Insurance 101

A Short Course in Insurance
by Northsound

Auto Insurance
Flood Insurance
Homeowners Insurance
Identity Theft Insurance
Personal Property Floater
Renters Insurance
Umbrella Insurance

Risk Management
What does credit history have to do with insurance?
Phishing Scams and how to avoid getting hooked
Insurance Crisis looms

Home

Homeowners Insurance

Imagine someone leaning on the railing of a ferry boat taking photographs of the Mukilteo Lighthouse. Suddenly, the camera slips from their fingers and falls into the water below. Would that be covered by their Homeowners insurance? Most polices, no. Some, yes.

Homeowners insurance is a very complicated subject, and probably the most misunderstood part of insurance. In the following, I will try to help you understand this coverage by taking you step by step through the many forms and add-on (endorsements) that make up this form of insurance. I’ll start with some background, and then take you into the basic forms. After you have the broad view of the three basic forms of Homeowners, we will then get into the endorsements, and finally how companies offer variations on these contracts.

The Start

The standard Homeowners polices include the perils of fire, lightning, tornados, windstorm, hail, plus those listed below, which can meet the requirements of a mortgage company, but do not include dropping cameras in saltwater. Can you insure your property to cover those things that “fall into the cracks”? Yes. It is what people in the insurance business call “all-risk” policy forms. It is not that complicated. If you read on, you will get a better understanding of how this works, how to get the type of policy that is best for you,

Some background information

Not too many years ago, the only thing that was available to a homeowner was fire insurance. Later, the home owners were able to get windstorm and hail coverage. After World War II, fire insurance was extended to personal belonging. About that time, you could add liability coverage by buying a separate policy known as Comprehensive Personal Liability. When the Homeowners policy was created, it combined the property part with the liability part. The policy continued to evolve to become what we have today; a very comprehensive form that covers the dwelling, contents on and off the premises, detached buildings, loss of use, and personal liability.

Homeowners insurance is designed to bring your home and possessions back to the same condition they were in before a loss occurred providing they have the perils listed in their policy. The word peril, when used in an insurance policy, defines what causes of loss the insurance company will pay. If an airplane or one of its parts falls on your home, it is a covered loss because Aircraft has been defined in the policy.

There are several different types of Homeowners policies offered by insurance companies and not all coverages are the same. You should speak directly with an independent agent – preferably us - about your specific coverage needs.

While reading through the information below, you should keep in mind a couple definitions: (a) Exclusions are situations where your policy does not provide coverage; and (b) Liability is something for which you are legally responsible. Personal Property is everything you own except the house and detached buildings. Insurance companies don’t refer to your home, they call it the dwelling. Premises is the property where your home is. So, you can see that when a policy mentions the dwelling is not the same as your premises. Why is this so complicated? It is because the courts had made ruling over the years that have caused the insurance companies to take out as much ambiguity as possible.

Homeowners Forms: Basic, Broad, Special and Comprehensive.

That’s right, four different forms of insurance plus Renters and Condo Owners.

Covered perils

Within these four forms are the many variations of coverage used by each company, but they all will contain the following:.

The Basic Homeowners (HO-1) policy provides protection from the following perils:

• fire or lightning
• windstorm or hail
• explosion
• aircraft
• vehicles
• riot or civil commotion
• smoke
• theft
• vandalism/malicious mischief
• glass breakage
• volcanic eruption.

The Broad Form Homeowners (HO-2) policy also provides coverage for:

• falling objects
• weight of ice, snow or sleet
• freezing of plumbing
• accidental plumbing discharge
• rupture of steam or hot water heating system, air conditioning systems, or water heaters
• damage from artificially generated electricity.

The Special Form (HO-3) of Homeowners does not list perils on the dwelling. Instead, it simply reads, “Direct physical loss”, but remember, that coverage only applies to the dwelling. Unless it is specifically excluded, any loss to the dwelling is covered. The contents coverage remains named perils. We used to call this an all-risk policy. We no longer use that term because the courts ruled that it implies that any risk is covered, including the content or Personal Property of the insured, which makes it confusing for the consumer.

