Homeowners Insurance: Am I Under-Insured? How do I know?

A home is one of life’s biggest investments.  Homeowners insurance protects your investment.  Having sufficient coverage is critical in case of a fire or other disaster, but how can you determine if you are properly insured so that you receive enough money to fully rebuild it?  On the other hand, you don’t want to be over-insured, paying larger premiums for insurance you’ll never use.

The Starting Point

The first thing you need to determine is the current market value of your “dwelling,” the structure – not the contents or the landscaping or the cars in the garage.   Just the house structure.  What you paid for it originally is probably not the replacement value today – the cost to fully rebuild your home.  Factors like appreciation, inflation, availability of labor and materials all factor in, as would home improvements or the addition of an attached deck, for example.  The costs associated with building materials and construction increase year over year.  Unless you have a builder in the family, you can’t possibly know what the cost is to rebuild your home.  But your home insurance company or a local realtor can provide you a pretty good estimate based on the type, size, and location of your home.  

Another way to estimate how much homeowners insurance coverage you need is to multiply the square footage of the home by the local building costs per square foot in your area.  For example, if your home is 2,200 square feet and local building costs average $80 per square foot, the cost to rebuild your home would be about $176,000.  You’d calculate costs the same way for any outbuildings.

This estimate is the “starting” point; there are times when even the “right” amount of coverage can fall short.  For example, after widespread disasters, especially, such as a tornado, the cost of materials and labor can shoot up dramatically due to demand.  Consequently, you may want or need to increase the number, year over year, to be sure you can rebuild your home if it’s destroyed.  

What is Extended Replacement Cost?

Having sufficient dwelling coverage to rebuild your house is the foundation of a good homeowners insurance policy.  But it’s not a guarantee that you’ll be fully protected and not have to pay something out of pocket.  Some home insurance companies offer extended replacement cost.  This feature can provide anywhere from 10% to 50%—or more—of extra coverage to absorb a cost spike.  “Guaranteed” replacement cost coverage is even better because it pays to rebuild your house no matter how much building costs have gone up.

Don’t Forget About Your Home’s Contents

Your contents coverage reimburses you for the contents of your home that are damaged or destroyed.  This encompasses your furniture, decorations, clothes, electronics, toys and appliances.  A good way to keep track of your stuff and determine how much content coverage you need is by creating a home inventory.  An easy way to do that today is to record your contents on your mobile device; it’s hard to remember all your stuff when it’s gone or unrecognizable, so take a video of all of it.

While some policies offer “actual cash value” coverage of your contents, again you generally want to have “replacement cost” coverage.  This reimburses you for the cost of buying new items, not the depreciated value of what was destroyed.

Most home insurance policies will default to a percentage of the dwelling coverage to determine contents coverage. This default could be 50% of the dwelling insurance.  You may find this insufficient when you consider all the furniture, rugs, window coverings, artwork, clothes and other items you would want to replace.  You can adjust your contents coverage higher to get better insurance protection.

Finally, home insurance policies typically cover damage to contents from 16 “perils,” which are listed in the policy. These perils include all the problems you’d expect, such as fire, lightning, and explosions.  But limiting coverage to 16 perils leaves you open to a potential gap in coverage.  Consider a comprehensive policy that provides “open peril” or “all peril” coverage on your contents for full protection.

It is critical that homeowners review their homeowners coverage every year, especially during periods of high inflation or following housing booms.  If the current coverage can only cover 90% of the replacement cost, the other 10% will be on the homeowner.  Consult with a property and casualty representative to ensure your insurance company will cover 100% of the costs to rebuild your home should it be damaged or loss.