How Much Homeowners Insurance Coverage Should You Buy?
Last updated in November 2015
It is important to obtain an accurate estimate of your home’s replacement cost, which will be used to determine how much dwelling insurance you need to buy. The replacement value of your home is not the same as its market value. Your home’s market value includes the value of the land the home sits on and the cost of your home’s foundation—two expensive components of your home’s market value that don’t need to be insured since a fire or windstorm is unlikely to ruin your lot or your foundation.
Instead, replacement value is calculated using construction costs; it’s an estimate of what it would cost to rebuild your house completely on the land that you own. Make sure that insurance quotes you receive from agents are based on replacement cost; many unscrupulous insurance agents try to sell customers too much insurance by basing dwelling coverage on their homes’ full market value.
To determine replacement cost, most insurance companies provide an appraisal when you take out your policy. Replacement costs are usually estimated by multiplying the square footage of your house by the average construction costs per square foot in your area, and then factoring in features of your home that may be costly to replace—top-of-the-line appliances, wood flooring, or marble tile, for example. Some companies routinely dispatch appraisers for on-site inspections; others calculate replacement costs based on surveys and tax records.
Unfortunately, it appears that it is a challenge for many insurance companies to estimate replacement costs accurately. Checkbook's shoppers were regularly quoted widely disparate replacement costs for the same house—from under $300,000 to more than $550,000 for one sample home.
This imprecision is troubling for two reasons: When you overinsure your house, you pay for coverage you don’t need and could never make claims on; worse, if you underinsure, you will not be fully covered in the event of a total loss. If, for example, your home is insured for $300,000 and burns to the ground and it costs $400,000 to rebuild it, the most you will receive from your insurer is $300,000—even if the insurer estimated your replacement cost at $400,000.
Because in the last few decades construction costs have risen far faster than the rate of inflation, and because neither insurance companies nor policyholders have kept replacement costs up to date, far too many U.S. policyholders maintain too little insurance for their homes. It is estimated that over half of U.S. homes are underinsured, by an average of more than 20 percent.
But you can take steps to ensure your home isn’t underinsured—
- Purchase a guaranteed replacement cost provision. Under this provision, the insurance company agrees to rebuild or replace your dwelling regardless of the expense, even if it exceeds the limit of your policy. To get this guarantee, you must accept annual premium hikes that account for increased construction costs.
- Purchase extended dwelling coverage. Rather than offering guaranteed replacement cost provisions, most insurers now offer “extended replacement cost” or “additional replacement cost” limits, which provide a cushion by increasing dwelling coverage by 20 or 25 percent above the dwelling coverage limit on the policy. Some insurers automatically include a certain level of extended dwelling coverage; others allow their customers to decide how much extra coverage to buy. Usually, if your policy has an extended dwelling coverage provision, you’ll have to accept annual dwelling coverage increases—and higher premiums.
- Sign up for an inflation-guard endorsement. All insurers offer an inflation provision that automatically increases dwelling coverage each year based on inflation or increases in construction costs. Some insurers include this provision at no cost, some offer a discount if you take it, and some charge a $10 to $30 annual fee.
- Have your home regularly appraised. Although it is ultimately your responsibility to buy enough insurance to fully cover your home, you will at least be in a position to argue for proper compensation in the event of a total loss if your home is appraised on a regular basis—especially if the insurer conducts the appraisal. Every few years, ask your insurer to re-estimate your home’s replacement cost and adjust your dwelling coverage accordingly. You may as well ask several other companies to provide appraisals and quote insurance rates to make sure you can’t save significantly by switching.
- Promptly report improvements you make to your home. If you add a room or a deck, remodel a bathroom or kitchen, or finish your basement, increase your dwelling coverage accordingly.