There is the fourth form that is rarely used by insurance companies. It is called the Comprehensive Form (HO-5). In this form, the contents (personal property) are also covered for “Direct physical loss”. It is with this form that the camera incident above would be covered. This is the form we recommend for the more affluent clients who have fine arts and valuable personal property. The broader coverage assures loss or damage to expensive items that would have limited coverage under the three previous forms. See more about this form under Personal Property (Coverage C).

Four of the insurance companies we insure through offer the HO-5; Austin Mutual, Encompass, The Hartford, and Safeco, however Safeco restricts it to the higher value homes with replacement costs over $500,000)..

There is a fifth form known as the HO-8, but is used rarely, not available in many states, or acceptable to lenders. It is very basic coverage.

Depreciation vs. Replacement Cost

Replacement cost is a relatively new concept for the insurance industry. Historically, the insurance industry did not want to insure anything that could cause the insured to gain from the loss. It is very important to have this provision (endorsement) because if the purpose of insurance is to bring you back to where you were before the loss (indemnity), then Actual Cash Value (depreciated value) will not do that. Today, it is common to have replacement cost provisions on both the dwelling and contents. To complicate matters, not all dwelling Replacement Cost endorsements are alike. Some will replace up to the limit shown on the declaration page. Others will cap out a 125% of that value, and others are unlimited.

Declaration Pages

This is the part of the policy that shows the limits the company will pay on your property and the liability limits. I insert this here because the policy forms only describe coverage, but not the values.

Dwelling (referred to as Coverage A in the policy)

Imagine your house on moving day...empty, waiting to be filled. This is the part referred to as Coverage A: your physical home (rooms, fireplaces, tile floors, drapes, carpeting, or anything that is permanently attached) and the structures attached to it, such as an attached garage.

The amount of coverage assigned to your dwelling should reflect the amount it would cost to completely repair or rebuild your home should it suffer a covered loss. Often this is determined by the cost per square foot. The quality of construction and size of your home are the prime factors. What is not considered is the real estate value or the tax assessor’s value. These values are determined by the market and the location of the home. Beachfront homes are more valuable, but may not cost any more to rebuild than one that is inland. If it's been a while since you last updated your policy coverage or if you are not sure that your dwelling is adequately covered, you should talk to us. We have software programs that do an excellent job of evaluating.

Other structures (Coverage B)

Not all structures that exist on your property are actually attached to your house. Therefore, Coverage B offers insurance protection for other structures such as a detached garage, gazebo, or storage shed. Most polices apply 10% of the home value to detached structure. You can increase this value if you have a barn or costly greenhouse. There are a few companies who do not have this limitation. You can also increase this value if you have a barn or shop that will cost more than ten percent of the house value.

Personal property (Coverage C)

Your personal possessions such as furniture, clothing and appliances are covered. Certain types of possessions are excluded or have limited coverage on the Basic, Broad or Special forms. This is probably the most misunderstood part of the Homeowners policy. The limitations on the above policy forms range from $200 on money to $2,500 on silverware. That is not much when there is more valuable property. The Comprehensive form usually has higher limits on these items. That is covered in more detail below under Personal Property limitations. The important part here is that common household goods are covered adequately, but the valuable things like jewelry, coin collections, valuable papers, firearms or business property can have severe limitations.

Some companies still have this limit at 50% of the dwelling value. Others are at 70%, and some at 100%.

There are insurance companies that include the loss of computers and the cost to reconstruct data. The can be an expensive task. Most of them do not.

Loss of use (Coverage D)

The coverage is also called Additional Living Expense. Essentially, this pays for your housing and other living expenses (like meals and laundry) if a major loss makes your house uninhabitable, and you have to move out temporarily while it's being repaired. Some companies pay up to 20% of the dwelling value, and still other pay the fair rental value. This is an interesting part of the policy. If there is a fire that makes the home unlivable, you may rent a house that has the same value as your home, but you may not! If your home would cost $2,000 to rent, but you rented a temporary place for $1,000, you would expect the company to pay that rental cost. They would, but some policies will pay you $2,000 because that is the rental value of your home.

