What Is Property Insurance?
The basic goal behind buying any insurance is to make you financially whole following a loss. You agree to pay a small certain fee to an insurance company today in exchange for a guarantee from the company that it will bear the burden of a large but uncertain loss in the future. Following that reasoning, property insurance protects you against damage to—or loss of—expensive personal property, such as a dwelling or a car. Forms of property insurance include auto insurance, homeowners insurance, renter’s insurance, and flood insurance.
Let’s say that you own a house free and clear and have a tidy nest egg. As long as you continue to pay your property taxes, you have every right to enjoy the use of that house for as long as you like, as guaranteed by law. You may live there, rent it out, leave it vacant, or sell it. You’re sitting pretty, and so you may ask yourself, “Why do I need property insurance?”
Then, all of a sudden, that giant tree in the backyard falls on your house and causes severe damage. Now you have to cover the entire cost of repairing the house, and that nest egg gets seriously reduced. If you’d had property insurance, it would have paid—in part or in whole—for your home to be fixed or replaced, sparing you an unexpected and large chunk of change.
- Carrying property insurance is advisable for anyone who owns an expensive property, such as a house or a car.
- It is often purchased in tandem with liability insurance.
- Property insurance doesn’t cover all property equally; for some things, such as jewelry, you may need additional floater coverage.
Who Needs Property Insurance?
Well, pretty much anyone who owns expensive property. Indeed, you are forced in many cases either by law or a mortgage contract to carry property insurance. All 50 U.S. states, for example, require drivers to carry auto insurance, usually in the form of liability insurance.
Liability insurance covers repair and financial restitution to someone else besides the individual at fault in an accident. For example, the person at fault’s liability insurance pays car repairs and medical bills for the other driver and any passengers. Fortunately, when you purchase the required liability coverage, you are also given the opportunity to purchase property insurance (in the form of comprehensive insurance and collision insurance with regard to auto insurance), thus saving you from financial hardship if your own car is damaged in the accident.
According to a survey published in the Journal of Financial Planning, many homeowners have vastly misguided views of what their homeowners insurance actually covers. According to reportage in The New York Times on a 2007 survey conducted by the National Association of Insurance Commissioners, 33% of homeowners believed that flood damage would be covered, 51% thought that damage from a main water line break would be covered, and 34% thought that mold damage is covered.
In actuality, the perils (causes of property destruction) that are typically not covered are:
- Flood damage (this is a separate policy)
- Earthquake (this is also a separate policy)
- Maintenance damage (e.g. worn-out plumbing, electrical wiring, air conditioners, heating units, roofing etc., as well as mold and pest infestation)
- Sewer backup
Policies are often written so that for something to be covered, it must be “sudden and accidental,” meaning that it wasn’t a slow leak that caused damage over many months. Often this is not covered by insurance. If your roof caves in from old age, and not from storm damage, it will likely not be covered.
The perils that typically are covered include:
- Fire or lightning
- Windstorm or hail
- Vandalism or malicious mischief
- Riot or civil commotion
- Damage caused by aircraft or vehicles
- Volcanic eruption
In addition to covering the value of your home or other property, many insurance policies also include an important provision for liability coverage. You may not think this is very important. However, there are scores of eager lawyers in every city searching high and low for lawsuits against people such as yourself. Liability coverage is well known to owners of automobiles, but it may be lesser known to homeowners.
If your neighbor’s house catches fire because you left your charcoal grill unattended, you will pay for the damage caused by the fire. You have paid the insurance company your premiums so that it will pay for larger claims when they do occur. The same goes for someone who is hurt and requires medical attention while on your property.
If you are on vacation and your property is stolen, such as a diamond ring, you may be entitled to reimbursement. Be sure to document the theft with evidence that you owned it, and you should be able to provide a police report to the insurance company.
You should know what your policy does and—more important—does not cover. Insurance companies don’t stay in business by charging a minimal amount to cover any and all things which could possibly happen to your property.
Additional (Non) Coverage
Home-based businesses are not typically covered. This doesn’t include a home study but rather a place where people come into your home as customers, such as a workshop where you repair furniture. You will need a separate business (commercial) policy to properly insure this area and its related liability. Again, these rules vary from state to state and country to country.
Also, if your property, especially your house, is left vacant for more than a certain time period, usually 30 days, then the homeowners policy may be canceled immediately by the insurance company. It is assumed that a vacant house is at a much higher danger of perils, such as fire or theft, and therefore changes the risk profile enough to require a separate policy. If you have a second home or vacation property, you may get another policy to cover this home as well.
Be aware of how your policy covers repairs. Covering the full replacement cost is better than just the actual cash value (ACV), but it will cost you more in premiums.
Pitfalls to Avoid
Check to see if your policy covers repairs at actual cash value (ACV) or at replacement cost. The latter is usually much better. Case in point: If your roof was damaged and needs to be completely replaced, the replacement cost will pay for it to be fully repaired less your deductible, while ACV will pay you what your roof was estimated to actually be worth at the time of the damage. The tradeoff is that ACV costs less than replacement cost coverage.
Art and Jewelry
Additionally, if you have expensive jewelry or art that you want to be covered, you may need to add a floater. This is an add-on to your main policy. Many policies have standard amounts that they will pay out for losses to particular items, and they will pay no more.
Finally, some property owners only want to insure a property for what they paid for it, which may bring into play a coinsurance clause. This is (depending on local laws) where the property is insured for less than say 80% of its current replacement cost. Have a lesser amount of coverage and the insurance company will require you to share in a percentage of the repairs above and beyond the deductible amount.
Do you live in an area prone to tornadoes, hurricanes, or floods? Do you own a large dog or a swimming pool? Are you a smoker? How’s your credit score?
You may be a higher-than-normal risk based on your answers to these questions, and an insurance company will charge you accordingly. These are factors that it takes into account when setting your insurance rates. The more that these and other risks are applicable to you, the higher your rates will be.
A Word of Warning
Some insurance companies provide seemingly unbelievable rates for their policies. If the company is unknown and its rates are exceptionally good, this should be a red flag. Check around for the company’s reputation and don’t just take the salesman’s word for it. Have a look at the policy and see what it covers and what it doesn’t.
You may find only too late that what you thought was adequate coverage was barely the legal minimum in your area. When seeking the benefits of property insurance, insist on quality coverage. Remember, cheap insurance can be very expensive.