Ordinance and Law Coverage
Even if you do what is necessary to cover your house for full replacement cost there is, unfortunately, still a loophole. Many insurance policies stipulate that coverage is for rebuilding the home exactly as it was, not as it should be. This stipulation may be a problem if codes for proper plumbing and electrical fixtures, roofing materials, or stairway construction have changed since your home was built. Depending on your policy, and whether you can get a waiver from your local government, your insurance company may not be responsible for covering the cost of rebuilding your home to the standards required by current codes.
To close this loophole, insurance companies offer clients “ordinance and law coverage,” which calls for the insurance company to pay more than the cost of replacement if complying with current codes makes such expense necessary. This coverage usually is limited to an increase in the company’s liability by 10 percent above what it otherwise would be. Some companies include this coverage for no additional premium; others charge about $10 to $60 for it.
Personal Property Coverage
Homeowners insurance policies typically cover your belongings for 50 or 75 percent of the amount for which you insure your dwelling. If your dwelling coverage compensates you for losses up to $300,000, and your personal property coverage is for 50 percent, your personal property will be covered for losses up to $150,000. You are entitled under Minnesota law to request a coverage limit lower than the standard limit—at a reduced premium—if you choose. But if you take out a policy with a personal property replacement cost provision (discussed below) the law does not apply, and insurers can set a higher minimum coverage limit.
Personal property insurance covers your possessions, whether they are at home or away. In most cases, the only specifically excluded items are pets, cars, and airplanes, but check what is excluded under any policy you are considering.
Personal property is protected against only named perils. Earthquakes, war, floods, and other perils excluded from coverage on your dwelling are also excluded from personal property coverage. In addition, accidental losses that would be covered on your dwelling under the popular HO-3 policy form are not covered for personal property. For example, if you accidentally spill paint on your brand-new leather sofa, or drop your fancy flat-screen TV while trying to mount it on the wall, the loss is not covered. Nor are you covered if you drop your wedding ring in a lake or a power surge knocks out your computer. You can insure your personal property against accidental losses by buying a special provision to an HO-3 policy or buying an HO-5 policy, but these policies are more expensive.
Another difference between personal property coverage and coverage on the dwelling structure is in the way your reimbursement is calculated. Standard homeowners policies cover personal property at actual cash value—replacement cost minus depreciation. If a bike you bought six years ago for $400 is stolen, you might be reimbursed only $200, not the $500 you’d pay for a comparable new model. If you were to lose several items in a burglary or fire, your disappointment in your insurance company’s payout might be rather grave.
For an extra premium, most insurance companies offer a special provision that will change your policy to cover full replacement cost of personal property. If your bicycle will cost $500 to replace, that’s what you’ll get (less your deductible) to replace it. Policies written under the HO-5 policy form automatically include replacement cost provisions for personal property. This extra coverage usually adds 10 to 15 percent to the cost of the policy—although a few companies provide this enhanced coverage for no extra fee.
All policies limit payouts for certain categories of personal property losses. Typical limits include:
- $1,000 to $1,500 for jewelry, watches, furs, and precious and semiprecious stones.
- $1,000 to $5,000 for computers.
- $200 for money, bank notes, bullion, gold other than goldware, silver other than silverware, platinum, and coins.
- $1,000 to $1,500 for securities, accounts, deeds, evidences of debt, letters of credit, notes other than bank notes, manuscripts, passports, tickets, and stamps.
- $1,000 to $1,500 for watercraft, including their trailers, furnishings, equipment, and outboard motors.
- $1,000 to $1,500 for trailers not used with watercraft.
- $2,000 to $2,500 for firearms.
- $2,500 for silverware, silver-plated ware, goldware, gold-plated ware, and pewterware.
- $2,500 for property used for business purposes.
Companies sometimes impose similar coverage limits on works of art, antiques, musical instruments, and cameras. Carefully review policies for any limits that may leave your coverage short.
To insure items worth more than these special limits, consider buying additional coverage either by paying to increase the category limit or buying a personal-articles floater for them.
