Understanding Your Homeowner's Insurance Policy

17 MIN READ

There’s usually a long to-do list of things that need to be taken care of when buying a home. Purchasing homeowner’s insurance is usually one of the top line items, as your mortgage company will require it. However, it’s difficult to cross this item off your list if you don’t even know where to begin. Utilize this guide to understanding your homeowner’s insurance policy so that you can confidently pick the most suitable insurance policy for your new home.

This article discusses the general provisions of homeowners’ insurance, such as what homeowners insurance is and the different types of perils coverage. It also goes over homeowner's section I coverage, other provisions, and homeowner's section II coverage. In addition, the article outlines what the general provisions are for Sections I and II. Lastly, the article discusses other critical provisions of property insurance and analyzing your home insurance needs.

Homeowners Insurance

Homeowners insurance is a combination of policies. It combines two or more separate coverages into one policy. Homeowners insurance will usually consist of fire, theft, and personal liability insurance.

However, there are eligibility requirements for homeowners’ insurance. The policy has to be for an owner-occupied dwelling, there can be no more than two families in the dwelling, and each family can only have a maximum of two rooms.

There are two basic types of coverage for homeowners insurance: a named peril coverage and an open peril coverage. A named-peril coverage only covers perils that are specifically mentioned in the policy. The coverage applies to personal property under all forms and includes coverage for 12 perils under the HO-8 policies and for 18 perils under HO-2 HO-2, HO-3, HO-4, and HO-6 policies. However, an HO-3 can be altered to have coverage on open perils rather than named perils coverage. Forms HO-1, HO-2, and HO-8 cover against the same perils that apply to personal property.

On the other hand, an open peril coverage is one that is designed to protect against all perils except for those that are specifically excluded. Premiums are higher because of the scope of coverage. HO-3 and HO-5 contain open perils coverage.

The property that sustains a loss will be valued either on actual cash value(ACV) or a replacement cost basis (RC). Actual cash value applies to personal properties that are under all forms except for an endorsement that can be added to an HO-3 policy to ensure personal property on the basis of the replacement cost. ACV is the replacement cost less than the property depreciation.

Replacement cost is the expense of replacing or restoring the property to its previous condition. Dwellings and other structures are on a replacement cost basis. The losses for personal property that is under an HO-3 policy can be valued at a replacement cost if an endorsement is added. Usually, the replacement must actually occur before the insured can recover from the loss, the insurer will not pay more than the ACV before the replacement of the damaged property. This applies to HO-1, HO-2, HO-3, HO-5, HO-6, and HO-8. However, HO-8 is on a modified basis, meaning the replacement cost is based on the currently available materials and workmanship.

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The Six Standard Homeowners Policy Forms

HO-2 broad form, for residential. Ensures the dwelling, other structures, and personal property for specifically named perils.
HO-3 special form, for residential. Ensures the dwelling and other property for any open perils basis except those that are specifically excluded. Personal property is subjected to the same coverage as HO-2 unless an HO-15 endorsement is added for the coverage of personal property on an open peril basis. Personal property is subject to ACV settlement unless an endorsement is added to provide settlement on a replacement cost basis.
HO-4 broad form, for residential and tenant dwellings. It provides protection from named perils for a tenant’s personal property.
HO-5 comprehensive form, for residential. Similar to an HO-3 coverage except it provides open perils coverage for personal property.
HO-6 unit-owners form, for condominiums. It ensures the personal property of the insured for named perils.
HO-8 A modified coverage form, for residential. It provides protection for dwelling with a fair market value that is less than their replacement value.

Each homeowner’s policy form contains two sections: Section I, for the coverage of property and loss of use of property, and Section II, coverage for liability and medical expenses. Generally, property losses are subject to deductibles. They range between $250 to $2,500. In some cases, it may even be a percentage which may increase each year. Rate deductions could be available with a higher deductible. Deductibles do not apply to liability losses, medical payments to other coverage, losses involving credit cards, counterfeit money, check forgery, or ATM cards.

