InsuranceLecturer — Years ago, insurance agents advised homeowners that they only needed enough insurance to cover 80% of the costs of rebuilding their home.
This ideology came from statistics based on years of information concluding it was unlikely a home would be totally destroyed. The recent weather patterns contributing to wildfires, flooding, mudslides, increased hurricane and cyclonic storm activity have forever changed that way of thinking. Today, almost all homeowners insurance agents will recommend the homeowner protect his property with coverage of 100% rebuilding costs.
Before choosing the type, coverage, and limits of a homeowner’s policy, the homeowner needs to know exactly how much his or her home is worth. Contrary to popular thinking, the worth of a home is not based on real estate market sales value. A home’s worth is determined by the cost of replacing not just the structures, but also the contents inside.
A good rule of thumb for estimating the structural worth is to multiply the square footage of the home by local building costs. While real estate agents, and appraisers, are helpful in determining local building costs, a local contractor is better qualified to give the homeowner a detailed estimate of building costs per square foot given the specific type of home.
Once building costs have been determined the cost of upgrades, amenities and the labor associated with installing them, must be factored into the equation.
After determining a proper estimate for the structural worth, the homeowner needs to calculate the value of the personal property inside. An inventory and pricing of the personal property contents will yield a reasonable estimate of the personal property worth.
With the combination of both structural and personal property worth the homeowner is now prepared to discuss with his or her insurance agent the type of policy, and limits of coverage.
Types of Policy
There are several types of homeowner, (HO) insurance policies. The abbreviations used for these policies are standard throughout the United States with the exception of the state of Texas.
(Editors note: Texas homeowner policies are not covered in this article.) Most homeowner insurance policies are called “named peril” policies because they only cover losses that are from those perils listed in the policy.
Typical named perils include fire, windstorm, hail, and other physical losses. To the contrary, “All risk” policies cover losses from any peril except those specifically excluded in the policy. An “All risk” policy is more expensive than a “named peril” policy but it provides broader, more extensive protection.
The following is a list of each type of policy including its abbreviation and general coverage:
HO-1 Basic Homeowners Policy
This type of policy covers your house and possessions against only 11 different perils. The coverage includes protection against: theft; fire or lightning; explosion; wind or hailstorm; civil commotion or catastrophe (riots); aircraft accidents; other vehicles colliding into your home; smoke damage; acts of malicious mischief (vandalism); damage by glass or safety grazing material of the structure; and volcanoes.
Today, many agents won’t even present this policy and because it simply does not cover your home adequately. Many states have also legislated against writing this type of policy because the coverage is not worth the premium cost.
HO-2 Broad Homeowners Policy
The HO-2 policy covers 17 perils including the structure of your home and your personal belongings from the 11 different perils covered by HO-1 and coverage of 6 additional perils.
The extra perils covered include: falling objects; weight of ice, snow, or sleet; three different types of water damage; electrical surge damage; freezing of plumbing, and damage caused by electrical and/or heating systems. The HO-2 policy premium costs about 5 percent to 10 percent more than the HO-1 policy.
HO-3 Special Homeowners Policy
The HO-3 homeowners insurance policy is also know as the “special homeowners policy”. The HO-3 policy makes sense for most people. It is preferred over the HO-1 because it contains much more coverage.
The HO-3 policy protects against all perils except those specifically excluded by name in the policy. Unfortunately, earthquakes, floods, and damage caused by war and nuclear accident are almost always excluded.
The HO-3 policy also covers, within limits, damage to the homeowner’s specifically named personal property. It typically runs about 10-15 percent more than the HO-1 policy and 15-20 percent more than the HO-2 policy.
HO-4 Renters Policy
It is estimated that over 50% of the population in the United States rent their home. Renters insurance protects your possessions against the same seventeen perils covered under the HO-2 policy.
Renters insurance covers liability for injuries occurring on the property, but it does not cover damage to the building being rented. Its cost varies depending on the risks involved such as flooding or high crime neighborhoods. (See the section below for more details about Renter’s insurance coverage.)
HO-5 Extensive Homeowners Policy
Today, almost every Insurance company writing homeowner policies offers an HO-5 policy. It is generally marketed as the “deluxe” policy and is usually the most comprehensive coverage one can buy from that company.
Because of state law requirements and competition, the policy language is nearly identical from company to company and state to state.
This policy is so expansive that, within limits, it even covers personal watercraft! Your dwelling is covered on an all-risk basis, (except for damage resulting from such occurrences as war, flood and earthquakes), where virtually nothing is excluded.
Unlike the HO-3 policy in an HO-5 policy your personal property is covered, but only if damaged by one of the 17 named perils. (example: fire, lightning, theft, vandalism, etc.)
While both the HO-3 and HO-5 policies cover damages to a home’s physical structure, only the HO-5 completely covers damages to the homeowner’s personal property contained within the home.
For most homeowners it is very important to have a policy which covers the replacement cost of personal belongings regardless of the peril. This particularly rings true for homeowners with a larger home, expensive furnishings, extensive jewelry, art collections, and/or a home office.
The companies that do not offer HO-5 frequently offer similar protection by adding supplementary insurance, or riders to a HO-3 policy. This method of coverage may be more cost-effective given the expense, 50-75% more than HO-1 insurance.
HO-6 For Owners of Co-ops or Condominiums
This type of policy provides personal property coverage, liability coverage and specific coverage of improvements to the owner’s condominium unit. It should be noted that insurance provided by the homeowner’s association normally covers most of the actual structure and common areas.
To determine what additional HO-6 coverage will be needed, the homeowner should review the homeowner association’s building policy before he or she buys the condominium or purchases an HO-6 policy.
The association’s building policy will usually not cover semi-permanent interior wall coverings or any other post completion interior improvements qualifying as fixtures, such as a built-in wet bar, bookcases, china hutch, etc.
If purchasing a planned unit development (PUD) or a detached condominium, the homeowner will need an HO-3 policy as the Association does not usually maintain structural insurance for this type of dwelling.
The PUD or DC owner will need to review the Homeowners Association insurance policy for structural and liability coverage in common areas such as the clubhouse, tennis courts, sidewalks, driveways, and yards before you buy. As a part owner in these amenities most banks or mortgage companies will require the areas be insured.
HO-8 Older Home Policy
This policy is truly unique in that it recognizes that home quality has drastically changed over the years. In this policy insurance companies are admitting that older homes are better crafted than the modern dwelling.
Unfortunately, insurers are well aware that the cost of rebuilding an older home using original materials and craftsmanship is cost prohibited. Insurance company underwriters view the cost of rebuilding an older home as an unreasonable risk.
For instance, many older homes contain real oak staircases, walls and trim and have elaborate internal and external structural ornamentation that was originally hand crafted.
If the insurance company were required to replace this material they would not make a profit. Consequently, many older homes will not qualify for a guarantee replacement policy under insurance company guidelines.
Still, insurance companies are required by most states to provide insurance for homeowners within state guidelines in the open market or under a pool system.
The creation of the HO-8 policy meets those state requirements providing coverage for the same eleven named perils as HO-1 but paying for only for repair costs or actual cash value if a claim is filed.
Simply put the HO-8 promises the homeowner that the insurance company will repair the damage, not necessarily using the same type quality materials, or pay the actual cash depreciated value of your home, which ever is less.
As discussed below, the actual cash value is not the present market value but the value of the home factoring in a discount for wear and tear due to age!