When you were a child, security items probably filled your childhood with peace of mind. Things like a blanket, stuffed animal or pillow might have protected you from monsters under the bed or ghost stories at your first sleepover camp.
As an adult, a homeowners' insurance policy gives you the same peace of mind. You carry coverage hoping you'll never need it, but feel assured knowing your insurance is in your back pocket in the event of a fire, tornado or flood -- or if a burglar ransacks your home. But is it enough?
"When people buy insurance, they don't think about the 'what ifs' and actually needing the coverage," says Eustace L. Greaves Jr., owner of Greaves Financial Services and The Bridge Insurance Agency in Brooklyn, N.Y. "A lot of times homeowners are thinking about how they can save money on their annual premiums so they opt to pare down their home insurance coverage or they don't choose the best coverage for their needs to save a buck or two."
That cheap coverage could leave you underinsured -- an all-too-common mistake that can cost homeowners big bucks.
"Many people think skimping on coverage makes sense because it saves on premiums but nothing could be more foolish. Being underinsured is asking to be under-reimbursed," says Lynch. "The mistake of underinsuring won't just cost a homeowner hundreds or thousands; it can cost a homeowner everything -- hundreds of thousands -- in the event of a total loss on his or her home."
One sure path to being underinsured is confusing cost with value when determining your coverage needs. "Homeowners often confuse the cost of their home when they bought it, or the cost of its contents, with the current value," says Lynch.
Rely On Replacement Cost
Your best bet to ensure you've got the right amount of coverage is insuring your home based on the replacement cost of the home -- not the tax-appraised value or the value determined by your mortgage company. "And not actual value, either," says Lynch. "Actual value appears to be cost-effective because it carries a lower premium than replacement cost, but it reimburses you for the fair market value, the amount a buyer would pay you to buy the item, or the cost to replace an item or dwelling with new property of like kind and quality, less depreciation."
"Replacement cost is the cost of totally rebuilding your home from the ground up in the event it is a total loss, whether by fire, flood, storm, hail, etc. It is what it will cost to completely rebuild your home and replace the contents at today's materials and labor costs, items prices, etc.," says Lynch.
So say you bought your home for $150,000 and several years later, it's totally destroyed in a fire. Due to inflation and the cost to bring your home up to your municipality's codes and myriad other costs, it may cost $185,000 to rebuild it. That wouldn't include any new upgrades or extras you'd want to add; that would just be the cost of rebuilding the house exactly the way it previously was, without skimping on quality or amenities. Given that, your dwelling should be insured by a replacement cost policy of at least $185,000. Then, you need to determine the cost of your contents separately to set that coverage amount.
Conduct Regular Reviews
Greaves says one of the best ways to ensure you always carry the proper amount of coverage for both your home and its contents is to conduct an annual review of your coverage. "Sitting down with your agent to discuss home improvements and remodeling, major purchases, current costs to rebuild or even an adult child that moved out and reduced the value of the contents in your home will help you ensure you're properly covered," he says.
"I highly recommend an annual review," adds Lynch. "It could be the best hour or two of the year because it protects your biggest investment: your home."
During a review, your agent will assist you in identifying risks such as weather patterns, theft trends, fire risks and hazards (for example, the lack of working smoke alarms) and make recommendations on how best to address them by adjusting your coverage limits.
The Investing Answer: A home inventory is a helpful tool to gauge the coverage needed for the contents of your home. Most carriers have a preprinted document your agent will happily make available to accomplish this important goal. You can also download free inventory software, courtesy of the Insurance Information Institute.
The inventory should include major updates or remodeling done to your house, such as adding new granite countertops, swapping out carpet for hardwood flooring and so on. Lynch recommends walking around your home, room by room, with a video camera and describing each possession in detail, making note of its rarity (if it's an antique or a high-value item) and other unique traits. Store the video in a safe place, such as a safety deposit box or keep an online version in the cloud. That way, in the event of a loss, you will be prepared for the claims process.