Fires … and Homeowners Insurance
Fires are scary.
My family had the distinct pleasure of being evacuated from our home a month or so ago due to a nearby fire.
We could see the flames from our house. Definitely too close for comfort.
We were away from our home for a few days, but everything turned out ok. The awesome firefighters were able to contain the fire and keep all nearby houses safe.
That experience got me thinking about the importance of homeowners insurance.
What should you look out for when getting home insurance? What's important vs. what's not?
Let’s dig in.
General approach to insurance
Generally speaking, my approach to all types of insurance is:
Focus on buying insurance for what you can’t afford to lose; anything else is optional and probably not necessary. Insurance companies need to make a profit after covering costs, commissions, and claims. On average, most people are likely to lose money on most insurance. Therefore, it’s probably best to only buy insurance for what you can’t afford to lose and/or to cover what could materially affect your financial picture.
Make sure you’re covered on the “big” things. Look for the big risks in your life and make sure those are covered. Optimizing the little things is nice, but not required.
Review insurance coverage periodically. People typically fall prey to a really powerful tendency – inertia. This leads them to keep paying for insurance they don’t need and not do periodic price comparisons.
Home insurance - the basics
Home insurance is meant to play two key roles for you:
To cover your losses, for example if there’s damage to your home (“property insurance”) and
To cover you if you need to pay someone else, for example if someone sues you (“liability insurance”).
I’m not going to go into all the details of how this type of insurance works. If you’d like to get a quick primer on the various components, see this helpful article by the Insurance Information Institute: Homeowners Insurance Basics
Property insurance
A few suggestions:
It’s best to make sure your Dwelling and Other Structures coverages are “replacement cost”. This means the insurance will pay to fully replace the structures. The other option is “actual cash value”, which gives you a depreciated amount based on wear-and-tear that covers how much the materials are currently worth.
Make sure your coverage is truly enough to be able to fully rebuild. Ask your insurance agent or insurer to do an analysis of this if they haven’t recently.
For your Personal Property coverage, there are usually many limitations for specific types of items. For example, jewelry is often limited to a few thousand dollars; coverage is usually limited for antiques; some items are covered only in the event of theft, not due to other causes. If you want to add extra coverage for any particularly valuable items, you may need to purchase a rider or a separate policy.
Liability insurance … you have enough?
This is serious stuff. You can be sued for a variety of things, many of which may be outside of your control. For example, if someone slips and falls on your property. Or your perfectly-behaved dog gets out and bites the grumpy neighbor.
It’s possible you could be sued for BIG money. Especially if the person has major medical bills, lost wages due to not being able to work, suffering due to mental stress, etc. So you could be on the hook for a major payout. Plus, you’ll have to cover various legal fees for your defense.
The insurance that would cover you if you’re sued is called “liability insurance”.
How much liability insurance should you have? There are different approaches.
A common rule of thumb is to carry enough liability insurance to cover 1-2 times your net worth. The thought process is that if you’re sued, the attorney may do some fact-finding to see what you own. If they’re able to find your various assets, the lawsuit might be for a bit more than that amount. Whether things happen like that in practice, I don’t know. But I think it’s a useful rule of thumb.
I think it can be adjusted a bit though to account for assets that can’t be touched in a lawsuit. Two examples are:
Retirement accounts. Most employer retirement plans like a 401(k) or a defined benefit plan are “creditor-protected” under a federal law called ERISA. A lawsuit can’t touch those assets. For IRAs, it depends on the state. IRAs are fully protected in some states, but not fully protected in others.
Primary home. This is also state-dependent. Most states allow for some amount of creditor protection for a portion of your home’s value. For example, some states allow for $100,000 of home value to be protected.
Let’s look at an example:
Let’s say your net worth is $3,000,000.
You have $750,000 in a 401(k).
You own a home worth $1,000,000 and $125,000 is protected per state law.
Therefore $875,000 of your net worth is creditor-protected ($750,000 + $125,000).
Your net worth that is potentially reachable in a lawsuit is $2,125,000 (which is $3,000,000 minus $875,000).
According to the 1-2x rule of thumb, you might consider having $2,125,000 to $4,250,000 in liability coverage.
Chances are your liability coverage in your homeowners insurance policy is set to a fairly low amount compared to your net worth. Common amounts are $300,000 and $500,000.
You might consider getting more liability coverage by:
Raising the limits in your home and auto insurance policies; and/or
Purchasing an umbrella insurance policy to bridge the gap in a much more economical way.
Other things to consider
Deductibles
The higher you set your deductible, the lower your premium will be.
I usually recommend to my clients that they set their deductible between $1,000-$2,500.
Having a low deductible makes it more likely you’ll file claims for smaller losses. The problem with this is that making claims will likely lead to your insurer raising your premium. In fact, policies can be canceled if small claims are made.
Therefore it’s better to have a high deductible, allowing you to retain a little bit of risk, while still insuring the big losses.
Rating of the insurer
You’ll want to make sure your insurer is financially strong, as you want them to be able to pay out if there’s a major disaster.
A useful way of doing this is to look up the insurer’s financial strength rating. Some rating agencies that issue these ratings include A.M. Best, Moody’s, and S&P. Ratings can usually be found fairly easily with a Google search.
A rating lower than “A” should be concerning. Anything that’s “A” or higher is very strong.
Disclose risks!
I strongly recommend that you disclose to your insurer all the known risks about your property/situation.
For example, pets, swimming pools, other bodies of water, trampolines, business activities conducted on the property, etc.
The reason for this is because if there’s an event/loss related to the risk area, the insurance company may argue that they were unaware of the risk and therefore aren’t liable to cover your insurance claim. It’s much better to disclose everything so that you’re sure to be covered.
Note regarding home-based businesses: Homeowner policies vary with respect to coverage for home-based businesses. Make sure you know what’s covered and what’s not.
Take a video!
If your house burns down, how are you going to prove to your insurer what you owned?
The most thorough thing to do would be to catalog and take photos of everything you own, along with notes about purchase price, condition, age, etc. Not many people have the patience or time to do this (including yours truly).
A more realistic goal would be to walk through your house and take a video of all your personal property. As you walk around the house, open drawers, closets, etc. to make sure you video everything. Having a video like that will enable you to make a thorough list in the event you ever need to make an insurance claim.
Make sure to store that video securely in multiple places. An easy way to do that would be to back it up to the cloud. You don’t want your only copy of the video to be stored at home and then you lose it in the same fire that destroys your possessions…
Shop around
When’s the last time you shopped for home insurance? You very well might be able to get a better policy with a lower premium if you shop around.
An online broker, such as PolicyGenius, is good for this because they provide quotes from many different insurers.
You can call your insurance agent to ask them to shop around for you.
If you’re a Costco member, you could also get a quote through their insurance partnerships.
Other property insurance?
Depending on where you live, do you need other insurance?
For example, homeowners insurance policies don’t cover losses due to floods or earthquakes. If you live in an area where there might be flooding and/or earthquakes, you should seriously consider purchasing these extra policies.
Final thoughts
Homeowners insurance isn’t the most exciting topic. But it’s something that most people have to carry (due to requirements with mortgages). And even if it’s not required, you really do want to carry it, as it’s there to protect you.