Exclusions

A Homeowners policy does not provide coverage for the following perils:

• loss due to flood (see; Flood Insurance), or water that backs up through sewers. Some companies do include this without cost. Other allow you to add it as an endorsement.
• loss by earthquake, aftershocks and mud slides (But you can get it added.)
• loss by enforcement ordinance or law regulating construction, repair or demolition, or zoning. Again, some companies offer this without cost.
• loss due to power interruption when the interruption takes place off the residence property, although some do cover this.
• loss due to neglect of the insured to save and preserve property following a loss
• war and nuclear perils – always!
• intentional loss except in cases of domestic violence.

Limits of liability

For basic Homeowners policies, a specific minimum amount of coverage is required for each of the major property coverages, based on the primary amount of insurance selected.

• Coverage A (Dwelling) = Primary limit
• Coverage B (Other Structures) = 10% of Coverage A limit
• Coverage C (Personal Property) = 50% of Coverage A limit
• Coverage D (Loss of use) = 20% of Coverage A limit.

Personal property limits of coverage

Certain classes of property have specialized limits of coverage. The standard limits are:

• money or related property, coins and precious metals other than tableware, $200
• securities, manuscripts, and other valuable property, $1,000
• water craft, including trailers and equipment, $1,000
• trailers, $1,000
• loss by theft of jewelry, watches, furs and semi-precious stones, $1,000
• loss by theft of firearms, $2,000
• loss by theft of silverware, goldware or pewterware, $2,500
• property on the residence premises used for business purposes, $2,500
• property away from residence premises used for business purposes, $250.

Some companies have much higher limits. The better forms from several companies will show up to $10,000 on Furs, Jewelry, Silverware - $$5,000 on Firearms - $10,000 on Business Property, and $1,000 on cash.

Territorial Limits

This applies to your personal property. I insert this here because it may be important to know that most companies insure you personal thing only in the USA, or sometime Canada. Other companies offer world-wide coverage. If you never leave this country, it is unimportant. Some companies have a limit of 5% off-premises (note that premises is used here not dwelling, so things in the greenhouse are on-premises). The 5% limitation can be a real problem if you have stored things in a self-storage unit, or in a motorhome stored off-premises. Some companies have no limitation on off-premises goods.

Deductibles

With a Homeowners policy, a deductible applies to the property portion of the policy. A deductible is the amount you would have to pay out of your own pocket before the insurance coverage kicks in. Typical deductibles are $100, $250, $500 or higher and some policies have several deductibles that apply to different things. The higher the deductible you select, the lower your premium. We recommend that you have the highest deductible you can tolerate. There are good reasons for this. First, your premium is less, and second because turning in small claims will affect your ability to get preferred policy forms and rates, and could cause a non-renewal of your policy. It may come as a surprise to most that if you have a water damage claim of any amount, the insurance companies will likely non-renew that policy.

Optional coverages

There are a number of optional coverages (also called endorsements) which enhance your basic Homeowners policy either by adding or removing certain coverages. Some companies make these coverages a part of their policy form and do not charge extra premium. This is another area of insurance that makes it difficult for consumers. When people get a quote on your home insurance, few of them will know what questions to ask. If you are an informed buyer, you may ask if the policy is a Special Form, but to ask about the many endorsements that broaden the coverage is beyond the ability of most buyers.

Some of the more common add-on coverages include:

Broadened coverage for contents: provides "all-risk" protection for your possessions. This means that your personal property is covered in most situations, regardless of the cause of loss. It would seem that by adding this endorsement you could make a Special Form into a Comprehensive Form, but that is not the case even though you now have “all-risk” coverage on home and contents, it is still not as broad as the Comprehensive from offers.

Contents replacement cost coverage: after a loss, you would be paid based on the replacement cost...with no deduction for depreciation...subject to your policy limits and deductible. Most companies offer this, but some do not. Others include it in their policies. This does not apply to things that you have placed on a Personal Property Floater. If you declare that a set of silver is worth $10,000, but on the date that it is stolen the price is $12,000, you are out of luck. $10,000 is what they will pay. This endorsement can be a built-in provision of some policies.

Scheduled Personal Property: provides higher limits and worldwide protection for special property such as jewelry, silverware, fine art, furs, cameras, firearms, musical instruments, and home computers for an extended variety of losses. This is often written on an “all-risk” form, which includes flood, or sinking. Some companies write this as a separate policy. This type of insurance is referred to as “floater” or Inland Marine. Please read the mini-course on Personal Property Floaters if you want a more detail description of this coverage

Water back up of sewers or drains: you're covered for a specific dollar amount if water backs up through a sewer or drain, or overflows from a sump pump. This is not included in the standard policy, but many companies build this into their policies or offer this endorsement as an extra charge.

