How to Plug a Leak in Your Safety Net

About 60% of U.S. homes are underinsured by more than 20%, according to a survey by the Chubb Group. Many people do not understand their home-owner’s insurance and how it has changed over the years. It is not the simple product it seems to be, and many people are overlooking some key details. The more valuable a home, the more likely it is to be underinsured.

Most homeowners consider insurance an expense to be cut as low as possible. Insurance, however, is a key element of a wealth preservation plan. You should work with a good insurance agent and perhaps a financial planner to ensure the coverage is what you need.

The replacement cost provision is wrong in many policies for several reasons.

The standard policy pays for replacement cost of the home (but not its contents). Most insurers will pay only for the coverage amount listed in the policy plus a percentage. A standard policy is for the insurer to pay a maximum of 120% of the insured amount. The insurer usually estimates the insured amount by multiplying the square footage of the home by a standard construction cost. If the stated coverage amount in the policy is too low, you are underinsured and could suffer a real loss.

The insurer’s formula can be inappropriate if a home is custom made or has custom features. Unique materials or craftsmanship can increase the cost of replacing a home. The standard formula might not allow for crown molding or other special features or details. If you have doubt that the standard formula properly reflects the cost of rebuilding your home, ask the insurer to send an appraiser or hire your own appraiser.

Another option is to purchase guaranteed replacement coverage or a higher percentage coverage than the standard 120% of the insured amount.

Changes in building codes or zoning codes also can affect the rebuilding cost if you live in an older home. In many areas, substantial repairs or improvements to an older home can be made only by bringing wiring, plumbing and other features up to current code standards. In such cases, it is possible for the cost of repair to exceed the market value of the home. To protect against having to pay this cost yourself, your policy should have a clause known as law and ordinance coverage.

The policy also should specify in-kind and quality replacement for all repairs and rebuilding. This is important if you have better-than-standard quality chandeliers, doors, wood trim, shelving, and other details.

Many people also do not properly insure jewelry, furs, and antiques. Most now know that these items are not covered under the standard policy; a rider specifically covering them is required. Yet, it might not be sufficient to have the items appraised and buy the standard rider for that amount. If the items are likely to appreciate, you want a provision that will cover at least some of the appreciation that will occur before your next appraisal. Otherwise the insurer will pay only the insured amount.

A policy also should provide adequate living expenses for the family if a home cannot be occupied until it is rebuilt or needs to be repaired. Check the policy for limits on these expenses. Some policies limit the daily expense amount and cap either the total amount or number of days the expenses will be paid. You want any daily amount to be sufficient to rent a comparable home in the neighborhood. The time limit should be long enough for rebuilding all or part of your home. Be sure to factor in time for the planning process and obtaining permits.

Homeowner’s policies have a limited amount of liability coverage. You can expand this coverage. A personal umbrella rider will cover liabilities above the standard policy limit and also will cover liability in a number of situations beyond accidents involving the home and its occupants. If you hire domestic help, you also might want coverage for employment practices such as discrimination, harassment, and wrongful termination.

Also, be sure that the policy covers the home and home owner. If a home is transferred to a living trust, for example, the policy might not apply to this new owner.

There are other steps you can take to reduce costs and maximize coverage.

Maintain the home. An insurer does not have to pay for losses if the homeowner contributed to the losses, including by failing to perform preventive maintenance. You need to cut diseased or dead trees. Take basic steps to prevent water or mold losses. Clean the gutters. Replace the water heater before it rusts through and causes water damage. Be sure sump pumps are working. Replace the roof before it leaks. Keep in mind that your insurer maintains the right to inspect the home at any time.

Limit claims and inquiries. Insurers will deny coverage or substantially raise premiums on difficult homes or homeowners. At many insurers now if two to four claims are filed in three years or less, a home or owner might become uninsurable. Even calling to ask about a potential claim could be included in the Comprehensive Loss Underwriting Exchange (CLUE) database and count against you. Independent agents aren’t required to report to the insurer questions and inquiries. But they must report actual major damages they know about, even if a claim is not filed. If you call the insurer directly or call a non-independent agent, the inquiry often will be reported to CLUE.

Pay for small claims. Reserve your insurance for the catastrophic or major claims. Handle other items yourself without bothering the insurer.

Increase the deductible. As with all insurance, reduce the premiums by increasing the deductible and handling all but the major claims yourself. Increase the standard $250 deductible to $500 or $1,000 or more. Your premiums should decrease by 10% or more.

Ask about discounts. Premiums often are reduced if you have both auto and homeowner’s coverage through the same insurer, have a security system or sprinkler system, or add storm shutters. A hard-wired smoke alarm system instead of a individual battery-operated alarms also cuts premiums. Your credit rating can influence premiums. New homes are cheaper to insure, as are homes with brick exteriors. If your insurer does not ask about these things when you apply for the policy, you should ask about discounts.

Investigate before buying. Insurers track each house. If a previous owner filed too many claims, a new owner might not be able to get coverage or will be charged high premiums. Make obtaining reasonable homeowner’s insurance a condition of closing the purchase.