Homeowner's Insurance Guide: A Beginner's Overview
Homeowners insurance (also known as home insurance or homeowner insurance) isn't a luxury, it's a necessity. And not just because it protects your home and possessions against damage or theft. Virtually all mortgage companies require borrowers to have insurance coverage for the full or fair value of a property (usually the purchase price) and won't make a loan or finance a residential real estate transaction without proof of it.
You don't even have to "own" your home to need insurance; many landlords require their tenants to have coverage in the shape of renter's insurance. But whether it's required or not, it's smart to have this kind of protection anyway. We'll walk you through the basics of this type of policy. (For a breakdown of basic insurance terminology, check out Understand Your Insurance Contract.)
What a Homeowners' Policy Provides
The elements of a standard homeowners' insurance policy provide that the insurer will cover costs related to:
Damage to the interior or exterior of your house – In the event of damage due to fire, hurricanes, lightning, vandalism or other covered disasters, your insurer will compensate you so that your house can be repaired or even completely rebuilt. Damage that is the result of floods, earthquakes and poor home maintenance is generally not covered and you may require separate riders if want that type of protection. Freestanding garages, sheds or other structures on the property must be covered separately using the same guidelines as for the main house.
For example, a woman wanting to insure her diamond engagement ring would obtain an endorsement to her homeowners' policy in order to prove not only that she owned the ring, but also its value. She would do this by obtaining a formal appraisal of the ring from a jeweler, and then sending the appraisal to the insurance carrier for special notation on the insurance contract. Formal endorsements such as these will help in the claims process and ensure that the homeowner gets the full dollar value of the item if it is lost, stolen or damaged in a disaster. Typical items that are endorsed in addition to jewelry include furs, art works, antiques and collectibles.
Personal liability for damage or injuries caused by you or your family – Liability coverage protects you from lawsuits filed by others. This clause even includes your pets! So, if your dog bites your neighbor Doris, no matter if the bite occurs at your place or hers, your insurer will pay her medical expenses. Or, if your kid breaks her Ming vase, you can file a claim to reimburse her. And if Doris slips on the broken vase pieces and successfully sues for pain and suffering or lost wages, you'll be covered for that, too, just as if someone had been injured on the premises of your home or property. While policies start in the range of $100,000 coverage, experts recommend having at least $300,000 worth of coverage, according to the Insurance Information Institute. For extra protection, a few hundred dollars more in premiums may buy you an extra $1 million or more through an umbrella policy. Note: Off-premises coverage often doesn't apply for those with renter's insurance.
Hotel or house rental while your home is being rebuilt or repaired – It's unlikely, but if you do find yourself in this situation, it will undoubtedly be the best coverage you ever purchased. This part of insurance coverage, known as additional living expenses (ALE), would reimburse you for the rent, hotel room, restaurant meals and other incidental costs you incur while waiting for your home to become habitable again. Before you book a suite at the Ritz-Carlton and order caviar from room service, however, keep in mind that policies impose strict daily and total limits. Of course, you can expand those daily limits if you're willing to pay more in coverage.
Different Types of Coverage
All insurance is definitely not created equal. The least costly homeowners insurance will likely give you the least amount of coverage, and vice versa.
In the U.S. there are eight forms of homeowners insurance that have become standardized in the industry; they range in name from HO-1 through HO-8 and offer various levels of protection depending on the needs of the homeowner, and the type of residence (condos, mobile/manufactured homes and rentals all have their own policies).
There are essentially three levels of coverage:
- Actual cash value – This value covers the house plus the value of your belongings after deducting depreciation (i.e., how much the items are currently worth, not how much you paid for them).
- Replacement cost – This is the actual cash value without the deduction for depreciation, so you would be able to repair or rebuild your home up to the original value.
- Guaranteed (or extended) replacement cost/value – The most comprehensive, this inflation-buffer pays for whatever it costs to repair or build your home – even if it's more than your policy limit. Certain insurers offer extended replacement, meaning it offers more coverage than you purchased, but there is a ceiling; typically, it is 20–25% higher than the limit. Some advisors feel that all homeowners should buy "guaranteed replacement value" policies if they plan to stay in a home for any length of time. Because you don't just enough home insurance to cover the value of your home, you need enough insurance to rebuild your home, preferably at current prices (which probably will have risen since you purchased or built). According to Adam Johnson at QuoteWizard.com, “Often shoppers make the mistake of insuring [a house just] enough to cover the mortgage, but that usually equates to 90% of your home's value. Due to a fluctuating market, it's always a good idea to get coverage for more than your home is worth." The good news is that guaranteed replacement value policies will absorb the increased costs and provide the homeowner with a cushion if construction prices increase.
What Isn't Covered?
While homeowners insurance covers most scenarios where loss could occur, some events are typically excluded from policies, namely natural disasters or other "acts of God" and acts of war.
What if you live in a flood or hurricane area? Or an area with a history of earthquakes? You'll want riders for these, or an extra policy for earthquake insurance or flood insurance. There’s also sewer and drain backup coverage you can add on, and even identity recovery coverage that reimburses you for expenses related to being a victim of identity theft.
