Why Your House May Be Underinsured
There are lots of reasons — natural and man-made — to make sure your homeowner's insurance is current, adequate and economical. But chances are, like many Americans, you have little idea or interest in the best way to buy it.
"Most people don’t understand much about homeowner's insurance," says industry veteran Robert Hunter, now director of insurance for the Consumer Federation of America. "They have a strange combination of fear and boredom."
Underscoring that emotional knot is a 2011 Deloitte survey showing 60 percent of the respondents said they never or rarely shopped around when their policy was up for renewal, even though a larger number, 75 percent, said price was either very or extremely influential in decision-making.
Yet you probably should shop around because there's a decent possibility your are under-insured when it comes to replacing your home.
Adding to the confusion, say industry players and consumer advocates, is that some people think the sharp decline in home prices of recent years merits a commensurate reduction in their replacement cost coverage and thus their premium.
"With the market depressed, some people may think they are over-insured," says Christopher Hackett, personal lines policy director at the Property Casualty Insurers Association of America. "There's a difference between the market value of the home and the replacement cost."
"Your home value may have dropped 30-40 percent, but the cost of rebuilding your home that burned down may have gone up 40 percent," adds Scott Mallasee, property casualty staff product director at Nationwide.
That's the least of it, according to industry experts, who attribute the insurance muddle to a variety of factors: insurance regulation (and thus coverage and price) varies by state; consumers rarely research their options and/or comparison shop; and insurance agents omit information or explain it poorly to customers.
"People tend not to understand what the coverage terms mean," says Douglas Heller, executive director of Consumer Watchdog, who maintains that the burden of education and communication is on insurers.
There are essentially two types of property coverage: actual cost value (ACV), and replacement cost, though the language may vary among insurers. Both include contents (up to a point) and related structures, such a fence or unattached garage.
ACV costs less and thus provides a lower coverage ceiling. It covers the cost of the house, essentially on an "as-is" basis, including depreciation of its parts.
The replacement is of a "like kind and like quality," says Hackett, citing the example of a 12-year-old roof, an important part of a house's structure.
Most experts say avoid it, except perhaps during the first year of a new home. "Depreciation happens quickly," adds Heller.
Replacement cost policies are by far the norm, but that's where things can get complicated.
These policies are based on a detailed and complex formula using a number of data sources from specialized subcontractors. This is why insurers ask you all sorts of questions about the size, structure, materials and contents of your house.
"The information collected gets pretty granular," says Hackett. (Think boredom!)
Replacement cost policies exclude depreciation and provides for comparable material and quality.
The average consumer thinks if a fire destroys my house the insurance company will pay to rebuild it," says Heller. "But that’s up to the coverage amount on the policy."
The cost of materials and labor change over time, usually for the worse, based on market forces and inflation.
So does your house, as a result of improvements, renovations and/or additions. Experts say this is just one reason to review and update your policy every couple of years.
Changes in local or state building codes can sometimes add to the cost.
"There are limits on replacement costs," warns Hunter, a former insurance director for the state of Texas, who also worked for insurers.
And this is where the industry divides.
State Farm's basic homeowner's policy is called "limited replacement cost” but includes a cushion of up to 20 percent over the stated cost, according to spokeswoman Holly Anderson.
"If for some reason, building materials go up, we’re going to pay for it," she says. "We’re not saying you need to take out any different coverage."
Other companies' standard replacement policies do not include such extra coverage, and instead charge separately for it, typically in the form of a rider.
Sometimes known as an "enhanced dwelling limit," according to Hackett, the concept varies by company but generally provide an additional 20 percent to 25 percent.
"It's definitely good protection to have," he says.
Nationwide, for instance, has "replacement cost" and "replacement cost plus," according to Mallasee, with the latter costing more.
Mallasee says the issue of inadequate replacement coverage doesn't come up very often these days, citing "diligence by insurers" to make sure "all the elements of the home were captured" properly by the agent interviewing the customer.
Consumer advocates say otherwise.
"Even when you buy these upgrades, it still depends on what their initial number is," warns Heller. "Sometimes that’s not even enough."
Tips for Savings
Hunter says consumers should avoid the riders. "I recommend they shop carefully," he says.
He recommends consumers take an inquisitive and aggressive approach in seeking competitive bidding.
First, they should determine the replacement cost of the home themselves, rather than leave it up to the insurers, which makes it easier to compare coverage and price.
"If you pay $300-$400 you can get an assessment as to what it will cost to replace the house," he says.
Or you can do the research yourself.
Start with the National Association of Insurance Commissioners, which has a map with links to all 50 state regulators. It has a wealth of information, including tables of consumer complaints by type and company.
New Jersey and Texas are among the many states whose insurance regulators have price guides and other tools, such as which companies operate in the state, and the number and kind of complaints for various companies.
There's also information on how to document the contents of your home, such as this inventory checklist, which will help determine coverage value and replacement cost.
These tools and others allow you to shrink your pool of potential insurers, making it easier to compare terms and prices.
"Hopefully you're shopping among the lowest-priced companies," says Hunter. "There could still be a 25 percent price difference. It's not like you have a unit-price guide."