or wood: the premium is usually lower for homes that are primarily brick or masonry than for wood frame homes
- The proximity of your home to resources and services, such as a water source or fire department and the quality of your community’s fire protection services
- The age and condition of your home; the premium is often higher for older homes and homes in poor condition than for newer homes and homes in good condition
- The claims history of your neighborhood and community, particularly the homes immediately next to your address
- A wood furnace or wood stove in the home
- Owning high-risk outdoor amenities, such as a swimming pool, a trampoline or playground equipment that could cause injuries
- The types of pets you have. Some insurers won’t insure you if you own certain breeds of dogs that are known to be aggressive, such as, but not exclusive to:
- Alaskan Malamutes
- Presa Canarios
- Chow Chows
- Doberman Pinschers
- German Shepherds
- Pitbull Terriers
- Siberian Huskies
Other companies do not exclude specific breeds, choosing instead to consider individual animals on a case-by-case basis. In some cases, the presence of exotic pets in the home, such as snakes, lizards, birds, and horses, may also drive up rates.
Getting Premium Quotes
Today, new apps have made quote-gathering online faster and easier than ever before. Rather than calling each insurance company individually or searching endless web pages for quote information, these online services allow you to quickly pull up a broad comparison of different companies’ prices. Many companies also offer online homeowners insurance calculators.
Also, most state insurance departments are now providing services that show you average premium price ranges (though not specific premium quotes) based on a property’s value, type of construction, mitigation features, various deductible levels and other criteria. For instance, check out the CHOICES page on the Florida Office of Insurance Regulation site or the Homeowners Premium Survey page from the California Department of Insurance.
Pulling It All Together
For far too many homeowners, insurance is just another piece of paper that is signed and filed away, rarely to be thought of again. That is until the worst happens. People who wait until they experience a loss before analyzing their own policies are not getting the full value – maybe little value – out of their countless premium payments.
Homeowners insurance is a financial covenant, but it should also be treated as a living, breathing entity to be nurtured over time. Only by reading the policy carefully, shopping around for the right agent, knowing your coverage limits and updating the property inventory can you ensure that your hard-earned dollars will keep that roof over your head – and another, stronger one after that.