How Much Does It Cost?
The average yearly premium cost for U.S. homeowners insurance in 2013 (the latest year for which data is available) was $1,096, according to a 2016 report by the National Association of Insurance Commissioners, but premiums vary widely and depend on multiple factors, including your state. First, of course, price will be determined by how much coverage you buy, a decision you can only make after evaluating the market value of your house, completing a household inventory, and deciding how much liability protection you want.
Other variables that need to be considered include your zip code. If you live in a high-crime area, for example, insurance premiums will be higher. Companies also take into account the size of your house, how close it is to a fire hydrant, the condition of your plumbing, heating and electrical systems, how many claims were filed against the home you're seeking to insure, and even details like your credit score that reflect on how responsible a consumer – and, therefore, a homeowner – you are.
How Are Rates Determined?
So what's the driving force behind rates? According to Noah J. Bank, a licensed insurance broker with The B&G Group, Inc., in Plainview, NY, it's the likelihood a homeowner will file a claim – the insurer's perceived "risk." And to determine risk, home insurance companies give significant consideration to past home insurance claims submitted by the homeowner as well as claims related to that property and the homeowner’s credit. “Claim frequency and severity of the claim play a considerable role is determining rates, especially if there's more than one claim relating to the same issue like water damage, wind storms, etc.,” says Bank.
While insurers are there to pay claims, they're also in it to make money. Insuring a home that has had multiple claims in the past three to seven years, even if a previous owner filed the claim, can bump your home insurance premium into a higher pricing tier. You may not even be eligible for home insurance based on the number of recent past claims filed, says Bank.
Replacement cost and accessibility to resources and labor to rebuild are other major drivers of annual premiums, according to Banks. “How far a home is from the nearest fire station, fire hydrant or source of water for putting out fires; a home's proximity to the coast and its relation to high crime areas or wildfire prone areas are also just a few other pricing considerations.”
Neighborhood, crime rate and building material will all play a part in determining rates, too. And of course, coverage options like deductibles or added riders for art, wine, jewelry, etc., and coverage amount also factor into the size of an annual premium.
“Pricing and eligibility for home insurance can also vary depending on an insurer’s appetite for certain building construction, roof type, condition or age of the home, heating type (if an oil tank is on premise or underground), the proximity to the coast, swimming pool, trampoline, security systems and more,” says Bank.
Depending on the breed, man’s best friend residing at your home can also raise your home insurance rates, says Billy Van Jura, owner, Birchyard LLC, an insurance planning firm and brokerage in Poughkeepsie, NY.
“The condition of your home could also reduce a home insurance company’s interest in providing coverage,” says Van Jura. “A home that’s not well-maintained increases the odds the insurer will pay on a claim for damage.”
Cost-Cutting Insurance Tips
1) Maintain a Security System and Alarms: A burglar alarm that is monitored by a central station, or that is tied directly to a local police station, will help lower the homeowner's annual premiums, perhaps by 5% or more. In order to obtain the discount, the homeowner must typically provide proof of central monitoring in the form of a bill or a contract to the insurance company.
Smoke alarms are another biggie. While standard in most modern houses, installing them in older homes can save the homeowner 10% or more in annual premiums. CO2 detectors, dead-bolt locks, sprinkler systems and in some cases even weatherproofing can also help.
2) Raise Your Deductible: Like health insurance or car insurance, the higher the deductible the homeowner chooses, the lower the annual premiums. However, the problem with selecting a high deductible is that smaller claims/problems such as broken windows or damaged sheetrock from a leaky pipe, which typically will cost only a few hundred dollars to fix, will most likely be absorbed by the homeowner.
3) Look for Multiple Policy Discounts: Many insurance companies give a discount of 10% or more to their customers who maintain other insurance contracts under the same roof (such as auto or health insurance). Consider obtaining a quote for other types of insurance from the same company that provides your homeowners' insurance. You may end up saving on two annual policy premiums.
4) Plan Ahead for Construction: If the homeowner plans to build an addition to the home or another structure adjacent to the home, he or she should consider the materials that will be used. Typically, wood-framed structures (because they are highly flammable) will cost more to insure. Conversely, cement- or steel-framed structures will cost less because it is less likely to succumb to fire or adverse weather conditions.
Another thing that most homeowners should, but often don't, consider is the insurance costs associated with building a swimming pool. In fact, items such as pools and/or other potentially injurious devices (like trampolines) can drive annual homeowners' insurance costs up by 10% or more.
5) Pay Off Your Mortgage: Obviously this is easier said than done, but homeowners that own their residences outright will most likely see their premiums drop. Why? The simple reason is that the insurance company figures that if a place is 100% yours, you'll take better care of it.
6) Make Regular Policy Reviews and Comparisons: No matter what initial price you're quoted, you'll want to do a little comparison shopping, including checking for group coverage options through credit or trade unions, employers, or association memberships. And even after purchasing a policy, investors should, at least once per year, compare the costs of other insurance policies to their own. In addition, they should review their existing policy and make note of any changes that might have occurred that could lower their premiums. For example, perhaps you have disassembled the trampoline, paid off the mortgage, installed a burglar alarm or installed a sophisticated sprinkler system. If this is the case, simply notifying the insurance company of the change(s) and providing proofs in the form of pictures and/or receipts could significantly lower insurance premiums. “Some companies have credits for complete upgrades to plumbing, electric, heat and roof,” says Van Jura.
