Our past columns have focused on auto insurance. We’ve much more to cover on auto insurance and we’ll return to it in future columns but for today let’s shift to homeowner’s insurance.
A question I hear often is, “My home is worth $XXX,XXX. Why does the insurance company want to insure it for more than it’s worth?” Like most other questions, the answer is simple.
When you say that your home is worth a certain amount you’re referring to your home’s market value. Market value is the price you would expect to receive for your home if you decided to sell your home. The price is usually negotiated between buyer and seller by volleying offers and counteroffers until they come to a mutually agreeable amount. The agreed upon amount is your home’s market value.
When you purchase insurance for your home, the insurance company’s first concern is not your home’s market value. Your insurance company isn’t selling your home. Your homeowner’s insurance policy is a contract where the insurance company promises, in exchange for your premium, to restore (in insurance language the term is “indemnify”) your loss. Therefore, your insurance company’s first concern is the cost to restore your loss. That’s different from market value. Market value is a negotiated sales price between buyer and seller. If your home is destroyed by an insured peril the result is a loss, not a sale. There’s no buyer/seller transaction to negotiate. Your homeowner’s insurance policy now requires your insurer to restore your loss. That’s non-negotiable. Period. Your insurer may even be required to build you a new house to replace the one you lost!
Most homeowner insurance policies insure dwellings and other property for replacement cost. A replacement cost provision in your policy says that the insurer will restore your loss without adjustment for age or depreciation. Replacement cost is the calculated cost to rebuild or replace, not sell, your home if it is totally destroyed. Think about it for a moment – if your home is destroyed by a covered peril, your insurer will build you a brand new home! The cost to rebuild and replace your home is probably going to be much greater than your home’s market value. All well and good but to get the replacement cost provision in your policy your insurer requires you to buy enough insurance to rebuild your home. The amount of insurance needed to rebuild your home will probably be greater than your home’s market value.
It’s important to mention here that most homeowner insurance policies offer limited replacement cost for wind or hail damage on your home’s roof. A 5-year or 10-year limit is common. Beyond that limit a wind or hail claim on your roof is adjusted for age and depreciation.
Dwelling policies are available without replacement cost provision. You can buy them and they’re usually pretty cheap. (Do you remember earlier columns when I told you there were reasons why some policies are cheap? They’re cheap because of what they don’t do.) Policies without replacement cost may satisfy requirements of some mortgage lenders but if you have a loss who do you want your insurance to take care of, you or your mortgage company? Policies without replacement cost often fall short of taking care of clients.
Sometimes we’re asked to provide a quote for homeowner’s insurance and the homeowner just wants a certain amount of coverage on the dwelling. We can do that but if the coverage you buy is less than the replacement cost needed to restore or replace your home, you’ll likely have problems and serious disappointment if you have a claim because your insurance policy may fail to do the job you bought it to do.
Our next topic: “I have several quotes for homeowner’s insurance. There’s a wide range of premiums. Why are some cheaper and others higher? What’s the difference?”
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Got questions about your insurance? Call me. I’m glad to help. Even if you’re not one of our clients, I’m still glad to help. Answers and help are free. Of course, I hope you’ll consider becoming one of our clients. I promise to make you glad if you do