Nearly two-thirds of homeowners are underinsured. Make sure you're not one of them.
By Pat Mertz Esswein, Associate Editor
From Kiplinger's Personal Finance magazine, July 2010
Hunkered down at home in Great Falls, Va., during the blizzard of 2010, Doug Colley and his wife, Christina, discovered a sparking surge protector that quickly set their bedroom on fire. Engulfing smoke drove the couple out into the cold with only their coats and Christina's purse. Fire trucks from several area firehouses responded, but they couldn't reach the house because 3 feet of snow covered the couple's half-mile-long driveway. The Colleys watched as the fire consumed their home of 32 years and, along with it, a lifetime of belongings.
Within days, the Colleys received a check for $225,000 from their insurer, Virginia Farm Bureau—enough to rebuild their house (although they plan to build a slightly larger home with a first-floor master suite). As it turns out, the Colleys were fortunate: Their insurance agent had visited them the previous summer and helped them update their homeowners coverage. Had the fire occurred a year earlier, their check might have been smaller.
The take-away: When you get your annual insurance-renewal notice, don't just toss it into the to-file pile. Instead, review your policy and beef up your coverage if necessary. Insurer USAA recommends that its customers review their coverage every three to five years, and with good reason. Almost two-thirds of U.S. homeowners are underinsured, by an average of 18%, according to Marshall & Swift, which provides building-cost data to the insurance industry.
And don't assume that the cost to rebuild sank along with home values over the past several years. The price of building materials rose sharply in 2008, along with the price of fuel, before flattening in 2009 because of the recession, according to Xactware, which tracks trends in the property-insurance and construction industries.
Without adequate coverage, you may not have enough insurance to rebuild your home and replace its contents in the event of a fire, tornado or other disaster that leads to a total loss. If you let your coverage fall to less than 80% of the insurer-estimated cost to rebuild your home, your insurer may either reduce the amount it will pay to rebuild (for example, it will pay 75% of the cost on 75% coverage) or it might pay only for your home's actual cash value. Many insurers also require that you notify them within a certain time limit if the cost of an improvement to your home exceeds $5,000; if you don't, they may not cover the full cost to rebuild.
Build a good policy
Keep in mind that you're not insuring the market value of your land, just the cost to rebuild your home, garage and any other buildings. Your policy should include an inflation guard that is keyed to regional costs and, ideally, adjusts your coverage every year. Building costs can change not only with the economy but also after a disaster, when contractors and materials may be in short supply, says Don Soss, a vice-president of Fireman's Fund. That's one reason it's also smart to purchase extended-replacement coverage, which covers the difference if the price to rebuild exceeds your dwelling limit. Your policy probably already has 25% extra coverage built in, but you can buy more in 25% increments—usually for $30 a year—up to another 100%, says Michelle Rupp, an independent agent in Seattle.
New building codes often create a discrepancy between the limits of coverage and the actual cost to rebuild, says Kathleen Stalter, risk-services manager at Fireman's Fund. After a disaster, municipalities may quickly tighten their codes. Some insurers include full building-code coverage, but most include either an extra 10% of the dwelling limit or a flat $25,000, which may also have to go toward removal of debris. You can beef up your coverage by buying an endorsement -- often called a building-code upgrade. It will cost about $50 to $75 a year to double your protection to 20% of the dwelling limit.
Take stock of your stuff
In the event of a total loss, you usually have 180 days to provide your insurer with a list of everything you owned, from sofas to soup spoons. Before the fire at their home, the Colleys had begun an inventory but hadn't finished it—and it went up in smoke, too. "Think about having to imagine yourself in every room of your home, trying to remember everything in it," says Doug.
You can create a detailed listing or just take photos or make a video (see Kiplinger's Recipes for Quick & Easy Financial Fixes). Open cupboards, closets, drawers and storage boxes and shoot those, too. Not only will the images jog your memory, they will also assure insurance adjusters that your furniture really was high-end or antique, and not just starter stuff from Ikea. The Colleys have asked family members for holiday photographs taken in their home that show heirloom antiques in the background.
Get appraisals of valuables and, if necessary, purchase a personal-articles floater to cover them beyond the normal limits of your policy. Such coverage typically costs $17 per $1,000 of property value annually. Fireman's Fund even offers a "collections" endorsement that would cover the contents of a wine cellar.
Focus on the fine points
Rebuilding almost always takes longer than you anticipate, so look for a policy that provides 24 months of coverage for comparable housing and related expenses (called loss of use coverage). If your insurance company offers a fixed dollar amount with no time limit, divide that amount by 24 months to compare the coverage with that of other policies.
You'll need liability coverage in case you (or a family member) are legally responsible for causing injury to someone else at home or elsewhere. Given that medical (and legal) expenses can quickly mount, Rupp urges clients to buy as much liability coverage as they can afford. To increase the standard limit of $300,000 to $500,000 would cost about $20 annually, says Rupp.
Overlay your homeowners coverage with an umbrella policy providing at least another $1 million of liability protection. To determine your premium, insurers will assess your exposure to risk, including the number of homes you own (and their location), as well as your vehicles and whether you have young drivers in your family. The deeper your pockets and the higher your profile—are you likely to be quoted in the media or do you sit on a nonprofit board?—the greater your need for coverage.
You can get a $1-million umbrella policy for about $150 to $300 annually. The next $1 million of coverage will cost about $75; each $1 million after that, about $50. Before insurers sell you an umbrella policy, most will want you to have a minimum of $250,000 of liability coverage on your auto policy and $300,000 on your homeowners insurance, and they may require you to buy both policies from them.