Remember when you bought your home? Among the reams of paperwork to sign, you had to provide various insurance coverages on the home before you’re allowed to close on your loan. Title insurance, to make sure that you have no problems with unknown liens or encumbrances on the property was included in the cost. Private mortgage insurance is normally required to protect the lender in the event of default. Then there’s Homeowner’s Insurance.
Commonly referred to as “hazard” insurance, homeowner’s insurance is required by the lender to protect their interest in the property in the event of loss to the home. While the lender obtains some protections under the policy, the primary purpose of the policy is to protect the insureds under the contract. All homeowner’s policies have certain things in common, such as protection for the house and other buildings on the property, the contents of the house, personal liability coverage and a host of other protections. The purpose of this article is to explore the more prominent areas of a policy and what it does for those in your home.
There are many different types of homeowner’s insurance policies, but we’re going to concentrate on the most common policy used for those purchasing homes today, the “Homeowner’s Special Form 3,” commonly called the “HO-3.” Insurance policies like to use letters and number a lot- there’s also HO-2, HO-4, HO-5, HO-6 and HO-8 policies. They’re all intended for different types of homes and occupancies, with the HO-4 being intended for renters and the HO-6 for condominium buyers. The HO-3 we’ll discuss is intended for those who purchase 1-4 unit family homes and provides a high level of coverage in the primary policy. The policy also offers many ways to alter, or “endorse” the policy to meet individual homeowner’s needs.
The HO-3 provides a package of coverages in one policy without the need for many additions or “endorsements.” Mentioned earlier, insurers like to use numbers and letters in their policies, and continue that practice when describing the coverage granted in the policy. While insurers have subtle differences in their policies, most conform to standards set in the industry and all conform to legal requirements in their respective states. Let’s start with the letters.
The property coverage in the policy, known as “Section I,” is broken into four sections:
- Coverage A: Dwelling
- Coverage B: Other (Appurtenant) Structures
- Coverage C: Unscheduled Personal Property (UPP)
- Coverage D: Additional Living Expenses/Fair-Rental Value
Here’s how Section I: Property works:
“Coverage A” is insurance-ese for coverage on the dwelling itself and just about everything that’s attached to it, like a garage, and everything that’s permanently attached in the house itself, like paneling or wood floors. The amount of coverage on the dwelling is the basis for the amount of coverage on the other protections in the policy, which we’ll discuss later. The HO-3 provides what’s known as “open-peril” coverage for Coverage A; a broad level of protection that covers the home for most losses that would typically occur.
“Coverage B” is protection for the “other” or “appurtenant” structures on your property that are separated from the main dwelling, like a detached garage, a permanent shed in the back yard or a built-in swimming pool. Unless endorsed to a higher level of coverage, the base policy will provide protection under Coverage B equal to 10% of that granted under Coverage A and also provides open-peril coverage.
“Coverage C” is the part of the policy that protects your personal property, and is known as “Unscheduled Personal Property.” Most agents just call it “contents” coverage. This protects all of your personal property up to the limit described in the policy. While the basic HO-3 provides coverage equal to 50% of the Coverage A limit, most policies these days are endorsed to protect personal property on a “replacement cost” basis loss settlement, which takes the place of an “Actual Cash Value” based loss settlement (discussed later). This endorsement automatically “ups” this amount of coverage to 70% of the Coverage A amount.
Coverage C losses are covered differently than those under Coverage A or B. Personal property losses are covered on a “Named-Perils” basis instead of on an “Open-Perils” basis. This will be looked at in a moment. It’s also important to know that the contents coverage granted under the basic contract has limits on what the policy will pay for losses to certain property, like jewelry, coins, stamps, tools, firearms, sterling silver and other things. Additional amounts of protection can be purchased for these items for, of course, additional premium.
“Coverage D” takes care of a couple of things, depending on your situation. Coverage D is known as “Additional Living Expenses/Fair-Rental Value.” It will pay for any additional expenses that the insured incurs due to a covered loss that required him to temporarily move out of the home while repairs are being made. For example, if your home suffered a fire and was uninhabitable while being repaired, the policy would pay for expenses incurred that were over-and-above the your normal living expenses. It pays until the home can be lived in again (with other certain limits) and the amount of coverage granted is normally 20% of that provided in Coverage A.
If the dwelling is a multi-family home, say a duplex, the policy can provide for payment of the fair-rental value that’s lost due to the rental portion being uninhabited while repairs are being made. The insured is limited to 20% of Coverage A including fair-rental. It won’t pay, for example “40%” of Coverage A for your living portion and your renter’s living portion.