Homeowners Section I Coverage

Section I consists of five sections from A through D and additional Coverages.

Coverage A

Coverage A provides coverage on dwellings. A dwelling includes the structure that is attached to it and the materials and supplies for the use in construction. However, the land is specifically excluded from Coverage A. There is coverage for partial losses on the dwelling on a cost replacement basis if the insurance coverage is at least 80% or 90% for commercial policies. If the coverage is less than 80% the insurance company will either pay the actual cash value or the percentage of the replacement cost of the partial loss the insurance company represents as coinsurer, whichever is higher. The actual cost value is replacement cost less the depreciation.

An inflation guard endorsement can be added to the coverage and will automatically increase the amount of insurance according to insurance. The endorsement guarantees that the insured never becomes a coinsurer. The homeowner's insurance policy only pays up to the policy limit. Even if the policyholder has the required 80% of the replacement cost for the dwelling coverage, the policy will not pay out more than its face amount. It is recommended that at least 100% of the replacement cost value of the home is covered.

Covered losses to the dwelling are paid on the basis of replacement cost necessary to purchase or replace the dwelling with similar materials quality at current prices. The policy should also be periodically reviewed for the replacement cost of the home due to changes in the replacement value to make sure that the home is currently insured for at least 100% of the replacement cost.

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Coverage B

Coverage B insures the garage and other structures that are detached from the dwelling. Typically 10% of the amount on the dwelling applies as insurance on detached structures. Coverage B does not cover the land. It also does not apply to any structure used for business purposes, and any structure that is rented to someone who is not a tenant of the dwelling except for the private garage.

Coverage C

Coverage C covers personal property and its contents. The coverage also extends worldwide. Typically the amount of coverage is 50% of the insurance on the dwelling. Coverage C can be decreased up to 40% of the value of the dwelling if the insured does not own a personal property that equals to 50% of the value of the dwelling. All personal property that is used or owned by the insured is covered under one policy.

Some personal property is covered by other types of insurance and is excluded:

Jewelry, furs, or boats
Animals, birds, or fish
Motor vehicles, including cars, motorcycles, golf carts, and snowmobiles, aircraft and their parts.
Property in a unit that is rented such as refrigerator, stove, furniture, bicycles or motor scooters
Business data such as paper software or drawings
Credit cards and ATM cards

Personal property coverage also contains items that are subjected to dollar limitations. When the value of the item is higher than the limitations, a rider can be attached to the policy for those specific items. Items such as cash and currency, banknotes, bullion, coins, and medals are limited to a $200 total. Items that are properties away from the dwelling and are used for business purposes are limited to $500. Items that are limited to $1,500 include securities, manuscripts, personal records, stamp collections, valuable papers, watercraft, trailers, jewelry, watches, furs, and electronic equipment.

Items that are limited to $2,500 each include firearms, property at the dwelling used for business, and theft of silverware, silver-plated ware, gold-plated ware, and pewterware. If any of the items are insured separately or the limit is increased. It must be separately and particularly scheduled. If that happens, the item will no longer be under one policy, and will not be subject to the deductible.

Coverage D

Coverage D provides coverage for living expenses or loss of income if there is a loss of use. It is limited to 20% of the amount of insurance on the dwelling for HO-2 HO-3, and HO-5 policies, while HO-1 and HO-8 policies are limited to 10. Coverage D includes additional living expenses, fair rental value, and prohibited use. The coverage pays for expenses incurred by the insured to continue to maintain the insured standard of living if the house becomes uninhabitable because of the peril.

The benefit is paid only for a reasonable period that is required to repair or replace the damage. If the insured does not incur any additional living expenses, the insured will receive a benefit equal to the fair rental value of the property. If the property is prohibited for use because of the damage, the insured may receive additional living expenses or fair rental value. Lease cancellation costs are not covered.

Additional Coverage

There is a debris removal extension that covers expenses for the removal of debris from the property that is damaged by an insured peril: Tree, shrubs, plants, and lawn can be covered for perils including lightning, fire, explosion, aircraft, unowned vehicle, theft, malicious mischief, riot, and vandalism. Fire department service charges are also covered.

