The basic goal behind buying 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.

Let's say that you have a house that you own, free and clear—with no insurance. 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 even sell it if you like.

However, if that giant tree in the backyard falls on your house causing severe damage, it is up to you to cover the entire cost to repair the house. This is the basic reason to carry property insurance, which would have paid—in part or in whole—for your property to be fixed or replaced

Who Needs Insurance?

Thankfully for those of us who might be negligent in our responsibility to have insurance on our property, we are forced in many cases by either law or contract (the mortgage contract) to carry insurance. While not many, if any, U.S. state laws require you to carry property insurance, they do often require some form of liability insurance, especially for cars.

This insurance covers repair or financial restitution to someone else besides the individual at fault. For example, the person at fault's liability insurance pays to have their car fixed, or pays their medical bills. Fortunately, when most of us purchase the required liability coverage, we are given the opportunity to purchase the property insurance (i.e., comprehensive or collision insurance) rather easily, thus saving us from financial hardship if our own car is damaged in the accident.

Coverage

According to a survey published in the Journal of Financial Planning, many homeowners have vastly misguided views of what their homeowner's insurance actually covers. According to this survey conducted by the National Association of Insurance Commissioners, " One-third of homeowners believe flood damage will be covered by their standard policy. Over half think their policy covers them in the event of a water line break. Thirty-five percent say they will be compensated for an earthquake, and a slightly lesser proportion thinks mold is covered."
In actuality, the typical 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)
  • Mold
  • Acts of war
  • Parts of the property in disrepair (Including worn-out plumbing, electrical wiring, air conditioners, heating units, and roofing).

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 typical perils which typically are covered include:

  • Fire
  • Wind (tornado or hurricane)
  • Hail
  • Theft

Liability Coverage

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 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 they 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.

Don't Guess - Know

You should know what your policy does and - more importantly - 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, such as 60 days, then the homeowner's 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 a vacation property, you may get another policy to cover this home as well.

Pitfalls to Avoid

Check to see if your policy covers repairs at actual cash value (ACV) or at replacement cost. Replacement cost 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.

Co-Insurance Clauses

Finally, some property owners only want to insure a property for what they paid for it, which may bring into play a co-insurance clause. This is (depending on local laws) where the property is insured for less than say 80% of its current replacement cost. 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.

Premium Factors

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 they will charge you accordingly. These are factors that the insurance company 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.

Final Thoughts

One last 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 for you. 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 they cover, and what they don't.

You may find only too late that what you thought was adequate coverage, was barely the legal minimum in your area. Seek quality coverage - remember, "cheap insurance can be very expensive."