Home Insurance: Don't Underinsure
Ask a homeowner who lost their home in a disaster if their insurance policy paid enough money to cover their rebuilding costs. Most likely the answer you'll get is "No!"
But most folks have policies issued by good insurance companies. The problem is that most folks don't have enough insurance.
Nearly 6 out of every 10 American homes are under-insured with folks having only enough insurance to pay about 80 percent of the costs to replace or rebuild their homes. This is according to Marshall & Swift/Boeckh . They should know; they are the leading supplier of rebuilding cost estimating software and data to the home insurance industry.
Most people have homeowners insurance that provides "Extended Replacement Coverage", which means that if their home is damaged or destroyed due to a covered peril, their policy will pay out no more than a specified percentage, typically 120 to 125 percent, of the DWELLING LIMIT that is specified in the policy. Unlike Guaranteed Replacement Coverage which is disappearing from new policies, Extended Replacement Coverage will not pay a penny more. The problem with this is that it could cost a lot more to rebuild or replace your home and if your policy limits are not enough you will end up paying the difference.
With the median price of an existing single family home , a homeowner with insurance that covers only 80 percent of rebuilding costs is at risk to pay an additional $32,000 or more, towards the actual replacement cost to rebuild their home.
"Underinsuraning" Can Creep Up on You
Most people buy insurance on their home when they buy the home. The amount of dwelling coverage is typically an estimate of the market price at that time which may or may not be a good starting point. But the mistake many people make is that once they buy home insurance, the only thing they keep up with is paying the premiums. They never read their policy and never revisit the coverage limits to see if their policy is still adequate. This "set it and forget it" thinking is what gets many people into an under-insurance situation. The tragic ending is that most people only find out that they are under-insured after they have a loss and make a claim. Then it's too late to increase the coverage.
What you should do is increase the amount of coverage on your home every few years. Remember, you can't do this when the peril is upon you. Insurance companies generally place a moratorium on coverage changes in areas that are in the path of an incoming wildfire or storm, typically several days before the expected peril is forecast to strike.
Also, you should call your insurance agent to update your coverage when you remodel and improve your home.
And even if you don't make improvements to your home, you can be sure that it will cost more to replace it today versus when you bought it. The reason is the surging price of building materials, energy and labor, all which have increased replacement costs up by over 7 percent a year since 2001. For this reason, many policies offer a rider that automatically adjusts coverage every year by an indexed amount or a set percentage.
And if your home is located in an area prone to severe weather, such as tornadoes or hurricanes, then your rebuilding costs could also be pushed higher by new building codes that protect against wind damage or earthquakes and therefore adding to the costs to rebuild the home.
If you have a home insurance policy that costs $2000 per year but you are under-insured, you could be wasting your money. Instead, increase your dwelling limits and increase your deductible. The savings from raising your deductible can offset the cost of increasing the dwelling coverage.
Check back in a few days when I'll write about what to look out for in your policy and how to determine a reasonable rebuilding cost for your home.
Ray Martin
View all articles by Ray Martin on CBS MoneyWatch»
Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.
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