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Is Your Home Underinsured? 8 Key Tests
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Don't rely on your insurance company to size up what you need. Here are the steps you should take to make sure that a disaster doesn't ruin you.
By Liz Pulliam Weston
Karen and Bill Reimus aren't cheapskates about insurance. In addition to life and health policies, the self-described "insurance freaks" have earthquake and disability protection. They also sprang for extended replacement coverage on their pricey San Diego County home, figuring better safe than sorry.
"We try to prepare for a rainy day," said Karen, a mother of two who, like her husband, is a lawyer.
But it was fire, not rain, that proved their undoing. Four months after they bought their house in 2003, it burned to the ground in the Southern California wildfires, and the Reimuses discovered that their policy limits fell at least $150,000 short of what they needed to rebuild.
After talking with their Scripps Ranch neighbors, the Reimuses learned they had plenty of company. California's insurance commissioner estimated that 90% of those affected by the wildfires were underinsured. A 2006 survey by insurance-services firm Marshall & Swift / Boeckh puts the number nationwide at 58%, with those homeowners covered to rebuild about 80% of their homes.
How much?
Trying to figure out the right amounts of insurance coverage, however, is a tricky, frustrating process. Your insurance company or agent may be surprisingly little help -- and may even steer you wrong.
Many San Diego wildfire victims, for example, said their agents used a computer survey that vastly underestimated the cost of rebuilding their homes.
The survey, called Quick Quote, was part of a larger software package sold to insurers to estimate replacement costs. The company said agents should have used the more detailed software, which requires a longer interview with homeowners, to determine policy limits. Quick Quote was later removed from the software package.
Reimus said she was surprised that an insurance company would offer too little coverage, because such a practice limits the premiums it collects. She now suspects insurers actively avoid selling adequate coverage to reduce their exposure to loss.
Insurers deny that, although they do admit that some agents may lowball, or give quotes based on inadequate policy limits, to sell more policies.
Lulled into complacency
Insurance analyst Brian Sullivan has another take on the situation. He says the annual premiums paid on most policies are too small for insurers to spend much time doing a detailed assessment of the customers' needs.
"If you ask most insurance companies what they're insuring -- how many hardwood floors, how many fireplaces -- they have no idea," said Sullivan, editor of Risk Information, an industry newsletter. "It's only companies like Chubb that have (policies with) premiums in the thousands of dollars that will come out and appraise your home and everything in it."
Homeowners are often lulled into complacency because they have "guaranteed replacement" or "extended replacement" policies, which sound like they'll rebuild a home regardless of the cost, said attorney Amy Bach of United Policyholders, an advocacy group for insurance consumers.
But true guaranteed-replacement policies are almost extinct, and virtually all insurers cap the payouts at 100% to 150% of the amount for which the home is insured.
Bach recommends consumers buy the highest cap they can afford, and take the following steps:
Know your replacement costs per square foot. Divide your home's policy limits, which are listed on the "declarations" page, by your home's square footage. Compare this to a custom-home builder's estimate of what it would cost to rebuild your house, with its current amenities. If your insurer can't explain discrepancies to your satisfaction, start shopping for another insurer.
Don't be cheap. Make it clear to your insurer or agent that you want the best coverage for your money, not the lowest possible premiums.
Check your "loss of use." Homeowners policies typically provide money to pay your rent and related living expenses while your home is being rebuilt. Again, you should find this coverage on the declarations page. If the amount offered wouldn't cover you for two full years, Bach recommends asking for a higher limit or finding another insurer.
Get "replacement cost," not "actual cash value." It's not just rebuilding coverage that falls short. Many policies severely restrict how much money you'd get to replace your stuff, and limit or even exclude some common household items from your policy. If you have a policy that pays out "actual cash value" on your home's contents, for example, you'll get a check for what your possessions were worth when they were destroyed -- not what they would cost to replace. It's much better to spring for "replacement cost" on your contents, and get a check for what you would need to buy a new item. The cost of this coverage is typically about 10% to 20% more than actual-cash-value coverage.
However, you still could be vulnerable. Some policies provide replacement-cost coverage for most items but make exceptions for others. Your policy might give you a check to buy a new couch, for example, but decide to depreciate your carpet and give you only a fraction of the replacement cost.
The only way to know how you're protected is to read your policy, front to back.
Does your coverage match your home's contents? Many policies peg your contents coverage to a percentage of your overall policy limit. If your home is insured for $200,000, for example, your contents coverage might be $80,000, or $100,000, or $150,000, depending on the insurer's policies. Obviously, there's a lot of variation, and these limits don't reflect whether your furniture consists of Chippendale or chipped-and-dented. The only way to be sure you're adequately covered is to do a detailed household inventory, writing down all of your possessions and what it would cost to replace them. A drag? Of course. But it's time you'll be glad you invested if you're ever faced with making a claim.
The good stuff needs its own insurance. If you own something truly valuable, chances are good that your policy restricts how big a check you'd get. Most policies put payout limits of $1,000 to $2,500 on such items as jewelry, firearms, artwork and antiques. If you want full coverage, you need to purchase a "floater" or "rider" on the item at added cost.
Consider your individual needs. Your policy likely has some other gaping holes. Homeowners insurance typically won't replace equipment you use for a home-based business. Property belonging to a tenant is usually excluded. Damage from certain causes, such as a flood or sewer backup, won't be covered, either. In these cases, you can get supplemental coverage -- and you probably should.
Are you protected from lawsuits? That's the role of liability coverage. Chances are pretty good that you don't have enough protection, which means you could be in danger of losing everything you own to the next person who decides to sue.
Again, deciding how much liability to buy is tough. You can't predict who is going to sue you or for how much.
Although most insurance experts advise buying liability coverage equal to one or two times your net worth, a jury could come back with a whopping award that bears no relationship to what you own or could earn in a lifetime.
Still, trial attorneys tend to go for the easy money and often settle for the amount of your policy -- unless you're vastly underinsured. Then they're likely to go to the time and trouble of identifying, and going after, all of your available assets.
That's why Steve Vidmar, an insurance defense attorney in New Mexico, recommends that most homeowners have at least $1 million in coverage.
That means buying the maximum coverage your policy allows -- typically $250,000 to $500,000 -- plus an "umbrella" or personal-liability policy that provides coverage up to $1 million.
"I'd recommend even higher limits," Vidmar said, "for those with teenage drivers."
Fortunately, boosting your liability coverage is still relatively cheap. A $1 million umbrella policy usually costs $200 to $300 a year.
Take action now, not later. The time to make these adjustments is now. It's too easy in the chaos of living to put off investing in your coverage, but it's too late once a disaster strikes.
In the months after the fire, Karen Reimus mourned everything they'd lost: the couple's high-school yearbooks, the children's baby books, all of their photos -- literally everything the family owned that they weren't wearing the day of the blaze.
They were in no shape to battle an insurance company, yet they did -- and they managed to negotiate a settlement that's helping them rebuild their home.
Now Reimus says she can finally see a silver lining in the struggles she and her neighbors had with their insurers.
"I always believed things happen for a reason," she said. "If this prevents someone from going through what we went through, then that's good."
Columns by Liz Pulliam Weston, the Web's most-read personal finance writer. Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money.
