Homeowners Insurance

The process of buying insurance to protect your home and its contents is similar in many ways to buying auto, disability, and health insurance. The clauses in the policies are filled with unfamiliar jargon, and it can be quite difficult to determine how much coverage you really need. Nevertheless, you should wade through this morass because you need to protect yourself against all forms of disaster that might afflict your home and your possessions.

The primary reason that you buy homeowners insurance is to compensate yourself for property damage or loss. Two sources of damage exist: natural occurrences and man- or equipment-made disasters. Some of the more common natural causes include earthquakes, fire, floods, hurricanes, mudslides, storms, tornados, volcanos, wind, hail, and weight of snow. Losses caused by people or the malfunctioning of equipment include arson, burglary, electrical fires, explosions, riots, theft, vandalism, and water pipe breaks.

Insurers offer two policies to cover these risks: named peril insurance and the all-risk insurance. Named peril coverage protects you against only the specific dangers spelled out in the insurance contract. The perils usually named are fire, wind, hail, riots, smoke, vandalism, and theft, among others. Under this policy, if you have a claim, you must show that the loss or damage was caused by one of the named perils. All-risk insurance, on the other hand, covers almost every possible source of loss or damage except those specifically named, such as floods, earthquake, nuclear war, dry rot, termites and insect damage, and wear and tear. You will need special insurance— for example, from the National Flood Insurance program—to cover those risks. Because the all-risk policy is more comprehensive, its premiums are usually higher than those on a named peril policy covering the same property.

Six basic types of homeowners policies exist, each offering protection against certain losses on both your home’s structure and its contents. They are all labeled HO (which stands for homeowners), followed by a number. The most basic plan is HO-2. The most comprehensive plan, HO-3, is an all-risk policy that also provides special coverages. Policies for renters are labeled HO-4 and for condominium owners, HO-6. If you own an older home, you will need an HO-8 policy.

Both the basic HO-2 policy and the HO-8 policy for older homes protect you against the following specific perils:

  1. Fire or lightning
  2. Windstorm or hail
  3. Explosion
  4. Riot or civil disturbance
  5. Damage from an aircraft
  6. Damage from a vehicle
  7. Smoke damage
  8. Vandalism or malicious mischief
  9. Theft
  10. Breakage of glass that is part of a building
  11. Volcanic eruption. The HO-2, or broad coverage, policy covers all of the perils of an HO-1, as well as the following:
  12. Falling object
  13. Weight of ice, snow, or sleet
  14. Freezing of a plumbing, a heating, or an air-conditioning system, of an automatic fire protective sprinkler system, or of a household appliance
  15. Accidental discharge or overflow of water or steam from a plumbing, a heating, or an air-conditioning system
  16. Sudden and accidental discharge from an artificially generated electric current
  17. Sudden and accidental tearing apart, cracking, burning, or bulging of heating, an air-conditioning, or a protective sprinkler system, or an appliance for heating water. The HO-4 for renters and the HO-6 for condo owners cover the same perils as the HO-2. In addition, these policies cover contents and some structural aspects of an apartment or condominium, such as a wall that is not shared with another unit or separate balcony.

The special homeowners HO-3 policy covers a house for all perils except those explicitly excluded from the contract, such as flood, earthquake, war, nuclear accidents, wear and tear, dry rot, or termite or insect damage. Clearly, because the HO-3 offers the most protection, it costs more than the HO-2 and HO-8, the renter’s HO-4, and the condo owner’s HO-6.

The purpose of homeowners insurance is to replace what has been lost or damaged; therefore, in determining how much coverage to buy, follow the most important rule of homeowners insurance: Buy enough to replace most or all property at risk. Frequently, homeowners insure their homes and the contents of their homes for what they paid for them, perhaps years ago. When these homeowners suffer a loss, they find—to their dismay—that they are reimbursed only for the present market value of the objects, which is usually far less than it cost to replace them. Unless your homeowners policy specifically stipulates that it pays replacement cost, the insurer covers only the actual, depreciated value of the goods. Though you will pay premiums that are 10 or 20 percent higher for replacement cost insurance, the coverage is worth the extra money.

If you cannot afford the premiums on full replacement cost insurance, the least you should settle for is 80 percent replacement cost. Cutting back from 100 percent to 80 percent will slash your premiums by as much as a quarter. However, if you settle for less than 80 percent, you expose yourself to too much financial risk.

Whether you opt for 100 percent or the 80 percent, though, always insist on a clause that indexes your coverage to changes in inflation.

In addition to your regular homeowners coverage, you might want to purchase special insurance, known as a rider or a floater, for particularly valuable artwork, collectibles, silver, furs, jewelry, or other items. Without these riders, you would collect nowhere near their true value if such precious objects were damaged or stolen.

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