Building Ordinance or Law: This means that if your home has to be rebuilt to current building code standard, there will be extra costs and basic policies will pay that cost. Most standard polices may pay the replacement costs of what exists, but will not pay the extra costs of meeting building codes. It should be noted that any house that is more than five years old does not meet building codes. This can be very costly. Some companies include this coverage as part of the policy.

This concludes the property part of the policy. Before I finish, I should tell you more, but I don’t want to leave you too confused. Although you now have a better idea of how these types of policies are made up, there is also the little parts of the policy that makes a difference in coverage. One company, Encompass, has a policy they call the Elite form that is different from all of the others, although Safeco’s Quality Crest comes close. It has more stuff in it than most people can imagine, and it is competitively priced. It has up to $20,000 for Mortgage Extra Expense. Those works when people have a 5% loan but have to rebuild after a loss when the interest rates at a 8%. They also have no limit on Additional Living expense, Building Ordinance or Law, Computers, Fine Arts Breakage. They also cover land restoration up to 10% of the dwelling value. They have up to $50,000 for Loss Assessments (That applies when a homeowners association assesses you), and $20,000 for Identity Theft.

With the above information, I hope you can now understand why it is difficult to explain to someone that the premium on the Encompass policy is higher than the policy their escrow company ordered when they bought their home.

Personal liability (Coverage E)

Provides coverage for bodily injury or property damage for which you are legally responsible. For example, let's say your dog bites someone, a guest falls down your front stairs, or your son throws a ball through your neighbor's window. You are legally responsible for these actions. Personal Liability helps to cover the associated costs of these related damages.

Most homeowner policies provide a minimum of $100,000 of liability protection. However, you can opt to increase this amount. Look at the mini-course on Personal Umbrella. It may help you determine whether the liability limits available on your Homeowners policy are sufficient for your needs. We recommend about four times your net worth.

Medical payments (Coverage F)

Pays all reasonable and necessary medical expenses for a period of three years from the date of an accident to a person or persons injured while on your property. This coverage does not apply to the insured or regular residents of the insured's household.

Bodily injury

Accidents do happen...and sometimes they happen to other people while at your home, or by a member of your household. This coverage helps to pay for the expenses created in the event that a physical injury to others is caused by you, residents of your household, or your pets.

Property damage

If someone's property is accidentally damaged by you, members of your household, or your pets, your Homeowners policy will help to repair or replace it.

Liability coverage exclusions

A Homeowners policy does not provide coverage for:

• bodily injury or property damage which is expected or intended by the insured
• bodily injury or property damage arising out of business pursuits
• bodily injury or property damage arising out of rental of any part of the premises
• liability arising out of ownership, maintenance, use, loading or unloading of aircraft, motor vehicles or water craft
• liability arising out of war or insurrection.

Additional exclusions to Coverage E only:

• liability assumed under contract or agreement
• property damage to property owned by, used by or in the care of the insured
• bodily injury which is covered under a Workers Compensation policy.

Umbrella or excess liability coverage

Umbrella or excess liability coverage provides liability coverage over and above what's covered by your auto, homeowners or other policy for personal liability and lawsuits. Such coverage can be purchased as an attachment to your policy or as a separate policy. Our Personal Umbrella mini-course provides much more information on this important protection. Or you can call us.

Summary:

Not all policies are alike! Some provide world-wide coverage. Some have built-in provisions for high value items. Some have guaranteed replacement cost regardless of what it costs to replace. Hopefully, after reading the above, you have a better idea of what to look for when buying a Homeowners policy. I would like to add another twist that may seem illogical. One of the companies, Encompass, offers both the Special Form and the Comprehensive Form, which give much more coverage, and they charge less for the better form. The Hartford does a similar thing. Why would they do that? The answer really is logical. To qualify for the better form, the policyholder must meet higher standards. When credit score is high, there have been no losses, and the value of the home is higher than average, they become better risks.