NEW YORK (This Old House) - As many as three-quarters of U.S. homeowners are carrying insurance policies that don't cover replacement cost if a fire or storm levels their house, according to a study released in 2002 by Wisconsin construction-data firm Marshall & Swift/Boeckh.
To make matters worse, those policies are undervalued by more than 35 percent in many cases.
The epidemic of underinsurance is relatively new. Until the mid-1990s, most standard homeowner's policies guaranteed full replacement for the building and at least 50 percent coverage for its basic contents, such as furniture, electronics, and clothing, no matter the extent of the damage or the value of the policy.
In recent years, however, faced with large and unexpected losses from wildfires, hurricanes, and mold, most insurers have abandoned this approach. Now only a few companies provide full-replacement policies, at much higher premiums.
Instead, the typical policy pays out a maximum of 120 percent of the home's assessed value and includes an inflation guard that hikes coverage about 2 percent annually -- not enough to keep pace with construction costs, which have been rising an average of 3.5 percent a year nationwide, according to the Census Bureau.
The boom in remodeling is also bringing insurance policies up short. Americans spent about $200 billion on renovations in 2002. Yet an estimated 60 to 75 percent of homeowners failed to increase their insurance coverage to reflect the improvements, according to the Independent Insurance Agents and Brokers of America.
"In many cases, rising construction costs and renovations have added fifty to one hundred percent to the replacement cost of a home since it was purchased," says Robert Hartwig, chief economist at the Insurance Information Institute. "Yet often the only time people think about their homeowner's insurance is when they first get a mortgage. That's like playing Russian roulette."
Here's how to make sure you have adequate coverage and at the same time keep insurance premiums to a minimum.
Get an Accurate Assessment of Your House's Value
An insurance agent can help you determine the amount of coverage you need, but be wary if the agent simply assesses the value of your home using a formula based on square footage and number of rooms. That's not precise enough.
Replacement costs vary widely depending on where the house is located and the materials used in construction. For example, the average cost of building a house in most parts of Alabama is about $65 a square foot, while in southern California it can run as high as $150 a square foot.
A custom-built home with top-of-the-line materials can cost $200 to $400 a square foot to replace, because plaster walls and hardwood floors are much more expensive than drywall and carpeting.
To make the most accurate appraisal, an agent must thoroughly inspect the house and the neighborhood, and plug the information into home-valuation software that crunches the data against regional variations in labor and materials costs. Remember that the final figure will likely be less than the resale value of the house, because the land the dwelling sits on is not insured.
To double-check your agent's assessment, you can get an independent evaluation by an appraiser, who usually charges between $200 and $300 for this service. A less expensive alternative is to ask a local contractor to provide an estimate of what it would cost to rebuild your home.
If after a thorough assessment you have to ratchet up the insured value of your home, expect premiums to rise between $2 and $4 for each $1,000 increase in coverage.
Increase Your Deductible
Typically, insurance policies carry a $250 deductible -- you pay the first $250 of damage, the insurer pays the rest. But if you can afford to take a bit more of the risk, a larger deductible can significantly reduce the premium.
On average, you can save about 12 percent a year on your homeowner's policy with a $500 deductible, 24 percent with a $1,000 deductible, 30 percent with a $2,500 deductible, and 37 percent with a $5,000 deductible.
Limit Your Liability
If someone slips on your driveway and you aren't adequately insured, it could wipe you out financially. Medical bills and legal fees, if there's a lawsuit involved, can run in the hundreds of thousands of dollars.
For that reason, experts strongly suggest that homeowners not scrimp on liability insurance, which covers the costs of personal injuries and damage to other people's property in or around your house. It's a relatively inexpensive safety net, especially if you have a lot of assets to protect from litigation.
Basic homeowner's policies provide about $100,000 in liability coverage. But increasing coverage to a more practical $1 million will only hike the premium about $40.
Liability protection can be more expensive for people who have potentially dangerous features on their property, such as a swimming pool. In those instances, an umbrella liability policy — a separate rider to basic insurance that covers an individual's home, rental properties, and automobile for $1 million or more — is recommended.
Protect Your Personal Possessions
Homeowner's insurance covers most basic contents of a house, such as furniture, clothing, and electronic equipment, at 50 percent of the value of the policy. Many people opt to increase this to about 70 percent, which has little effect on premiums.
One-of-a-kind possessions like jewelry, artwork, a coin or stamp collection, and similar high-priced articles are also not fully protected by basic homeowner's policies.
Stolen jewelry, for instance, is limited to $1,000 in coverage in most cases. To adequately insure these items, a rider or "floater," which costs about $17 per $1,000 in coverage, must be added to the policy.
"People are usually unaware of the restrictions on reimbursement for valuables in their policies," says William Bland, director of large accounts and personal lines at Insure.com. "And often after they find out, they think that floaters cost too much. But since thefts are more likely to occur than a house being completely burned to the ground, it's foolish not to protect the most expensive contents in the home."
Cover the Cost of Building-Code Compliance
Insuring historic and landmark houses raises a separate set of concerns, but any home that is more than 20 years old has fallen behind the current municipal building codes related to structural design, earthquake or storm protection, wiring, plumbing, and other safety issues.
If the house has to be fully or partially replaced, the cost of improvements required to meet current regulations will most likely not be covered by standard homeowner's insurance. The coverage only replaces what you had. Literally. Check with the local building department to find out whether codes have changed significantly since your home was constructed. If they have, consider purchasing upgrade coverage, sometimes called ordinance and law coverage, which protects against these additional replacement costs for about 8 percent of the annual premium.
Earn Premium Discounts
Even the simplest security and safety measures — deadbolts, basic burglar alarms, and smoke detectors — can bring discounts of 5 percent each from most insurance companies. A more sophisticated home-security network linked to an outside 24-hour monitoring station can cut yearly premiums by as much as 20 percent.
Some insurers offer discounts if no one in the household smokes. In addition, retired homeowners who are at least 55 years old might qualify for as much as a 10 percent reduction in premiums, on the theory that people who are home a lot will spot fires before they do too much damage.
Another area where big discounts are available is roofing. Upgrading to impact-resistant shingles, which can withstand damage from hail and high winds, can shave as much as 27 percent off annual premiums, according to the Federal Alliance for Safe Homes.
Keep Your Policy Current
Assessing your homeowner's policy is not a onetime activity. Insurance experts recommend that you reevaluate your coverage each year when the policy is up for renewal. If you've undertaken a major renovation during the past 12 months, you can increase the value of the insurance, and if you sold a painting or two, you can drop some personal effects coverage.
You may also be able to take advantage of new discount programs for safety equipment or structurally sound materials used in renovations.
Not least of all, an annual insurance checkup may be an opportunity to shop around for a better price through another underwriter. "It takes only a short time to reexamine your insurance needs each year," says the Insurance Information Institute's Hartwig. "And the combination of the savings that can be turned up and the certainty that the coverage is adequate could pay off in a huge way."