Figuring the Right Amount of Home Insurance

An unsolicited insurance quote caught Frank Glaser’s attention. The annual premium not only was $150 cheaper than his current homeowner’s policy, but the new insurer maintained that Glaser only needed $160,000 in coverage for his 2,800-square-foot home--a whopping $100,000 less coverage than his current insurer required.

Glaser, a retiree from Rancho Palos Verdes, decided to check around. Several quotes later, he found out what few people know: There is no standard way to determine how much insurance coverage is necessary to replace your home.

“It’s a little bit arbitrary, depending on the insurer you contact,” acknowledges Steven Goldstein, vice president of the Insurance Information Institute, a New York-based industry information service.

That fact is troubling, because having sufficient insurance is of pivotal importance when it comes to rebuilding your home and replacing personal items after a theft, emergency or disaster. And even if your insurance agent suggested the coverage limit, you are ultimately responsible for making sure that you buy enough.

At the same time, having too much insurance is simply a waste of premium dollars. Depending on where you live and how over-insured you are, you could be throwing away between $50 and $500 annually, experts say.

Indeed, insurance experts believe that millions of people either have too much or too little homeowner’s insurance, thanks to inattention or misunderstanding.

Those who have been with the same company for several years are particularly vulnerable, experts say. That’s because some insurers automatically adjust your policy coverages by “an inflation factor” that may exceed the actual amount of construction cost inflation in your area, leaving you overinsured. Other insurers don’t adjust policy coverages unless you ask them to, which could leave you dangerously underinsured after a period of years.

So how do you determine and maintain the right amount of coverage?

Most people rely on their insurance agent. But oddly enough, insurers say you’re better off talking to real estate and construction experts and then doing some investigation on your own.

Here’s why:

Homeowner’s insurance is actually a “package of policies” that are all tied to the amount of insurance that you buy to replace your dwelling, says Rick Dinon, senior vice president for 20th Century Insurance in Woodland Hills.

To determine the amount of coverage you need, you must figure out what it would cost to rebuild your home as-is. And you must determine whether all the ancillary coverages that pivot off the dwelling coverage would be sufficient to cover things such as your contents, landscaping and detached buildings.

Some people assume they can maintain less coverage if they buy a “guaranteed replacement cost” policy. But that may not be true. Generally, these policies will replace the structure of your house, regardless of how much that cost exceeds your coverage limits. But it may not replace all your contents or your garden.

That’s because limits on contents and landscaping--all part of your homeowners insurance package--generally are tied to the face amount of your policy.

Each insurer has different limits. But commonly, contents coverage is limited to 50% of the policy amount, while landscaping is 5% of the face amount. “Loss of use” payments--the amount an insurer pays if you must rent another residence while your home is being rebuilt--also can be limited based on the face amount of your policy.

*

What does that mean in dollars and cents?

Let’s say your four-bedroom house burns down. You’ve got a $100,000 guaranteed replacement cost policy. But it actually costs $200,000 to rebuild. Since you have a guaranteed replacement cost policy, the insurer pays to rebuild the home, even though you’re seriously underinsured.

What about contents? Your policy limits coverage to 50% of the $100,000 “face amount” of the policy. But your losses are $75,000, so $25,000 of your loss is uninsured.

Landscaping coverage is limited to $5,000, or 5% of the $100,000. You’ve got $10,000 in losses, so $5,000 of that is not covered. You’ve got a sum total of $30,000 in out-of-pocket expenses, thanks to the inadequate coverage.

Now if you had purchased a $200,000 guaranteed replacement cost policy--which would have cost about $150 to $500 more annually, based on where you live and the insurer--the entire $30,000 would have been covered. Or, to put it another way, it will take you roughly 60 years to “save” enough on the annual premiums to make up for what you lost from inadequate coverage limits.

How can you avoid such problems?

Periodically--once every two or three years--check per-square-foot building costs with local contractors or building groups. In Southern California, you can also visit the Construction Industry Research Board at 2511 Empire Ave. in Burbank, (818) 841-8210. They have copies of the Marshall & Swift Residential Cost Handbook, which can help you calculate a pretty accurate per-square-foot construction cost for your home. The handbook should also be available at some bigger public libraries.

Then, inventory your personal effects and estimate what it will cost to replace everything. If your policy would not adequately cover your contents, consider increasing the face amount of the policy or buying separate coverage “riders” for your more expensive possessions.