I’ve had a number of conversations with people about home insurance over the last few of weeks. Based on those conversations and the questions I’ve addressed, I wanted to write a series on the different types of home insurance policies to provide a foundation for home buyers and owners to reference.
Broadly speaking, there are two types of home insurance policies; actual cash value and replacement cost. There are multiple forms with various options and coverage, but they all fit into one of these two “buckets.”
Actual Cash Value Policies: This is a very basic policy both in terms of coverage and how it pays on a claim. Actual cash value or ACV policies generally have four attributes;
- They are usually named peril policies in that they cover only the perils, or causes of loss, listed in the policy such as fire, smoke damage, theft, vandalism & malicious mischief, and wind and hail
- They may provide coverage for other types of claims such as water leaks, but these are added as options
- Claims are paid on a depreciated basis
- As an example of how a claim is paid on a depreciated basis, let’s assume we have a home with a 20 year composition shingle roof
- The roof is 8 years, damaged by hail and needs to be replaced
- The cost to replace the roof is $8,000. Since the roof is a 20 year roof, the roof is depreciated by $400 a year ($8,000 / 20 years) or in this case $3,200.
- The remaining “value” of the roof is $4,800 from which the deductible will be subtracted before the claim is paid.
- While this policy type does save the homeowner money in the short term, it will costs the homeowner more out of pocket if there’s a claim
Replacement Cost Policies
Replacement cost policies provide the homeowner a more complete level of protection in the event of a loss or claim.
- A replacement cost policy may cover only named perils or they may cover everything unless it’s excluded such as earth movement, water backup, etc.
- Claims are paid on the basis of what it would cost to replace a specific loss
- In the example of the hail claim above,
- The age of the roof does not matter
- The only thing factored is the cost to replace the roof (materials & labor) less the wind/hail deductible
- Most policies sold today are either replacement cost to begin with or endorsed to make them that way
- Replacement cost coverage should be on the home as well as your contents
- The amount of replacement cost is limited to the amount of coverage on the home and the amount of coverage on the contents or personal property
Actual cash value and replacement cost policies have their place depending on the coverage that is wanted and needed, as well as the financial ability to withstand a major loss Note, the mortgage company may require the home policy be a replacement cost policy to protect you and themselves. The bottom line is to know what you’re buying because, no one wants to find out what’s covered and what’s not when a claim is filed.
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