Understanding My Homeowner's Insurance Policy
The devastating fires in Los Angeles have resulted in thousands of people losing their homes, and many are just now realizing that their homeowners insurance policies won’t cover as much as they had assumed. If you are a homeowner, this is a great time to review your homeowner's insurance policy to make sure that you understand what is, or is not covered.
Understanding your homeowner’s policy
There are two components to homeowners insurance policies. The first covers the cost to repair/replace damaged property (and the costs you may incur if you need to live elsewhere while the home is being repaired). The second component covers the liability costs if someone is injured on your property and you, as the homeowner, are deemed responsible. For this article, we will be focusing on the first component.
Your policy will state the maximum limits for how much it will pay out for different types of potential costs incurred.
Dwelling - This is your home (and anything directly attached to it, like a garage, shed, deck, etc). The limit stated here is the MOST the insurance company would potentially pay out to repair/replace the building itself.
Other Structures - This includes structures that are not connected to/touching your home. This could be a detached garage, in-law unit, fence, swimming pool, shed, etc. The limit for this is usually 10% of your main dwelling coverage.
Personal Property - This is all of the things in your home (or in your other structures, like a detached garage). This includes your furniture, clothes, electronics, etc. There are limits for specific categories. For example, your policy may only cover $1,000 for jewelry that is destroyed, so if you have particularly valuable jewelry (or electronics, art, etc) you may want a separate policy that covers the value of those high-value items. The limit for Personal Property coverage is usually 50% of the dwelling coverage.
Loss of Use - This covers your expenses if you are displaced from your home while it is being repaired/rebuilt. In the example of the LA fires, many homeowners will need to find alternative accommodation while their homes are rebuilt, which will result in several months (if not years) of rent expenses. The limit for Loss of Use coverage is usually 20-30% of the dwelling coverage.
How much coverage is enough?
The most accurate way to determine the cost to rebuild is to hire an appraiser. Alternatively, your insurance broker can help you come up with an approximate number based on the home’s square footage and the average building cost per square foot in your area. If your home has lots of high-end features and building materials, you may want to consider going a bit above the average cost for your area.
Keep in mind that the price of your home (if you were to sell it today) is likely more than the cost to replace/rebuild it. A significant portion of the sales price includes the land value. The portion your homeowners insurance covers is just the cost to replace the building (and your personal property).
It’s important to note that the basic (cheapest) policy is only going to cover the depreciated value of your items. So if you have a 10-year-old refrigerator that needs to be replaced, your insurance company will likely only reimburse you for the current market value of a 10-year-old refrigerator. If you opt to buy a new one to replace the damaged one, you will have to cover the difference in cost. However, if you opt for Replacement Cost Coverage (this will increase the cost of your premiums slightly), your policy will cover the cost of replacing your refrigerator (and everything else that's damaged) with new items.
Similarly, another add-on you may want to consider, especially if you have an older home, is Building Code or Ordinance Coverage. In an older home, you aren’t required to make adjustments to your home every time there is a new building code update. However, if you are doing work to your home, that new component must be up to the current building code standards.
So if you have an older home that has sustained major damage, to repair it, you will need to bring things up to the new codes. However, the basic homeowner’s insurance policy will only cover the cost to replace it to the standard it was previously, and you will have to cover any additional costs needed to bring it up to code.
Exclusions
With most policies, there are some specific scenarios that are explicitly not covered. It’s common for homeowners to assume their policy will cover ANY damage to their home, but you must understand the limitations of your coverage.
Floods and earthquakes are two of the most common exclusions. In some high-risk areas, wildfires are now being excluded from standard policies. With these exclusions, you have the option to take your chances and hope that those specific scenarios don’t happen (knowing that your insurance policy won’t pay out in those situations). Or you can get a separate policy (at an additional cost) that protects you from those specific events.
If your home is in a high-risk zone, getting an additional policy to specifically protect against an excluded event is likely to be expensive. However, the cost of having to replace your home out of your own pocket after a natural disaster would be much more expensive.
It’s also worth noting that natural disasters are happening more frequently and in broader areas than before. So even if your home isn’t in a traditional flood or fire zone, it's possible your home may still be at risk for these events. Thanks, Global Warming.
Deductible
A deductible is the amount that you have to pay towards a repair/replacement before your insurance will kick in. The higher your deductible is, the lower your policy premiums will be. Having an Emergency Fund or a dedicated Home Repairs Savings Bucket is a good way to ensure those smaller expenses don’t derail your financial stability.
Other Tips:
Have an Emergency Fund - This is good advice for so many reasons, but when it comes to homeowners insurance, you will typically need to pay for things upfront and then submit a claim and wait for your insurance company to reimburse you. If you are displaced in an emergency situation, you want to have enough to cover your out-of-pocket expenses for a while.
Insurance companies are notorious for dragging their feet on making payments. Often there are months of back-and-forth negotiations to get the amount you are actually entitled to.. Having a solid emergency fund will help you survive that period.
Take a video walk-through of your home - Can you name all of the items in your home right now? Of course not. But if you take a few minutes to walk through your home, recording a video of everything in your home (scanning what's in each closet, opening each drawer, etc) you will have a document of all the items you have in your home. Then, if something happens and you need to list out all your possessions for an insurance claim, you can watch the video back to help you recall all the many things in your home.
Doing this on an annual basis would be fantastic. But even if you were to do it today, and then needed it 5 years from now, today's recording would still be incredibly helpful in recalling the things in your home.
Having a video recording will also make it easier to provide evidence of what you own.
Review regularly - Every year when your policy renews, take a few minutes to review it. Not only will it ensure that you have an accurate understanding of your coverage, but it may also prompt you to adjust your coverage when appropriate.
Did you just finish renovating the bathroom? Maybe your dwelling replacement cost should be a bit higher now. Did your grandma leave you her engagement ring with a huge diamond? Maybe you need a separate policy to protect that. Or has inflation drastically increased building costs in your area? Time to increase your replacement cost limits.
Avoid filing minor claims, especially if you are in a hard-to-insure area - With the increased rate of natural disasters, it’s no longer profitable for insurance companies to provide coverage in certain regions. If your home is in a hard-to-insure area, getting dropped from your insurer can leave you will limited (or only very expensive) alternatives. When you file a claim, you become a less desirable customer for the insurance companies. So even though it is in your rights to file a smaller claim, doing so may result in your provider deciding not to renew your policy next year.
If your home was destroyed and you have hundreds of thousands of dollars in repairs/replacement costs, by all means, file the claim. But if you have a small leak and $2k
In damage, you may be better off paying for that out of pocket. Sure, you are out $2k, but if you are dropped by your insurance provider you may find yourself paying more than that in additional premiums with an alternate provider.
Paying for homeowner’s insurance isn’t fun. Ideally, you never need to file a claim, in which case it can feel like wasted money. However, if you do have a major catastrophe happen, you will have a much easier time navigating it if took the time to set up an insurance policy that appropriately covers your risks.
