Homeowners Insurance 101

Take this crash course to find out if you have the coverage you need
before you need it.

by Caitlin O'Neil

Whether you are a first-time home buyer or a veteran of many years of
mortgage payments and house upkeep, chances are your home is your
single most expensive budget item and your most valuable investment.
But few homeowners ever think twice about the homeowners insurance
that protects their investment, let alone take the time to read their
policy. Knowing what is covered and what's not can make all the
difference when disaster strikes.

The basics

Homeowners insurance evolved in the late 1950s, when the insurance
industry needed a single comprehensive policy to cover a house, its
contents, and liability. The standard package policy has two
components: property insurance and personal liability. Although the
over 900 U.S. insurance companies write many different policies, 80
percent of them are based on a form called HO-3, which provides
coverage on the house and other structures for all risks except those
excluded by the policy—most commonly floods and earthquakes. HO-2, a
cheaper policy, and HO-1, a bare-bones option, cover only those risks
that are specifically included. HO-4 is a policy designed for renters
while HO-6 covers condominium owners.

What's Covered

Standard homeowners insurance (form HO-3) customarily covers damage to
both structures and personal property caused by fire or lightning;
windstorm (including hurricanes and tornadoes) or hail; explosions;
riot or civil commotion; aircraft; vehicles; smoke; theft or vandalism
(sometimes called malicious mischief); falling objects; weight of ice,
snow or sleet; and freezing of plumbing, heating, air conditioning or
other household systems. It also covers personal liability: if you,
your family or your property injures someone. In fact, your coverage
is likely to be more comprehensive than the above list. Many
homeowners policies cover damage by "just about everything," unless
the coverage is specifically excluded. In these cases, it is even more
important to understand what is not covered.

What's Not Covered

Although floods and earthquakes are widespread in the U.S., the damage
they cause is not covered by the standard HO-3 policy. Almost 90
percent of the U.S. population lives in earthquake-prone areas; since
1900 earthquakes have occurred in 39 states and caused damage in all
50. If your home is located in a flood-prone area, you are 26 times
more likely to suffer a flood loss than a loss from fire. Of course,
the cost of flood and earthquake coverage reflects the high risk
involved. If you live along a shoreline, you can expect to pay a
higher premium for flood coverage than someone living in the
mountains.

Other exclusions can include neglect, intentional loss, earth
movement, general power failure and even damage caused by war. A
costly exclusion is the ordinance or law exclusion, which refers to
changes in building codes that can drive up the cost of rebuilding or
repairing. Thus, if you discover when replacing damaged property that
current law requires a higher grade of electrical wiring, the
difference in cost between the old wiring and the new wiring is your
responsibility.

Loss and Recovery

The value of the real property—your home, garage, shed and other
structures—is generally based on the value of your house. Homeowners
insurance also covers your personal property, including the contents
of your home and any personal belongings you or members of your
household use, own, wear or carry—basically everything and the kitchen
sink. This coverage is also based on your house's coverage, and there
are limits on the losses that can be claimed for certain items, such
as cash, furs or jewelry—limits that can be increased with
supplemental premiums. You can also pay an additional premium to cover
living expenses if your home is not habitable for a period of time.

Most insurance companies now offer guaranteed replacement cost
coverage —the coverage that helped the Silva family rebuild their home
after the fire. Replacement cost coverage pays to repair or replace
damaged homes without a deduction for depreciation or a dollar limit.
If an old TV set damaged in a fire costs $500 today, replacement
coverage will pay the full cost. Because the Silvas had guaranteed
replacement cost coverage, the insurance company paid out the full
cost of rebuilding their home and replacing their possessions. Without
it, they would have only received the actual cash value—the
replacement cost minus depreciation. In the case of the old TV, if its
value has depreciated 50 percent, actual cash value coverage would pay
only half of the replacement cost, $250. Unless a homeowners policy
specifies that property is covered for its replacement value, the
coverage is for actual cash value. An upgrade from actual cash value
to replacement coverage typically raises your premium 10 to 15
percent.

If you were to suddenly lose your home due to fire or a tornado or
have the contents damaged or stolen, you probably could not afford to
replace everything all at once. By becoming familiar with your
homeowners insurance policy, you will be sure to have the coverage you
need when you need it.

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