Homeowners naturally want to spend as little as possible on insurance, but they depend on their policy for sufficient compensation.
However, it is important you understand the details of your policy and align your coverage to your home’s current value. Otherwise, your policy may not cover expensive upgrades, additions, appreciated value, and increased building costs.
Your Home’s Value for Insurance Purposes
The replacement cost of your home is not the fair market value or your mortgage balance. The best way to determine replacement value is through a professional appraisal. Otherwise, you could be over or under-insured.
Additionally, standard homeowner’s insurance policies provide actual cash value coverage to replace your home and personal belongings, not replacement value. Here are the differences.
Actual Cash Value Coverage
Insurers calculate the amount they will reimburse you for a loss, less depreciation. Depreciation is the estimated loss in value due to wear and tear, age, and obsolescence.
While all insurers use their own method to calculate depreciation, typically they estimate the life expectancy of an item, less the number of years you’ve owned it.
For instance, a sofa you bought for $2,000 may have a life expectancy of 10 years. Consequently, it depreciates 10 percent annually (10 years x 10% = 100%).
If you’ve owned the sofa for 3 years, the actual cash value would be 30 percent less than what you originally paid ($2,000 – $600 = $1,400). If you’ve owned it for 10 years, the insurer might not offer you a dime since they consider it depreciated.
Some items may appreciate in value such as jewelry, fine art, firearms, collections and antiques, but unless you have specific coverage for these items they will depreciate too. Additionally, most homeowner’s policies cap the limit for valuable items such as these to about $2,500.
Obviously, this is often a great concern for most homeowners since they usually need to replace the item. The item may cost more than it did originally too, so they pay even more.
If your items have value, the insurance company will offer you a settlement which includes depreciation and ask you to sign off on your claim.
Replacement Cost Coverage
Replacement cost coverage pays for new property of comparable material and quality used for the same purpose when lost, stolen, damaged, or destroyed. Insurers do not deduct depreciation.
Policies are more expensive, but they offer better coverage. You need to provide a detailed list which the insurance company reviews before offering you a settlement. No matter which coverage you choose, you should maintain an accurate home inventory.
Settlements are usually in two parts. First, the insurer pays you the actual cash value of your items so you can start to replace you items. Once replaced, you submit your receipts and the insurer provides final payment for your loss. If it is a large loss, you may replace items gradually and receive multiple payments.
Clearly, receiving these final payments can easily compensate you for the increased cost of your premium. Otherwise, you’ll pay out-of-pocket for depreciation and the increased cost of replacement items.
Don’t assume your homeowner’s policy protects you well. Unless you understand the fine print, you could receive a very small settlement when you need money the most.
Review your policy with your agent. They can provide you with advice and quotes on both levels of coverage so you can make an informed decision.