Homeowners' insurance is deceptively simple. It's the coverage you need in the event of significant damage to your house, yet not all policies, or situations, are equal. For example, the homeowner who is covered for a fire may not be covered for a flood or an earthquake.
What's more, coverage comes in many different flavors. For example, some insurers offer guaranteed replacement policies. But these policies, which guarantee to rebuild your home no matter the cost, have proved problematic in recent years. Take the San Francisco Bay area. Insurers hit with a wave of claims from fires during the 1990s were paying $900,000 or more for homes that had originally been insured as $200,000 dwellings.
Guaranteed replacement cost policies are some of the most expensive products that fee-hunting agents offer. If you have an insurance agent with current information on construction and other costs in your area, many analysts believe that guaranteed replacement cost policies aren't worth the extra cost.
Ideally, a good policy would cover you only for what you'd need to rebuild your home on your property. Unfortunately, too many don't do that.
What should you buy?
Residents tend to overinsure when it comes to protection against fire and the like. But that's not the greatest danger when it comes to homeowners' insurance -- exclusions are. Buying a policy without knowing what you won't get, and why, is like walking into the lion's den covered in catnip.
Consider the thousands of homeowners devastated by Hurricane Katrina. For many of the survivors, the worst damage was caused by flooding. Problem is, most hurricane coverage relates to destruction caused by high winds, rather than high water. If you're thinking that's a ludicrous and somewhat arbitrary line to draw, I'm with you. Just know before you buy that profit-seeking insurers usually disagree.
Foolish questions to ask before you buy
Therein lies the real problem for Foolish homeowners. Too many of us don't know exactly what our insurers will and won't pay for. And we're not at all clear about how what we don't know affects what we pay annually in premiums.
That's why many of the experts at our Insurance and Living Below Your Means discussion boards recommend a regular review of coverage. Doing so annually seems to be a good idea. As you go through the process -- or seek a new policy -- consider these three Foolish questions:
1. What does it cost to build in your area? There's simply no way to effectively price insurance without knowing what it would take to rebuild your home. You'll want to know the per-square-foot average construction cost for your ZIP code. Multiply that by the total area of your home, and you have a replacement cost. Insure for that amount, and then recheck pricing annually. One caveat: This data's rarely freely available, so be sure that your agent is relying on a credible source in writing your policy. Experts at the Fool's Insurance board suggest that Marshall and Swift's software is among the best.
2. What risks does your home face? Exclusions and riders are common for homeowners' insurance. In Colorado, for example, policies frequently exclude damage from mold; it's a very dry climate, and mold doesn't thrive in the Rockies, unless there's constant moisture applied from a longstanding leak. Insurers here tend to view that kind of thing as owner negligence. Other common exclusions apply to older homes, where outdated plumbing or fixtures may lead to greater risks. Be sure you understand what risks your insurer is willing to accept on your behalf; they may be far fewer than you realize.
3. What funds do you have? Many posters to the LBYM board say that the best way to save money on a homeowners' policy is through the deductible. The higher, the better -- assuming, of course, that you have or could easily raise the cash to make common repairs without involving your carrier. As Foolish poster Wheee once put it, "Would I make a claim for $2,000 [in] water damage from a burst pipe ... even if it was covered? Not a chance." Call it another excellent reason to have a well-stocked emergency fund.
Follow the money
Homeowners' insurance is essential protection for any Fool. That includes renters, too. Just because you don't own the place, that doesn't mean you shouldn't protect what's in your apartment in the event of a disaster. So be prepared, but don't pay any more than you have to. Know the replacement costs cold, and update your numbers annually.