Here’s an example of how a basic policy would provide coverage without any changes or endorsements to the contract:
- Coverage A: Dwelling: $300,00
- Coverage B: Other (Appurtenant) Structures: $ 30,000
- Coverage C: Unscheduled Personal Property: $150,000*
- Coverage D: Add’l Living Expense/Fair Rental Value: $ 60,000
*If the policy is endorsed for Replacement Cost on Coverage C, the coverage amount would be increased to $210,000 (70% of Coverage A).
Open-Peril vs. Named-Peril Coverage
The HO-3 policy gives the insured open-peril coverage on the primary dwelling and other buildings located on the “residence premises.” This means that all losses that occur would be covered under Coverage A and B, except for those losses that are specifically excluded by the policy. Don’t get the idea that everything that can happen to the buildings would be covered, that isn’t the case at all. Many agents refer to this scope of coverage as “all-risk” coverage which gives the insured the impression that everything’s covered. That’s a big mistake- there isn’t a policy out there that covers anything and everything that could possibly happen. Many things are excluded and it’s important to review your policy carefully under the “exclusions” section to see your policy’s specifics. Policies are widely consistent and typically conform to industry standards and norms.
Coverage C does not have open-peril coverage; instead it has “named-peril” coverage. Losses would be covered only if the cause of the loss, or “peril” was specifically named in the policy. Since the policies have been heavily standardized in the industry, your policy will likely cover a host of perils, including what most people worry about- fire, theft, wind and other natural disasters, and many others potential losses. Every policy lists the perils that are covered in the policy under Coverage C.
As mentioned earlier, no policy covers everything that can happen. A couple of very important things that are not covered by the HO-3 policy are flood and earthquake losses. Flood insurance is only available through a separate policy which most agents should be able to procure for you, and the HO-3 policy can be endorsed to cover earthquake.
Replacement Cost (R/C) vs. Actual Cash Value (ACV)
Replacement Cost
When insuring your home, the insurance agent should make sure that the amount of coverage that’s placed on the home is for the replacement cost of the home and not the purchase price. Insurers use “construction estimators” that assist the agent in determining what the home would cost if it had to be rebuilt. It’s important to consider the premium cost when placing insurance on your home, but not at the expense of the proper amount of coverage. Replacement cost coverage will provide for the current cost of construction, using like kind and quality materials, in the event of a covered loss.
There’s another reason to have your home fully insured. Homeowner’s policies, like most property policies, have a funny little condition known as “coinsurance.” This condition requires that, in order for the insurer to pay the replacement cost for losses, that the home is insured at least a certain percentage of its replacement cost. If the insurance amount on the home is less than that required percentage, the insured would be penalized by not receiving the replacement cost on any loss settlement. This is why most insurers will insist that you insure the home for its full replacement value, which provides you with replacement coverage in the event you suffer a loss.
Actual Cash Value
Actual Cash Value, or “ACV,” settles losses on a different basis. Instead of considering the replacement cost of an item and paying the loss based on that value, the insurer will pay losses on a depreciated value basis. ACV is determined by taking the replacement cost of a covered item and applying a depreciation factor. For example, let’s say that a burglar stole your flat-panel television. What you paid for the TV is not considered, the insurer will base their settlement on what a “like kind and quality” TV would cost today. We’ll say that the TV costs $800 today and that you owned the television for 2 years prior to the burglary. The depreciation on the TV would be roughly 40%, meaning the ACV on your two-year old would be about $480 ($800 – 40% = $480). Without replacement cost coverage on your property, you would be paid the ACV for that television. Ouch.
This is why you should make sure that your policy covers Coverage C losses on a replacement cost basis. Personal property tends to depreciate rapidly, and remember, if it’s lost in a fire or stolen in a burglary- you have to pay today’s prices to replace your property. Your policy’s declarations page, which is usually the first page of the policy, will state the amounts of coverage in place for Coverage A-D. If your Coverage C is at least 70% of Coverage A, you almost certainly have replacement coverage for your contents. As always, check with your agent to verify.
Finally, one last thing about replacement cost. There’s a condition in the policy that states that you actually have to replace the lost items in order to claim the full replacement cost. The company has the option to pay only the ACV until the repair or replacement is actually completed. The policy will give the insured 180 days to actually repair or replace and claim the balance of the claim. Some insurers are stickier on this than others and a lot depends on the loss.
