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The calculation of the adequate amount of home insurance coverage that one needs to have is always a careful balancing act. Buying too much insurance can waste thousands of dollars while buying too little leaves you bankrupt after a catastrophe.
An average home insurance policy is made up of several distinct types of coverages designed to protect different aspects of your finances. To determine your required insurance coverage, you first need to evaluate these crucial factors separately.
1. Dwelling Coverage: Rebuild Price Not Market Value
The very core of your insurance policy is the Dwelling Coverage or Coverage A, which helps you rebuild your home structure in case of damage from a covered peril such as fire, lightning strike or wind storm.
The main mistake people tend to make when determining their coverage needs is confusing the replacement price of their home with its market price. The Dwelling Coverage limit should be 100% equivalent to the cost of rebuilding your structure.
How to Determine it:
Basic Formulas: Multiply the overall square footage of your house by the price per square foot required to reconstruct your home.
Dwelling Cover Limit= Total Square Footage x Price to Rebuild Per Sq Ft.
In addition, consider the following factors:
Finishes, high-end cabinetry, historic brick work, and number of bathrooms add greatly to the cost of rebuilding;
The 80% Rule: In case your coverage is less than 80% of the entire replacement value, the insurance company reduces your payment according to a percentage prorated against your actual coverage amount. For example, if your home has a replacement value of $300,000 but is only covered for $240,000, you get 80% of your claims paid.
Additional Considerations for the Extra Peace of Mind:
Because the price to rebuild is very sensitive to inflation and sharp rises in material prices caused by disasters, there are the following options for consideration:
Extended Replacement Cost: A coverage option that increases the insurance coverage limit by 10% to 50%.
Guaranteed Replacement Cost: The highest level of coverage that ensures the rebuilding of your property to its pre-disaster state despite the amount of money stated in your policy.
2. Personal Property Coverage: Protection of Your Possessions
Personal Property Coverage or Coverage C insures the content of your home including furniture, clothes, appliances, electronic equipment and other household items in case of theft or destruction.
Typical Settings: Personal Property coverage is usually automatically provided by the insurer in a certain percentage range between 50%-70% of your Dwelling Coverage Limit.
Replacement Cost Value (RCV) and Actual Cash Value (ACV):
It is always better to opt for the RCV option. In case a fire destroys your 5-year-old laptop, an ACV will provide the depreciated value of that device, i.e., nothing, while an RCV will give you a payment based on the current market price for a new computer.
Sub-limits: Personal Property Coverage has strict sub-limits (typically ranging from $1,500-$2,500) on valuables such as jewelry, fine art objects, costly sporting equipment and collectibles. In case any of these exceeds the sub-limit amount, you will need to purchase additional Coverage F.
3. Personal Liability Coverage: Protection of Your Finances
Personal Liability Coverage or Coverage E is essential to cover all costs resulting from legal action against you in case of injuries on your property, injury or damage caused off-premises by your actions or those of your family members.
Default Settings: All basic insurance policies provide a default Personal Liability Limit of $100,000. However, in the contemporary market, this amount is not sufficient. Just one serious accident can easily exceed this amount by millions. In order to avoid such losses, it is essential to get a much higher Personal Liability coverage limit.
Asset Protection:
You should always have Personal Liability Limit that equals your total net worth (savings, investments, equity in your home and earning potential).
Recommended Options: Coverage limits of $300,000 and even $500,000 are considered necessary nowadays. In case your total net worth exceeds this amount, it is advisable to purchase additional coverage called Umbrella Liability policy providing additional coverage limit of $1 million to $5 million.
4. Additional Living Expenses (ALE): Loss of Use Protection
In case of a disaster, Additional Living Expenses coverage or Coverage D protects you from the loss of use of your home by covering the additional costs incurred while waiting for repairs or reconstruction.
This includes
Increased cost of living in hotels or other rented properties
Increase in restaurant expenses because of the unavailability of your own kitchen facilities;
Additional fees for storage units and/or boarding of pets.
Typically the limit of Additional Living Expenses insurance is calculated as 20% or 30% of your Dwelling Coverage limit. If you have a large family or live in a very expensive renting market and expect long-term repairs of your property, make sure that you have maximum additional Living Expenses coverage. In case of this necessity, it is better to purchase a policy with unlimited Additional Living Expenses insurance for a set period of time.
What a Standard Policy does not Cover
Even if you cover Dwelling, Personal Property and Personal Liability to their maximum levels, you will face large financial risks if you fail to take into account some special exclusions that you might need. Thus, check if your needs include:
Flood Insurance: Your regular policy does not cover surface water flooding or storm surge. In case you live close to bodies of water, experience climate changes or bad drainage in your city, buy separate flood insurance.
Earthquake Coverage: Earth movements are excluded from the coverage. In case of active earthquakes in your area, purchase additional earthquake coverage.
Water Backup Endorsement: In case of water damage or sewage backup as a result of failure of your basement sump pump or sewer lines backup, you will have to cover structural repairs and remediation of hazardous conditions yourself.