To determine how much coverage you need—and to create a record of what you own—take an inventory of all your possessions. Go room by room and through each drawer, recording each item individually, making note of prices paid, approximate dates of purchase, and model numbers. To aid you in this task, most insurance agents will provide an inventory form. It is also a good idea to take pictures or videos of each room in your house from different angles to capture every item. Lay drawers out on the floor and take a picture of the contents. When you have finished your inventory, store a copy in a safe place away from your house.
Additional Coverage for Other Losses
As mentioned previously, standard homeowners insurance policies automatically include coverage for several other loss categories—
- “Other structures” coverage insures all structures on your property that are not attached to your house, such as gazebos or freestanding garages. Policies usually include coverage limits for an amount equal to 10 to 30 percent of your dwelling coverage. The coverage does not apply to structures used for business purposes.
- “Loss of use” coverage pays for extra living expenses you incur as a result of being forced out of your house by a covered peril. Many policies include loss of use coverage for up to 30 percent of the value of the dwelling coverage, but some insurers have higher, or even unlimited, loss of use coverage built into their basic policies.
Liability coverage protects you from claims by others for injuries or property damage for which you, members of your family, your pets, or hazards on your property are at fault. Under this coverage, your insurance company will hire legal representation to defend you and pay damages if you are found liable. Your policy won’t cover injuries or property damage caused by business pursuits or automobile accidents (the liability coverage in your automobile policy covers this). Without adequate liability coverage, your home, savings, and future income are vulnerable.
The basic liability insurance limit in most policies is $300,000, but you can purchase additional coverage inexpensively. Most insurers offer increased liability coverage at $500,000 for an additional premium of only about $10 to $25 per year. Most consumers consider these extra costs a bargain for increased peace of mind.
If you want to protect yourself from claims in excess of $500,000, consider an “umbrella” policy, which provides liability protection in addition to what your homeowners and automobile insurance provide. Umbrella policies are generally available in million-dollar increments; they typically cost about $100 for the first million dollars in coverage, then less for additional millions.
In addition to protecting you from liability claims, an umbrella policy protects you against suits for libel, slander, defamation of character, false arrest, invasion of privacy, and other claims not covered by your homeowners policy. Before selling an umbrella policy, many insurance companies require you to increase the liability coverage in your homeowners and automobile policies to the maximum amount offered.
Medical Payments Coverage
In addition to general liability coverage, homeowners policies include provisions for payment of medical expenses incurred by people outside your family for injuries that occur on your property or are caused by members of your family residing with you, your pets, or your domestic employees. Unlike liability claims, claims under the medical payments provision will be paid even if you would not be legally liable. If a guest drops an object and injures his or her foot while in your home, for example, medical payments will be provided, even though the injury is the guest’s fault. Keep in mind that medical payments coverage is usually limited to $1,000 or $2,000 per person unless you pay extra for an increased limit.
Should You Add Identity Theft Coverage to Your Policy?
Most insurers now offer identity theft coverage. Some include coverage with their standard homeowners insurance policies, but most charge extra for it.
Unless your insurer includes identity theft coverage in its standard policy for free, we do not generally recommend purchasing it, since the premiums for these policies are high compared to the potential losses.
It is important to recognize that identity theft insurance does not promise to clear your credit history and record for you; it merely covers the expenses you incur to do so on your own. Although millions of Americans are victims of identity theft each year, the average out-of-pocket cost to remedy the effects of the crime is well under $1,000, and many pay nothing.
Most of the damages inflicted by identity theft are not out-of-pocket, measurable costs, but rather the time and effort you have to devote to repairing the damage. Although some identity theft policies compensate policyholders for lost wages (with claims usually limited to $2,000), in reality most consumers can’t take unpaid leave to clear up their credit record and don’t file claims for lost wages.
Another reason to forgo special identity theft coverage is that you may be able to get a similar policy for free from another source. Many banking institutions, including credit card banks, offer identity theft protection for free. Also, you already have some protection from fraudulent credit card charges—the most common form of identity theft injury—under the federal Fair Credit Billing Act, which stipulates that victims aren’t responsible for fraudulent charges of more than $50 per card.