Understanding home insurance policies

I started this week with news that home and business insurance companies have stopped writing new policies in the state of California. While there were several reasons why, one was the rate of inflation is making it difficult to correctly value the risk. Ask yourself, do I have the necessary insurance on my home?

Whether you own a single family home, a town home or a condo, home ownership comes with pride and responsibilities. No one wants to buy their home twice and that is why we purchase home insurance. Unlike car insurance, where the state, by law, dictates the parameters of auto policies, home insurance policies are designed by each insurance company and then approved by the state. Thus, it is not easy to compare home insurance policies.

Insurance companies design home insurance policies using some basic forms: HO-1, HO-2, HO-3, and HO-5. It is understood in the insurance industry that all HO-5 policies provide more coverages than HO-1 polices. So if you want to compare polices, start by asking an insurance agent which form policies they offer.

A form HO-5 has the broadest coverages in the industry. At first, it seems simple to compare policies, but then come endorsements. Endorsements are insurance company-created additions to policies that can increase or limit coverages. Some insurance companies have determined that the market desires more coverages than the HO-5 policy provides, so they add endorsements to their HO-5 policy. Other companies have determined that the HO-5 policy provides more coverage than necessary, so they add endorsements to limit coverage.

For example, there are endorsements that limit coverage for theft of jewelry. Some companies have added endorsements that limit the amount of jewelry covered for theft, while others have endorsements that increase the amount of jewelry covered if stolen. In addition, some endorsements are automatically part of the policy, while other endorsements are optional.

The first and most important step to insuring your home is choosing the appropriate amount of dwelling coverage, since it protects the most costly item – your house. The two terms people confuse most are "market value" and "replacement cost." Market value is the price a person would pay for your home today. Replacement cost is the cost to rebuild your exact home in the same spot today. These terms help you determine your appropriate dwelling coverage.

Insuring your home for its replacement cost will help you return to the life you had prior to your claim. Also, if you choose to underinsure your home, then there are clauses in most policies called coinsurance that penalize you at claim time, which results in your paying more if you want to replace your house.

Most insurance companies provide tools that can determine the cost of replacing your home. It is important for you and your insurance company to agree up front that your home is properly insured. It is also important to keep your replacement cost up to date. Home policies can provide protection for inflation – ask if your policies does. Then, ask how. Some companies use a simple interest rate, while others use construction indexes for the area you live in. You may go 20 years without a claim and if your policy does not keep up with inflation, then you may be disappointed with your settlement.

Older homes may have higher replacement cost than market values because of their age or location. Even newly built homes can cost more to replace because the first contractor lowered the price to get the first sale. I can assure you that some contractors offer few discounts when they know you have to rebuild.

Lastly, your mortgage may determine the amount of dwelling coverage you must carry. Your lender will require you to have the same amount of dwelling coverage as the amount of your loan. However, your loan may include the amount of land or location of your home and this may put the replacement cost of your dwelling at odds with the demands of your lender. If you think this may raise a problem, such as overinsuring your dwelling, discuss the issue with both your lender and insurance agent.

Next to insuring your ability to earn money, your home insurance will be your most important insurance. I will continue to discuss all the possible home insurance coverages in the future.

Bob Hollick is a State Farm Insurance agent based in Washington. His column appears every other Friday in the Observer-Reporter.