Loyalty often pays, too. The longer you stay with some companies, the lower your premium can become – or the lower your deductible will be.
In order to know if you have enough coverage to replace your possessions, make periodic assessments of your most valuable items, too. According to John Bodrozic, co-founder of HomeZada.com, “Many consumers are under-insured with the contents portion of their policy, because they have not done a home inventory and added the total value to compare with what the policy is covering.”
Look for changes in the neighborhood that could reduce rates as well. For example, the installation of a fire hydrant within 100 feet of the home, or the erection of a fire substation within close proximity to the property may lower premiums.
How to Compare Home Insurance Companies
Before you sign on the dotted line, here's a checklist of search tips.
1. Compare statewide costs and insurers
When it comes to insurance, you want to make sure you are going with a provider that is legitimate and credit worthy. Your first step should be to visit your state’s Department of Insurance website to learn the rating for each home insurance company licensed to conduct business in your state, as well as any consumer complaints lodged against the insurance company. The site should also provide a typical average cost of home insurance in different counties and cities.
These will help you determine which carriers you want to size up and compare against each other.
2. Do a company health check
Investigate home insurance companies you’re considering via their scores on the websites of the top credit agencies (such as A.M. Best, Moody's, J.D. Power, Standard & Poor's) as well as those of the National Association of Insurance Commissioners and Weiss Research. These sites track consumer complaints against the companies as well as general customer feedback, the processing of claims and other data. In some instances, these websites also rate a home insurance company's financial health to determine whether the company is able to pay out policies in the event you need to file a claim.
3. Look at claims response
Following a large loss, the burden of paying out-of-pocket to repair your home and waiting for reimbursement from your insurer could place your family in a difficult financial position. A number of the insurers are outsourcing core functions including the handling of claims.
Before purchasing a policy, find out whether licensed adjusters or third-party call centers will be receiving and handling your claims calls. “Your agent should be able to provide feedback on his or her experience with a carrier, as well as its market reputation,” says Mark Galante, senior vice president and chief marketing officer at the PURE Group of Insurance Companies. “Look for a carrier with a proven track record of fair, timely settlements and make sure to understand your insurer’s stance on holdback provisions, which is when an insurance company holds back a portion of their payment until a homeowner can prove that they started repairs.”
4. Current Policyholder Satisfaction
Every company will say they have good claims service. However, cut through the clutter by asking your agent or a company representative what percentage of policyholders renews each year. Called the insurer’s retention rate, many companies report retention rates between 80% and 90%. You can also find satisfaction information in annual reports, online reviews and good old-fashioned testimonials from people you trust.
5. Get multiple quotes
“Obtaining multiple quotes is important when looking for any type of insurance; however, it is especially important for homeowners insurance since coverage needs can vary so much," says Eric Stauffer, president, ExpertInsuranceReviews.com. "Comparing several companies will yield the best overall results."
How many quotes? According Sarah Brown, insurance expert at Obrella.com, “Contact five or more companies so that you know what people are offering and you have leverage in negotiations. But before collecting quotes from other companies, request a price from insurers you already have a relationship with. As previously mentioned, in many instances, a carrier you’re already doing business with (for your auto, boat, etc.) may offer better rates because you're an existing customer.
Some companies provide a special discount for seniors, or for people who work from home. The rationale is that both these groups tend to be on premises more often – leaving the house less prone to burglary.
6. Look beyond price
Annual premium is often what drives the choice to purchase a home insurance policy. But don't look solely at price. “No two insurers use the same policy forms and endorsements, and policy wording can be very different,” says Bank. “Even when you think you're comparing apples to apples, there's usually more to it, so you need to compare at coverages and limits.”
Be sure you understand what each policy you're considering truly covers – and what limits or exclusions are attached to it – rather than comparing only costs. “Something as simple as septic-tank backup protection could be overlooked on a specific house, and that can greatly impact price if an insurance agent primarily sells policies to people hooked up to city sewers,” says Stauffer.
7. Talk to a real person
Finally, contact local agents for quotes. While there are websites that can get an aggregate list of prices, to actually buy "there aren't many online options – only about 5% of homeowners insurance is sold online)" according to Tom Austin, co-founder of Bungalow Insurance, a Philadelphia independent insurance broker. So if you want to get multiple quotes, you'll have to deal with a human.
Stauffer feels the best way to get quotes is to go directly to the insurance companies or speak to an independent agent who deals with multiple companies, as opposed to a traditional “captive” insurance agent or financial planner who works for just one home insurance company. Bear in mind, though, “a broker licensed to sell for multiple companies often attaches their own fees to policies and policy renewals. This could cost hundreds extra a year simply by using them over a captive agent,” he notes.
Bank urges consumers to ask questions that give them a detailed sense of their options: “You want to consider different deductible scenarios to best weigh if it makes sense to opt for a higher deductible and self-insure,” he says.