There is standard coverage of $500, but can be increased up to $10,000 for credit cards, forgery, and counterfeit money coverage. Collapse coverage is also available for the direct loss of the property due to a collapse caused by an insured peril: hidden decay, the weight of contents, equipment, or people, the weight of rain on the roof, and defective material. Also, there is coverage for glass or safety glazing materials. A landlord furnishing covers the appliance and carpet in an apartment on a rented premise.

Other Provisions

The insurance company is not liable for more than the insured’s interest in the property or the face value of the policy. The insured is also required to notify the insurance company if a loss occurred and has to prepare an inventory damaged property and submit a signed statement stating the amount loss within 60 days of the request of the insurance company. When a loss is settled, personal property is settled with actual cash value and buildings with replacement cost except for HO-8.

Personal property can be settled on a replacement value basis if the personal property replacement value endorsement is attached. If an item of a set such as earrings is damaged or lost, the insurance company may replace the lost part to complete the set or restore the item. Glass will be settled on a replacement basis.

An insurance company pays a proportion or pro-rata of its liability when there is more than one insurance company. A loss must be paid within 30 days after the agreed loss amount. A mortgage that is listed in the policy becomes a party to the contract with a distinct right that is separated from the insured. The mortgagee has the right to: receive any loss or damage payments to the extent of its interest to the property, whether or not the insured has violated the policy, receive notice of cancellation, and sue in its own name.

Homeowners Section II Coverage

Homeowners section 2 has two firms: Coverage E for personal liability and Coverage F for medical payments to others. Section II liability protects the insured and their family members that are residing in the insured household against risks that are associated with personal activities whether or not caused by negligence.

Coverage E

Coverage E protects the insured against claims that arise from bodily injury and property damage. Personal injury claims are not typically covered, but it includes damage to the reputation or character of an individual. The insurer will cover the damages and the costs of any defense of a covered claim. The minimum amount of coverage is $100,000 per occurrence. However, most homeowners insurance policies have a limit of at least $300,000 and can be increased up to $500,000.

An occurrence is defined as an accident and includes exposures to general harmful conditions. Though an accident may meet the definition of an occurrence, certain situations are excluded such as liabilities arising from an auto accident. Liability coverage also applies to liability claims that are there as a result of the action of the insured, the family members residing in the household, and any person under the age of 21 that is in the care of one of the individuals listed.

Coverage E is based on the legal ability to pay, the insurer will only pay when the insured is legally liable. The insurer will only pay the lesser amount of the damage or the amount of the coverage. In addition, coverage E also protects the insured homeowners and family members against personal liability for bodily injury and property damage that may occur on and off the premises because of negligence.

Coverage F

Coverage F covers medical payments to others for injuries that arise even when the insured is not liable for the injuries. Medical expenses include reasonable charges for medical procedures, surgical procedures, hospital stays, ambulances, dental care, x-rays, professional nursing, prosthetic devices, and funeral services. However, the coverage does not cover the medical expenses of the insured or members of the insured’s household.

The payment coverage generally excludes the residence’s employees. A residence employee can receive medical payments under Coverage F if the residence employee is off the premise and in the scope of employment when injured. Medical payments coverage is not a liability coverage and is not based on fault. Coverage F covers injuries that occur off and sometimes in the premise whether or not the injured party was at fault.

Coverage F will pay up to $1,000 for medical payments to others. Due to the fact that medical payments are not based on fault, the insurer will pay regardless of who is responsible. If the insured is liable, Coverage E would pay for the liability.

One of the following conditions must be met in order for an individual to receive medical payment coverage from the insured’s coverage:

The injury occurs while the person has permission to be at the insured location.
The injury occurs while the person is away from the insured location and is caused by a condition at the insured location or on the property immediately adjoining the insured location.
The insured injures another person while away from the insured location.
The injury occurs because of the actions of a residence employee of the insured away from the insured location while the employee is in the course of employment.
An animal owned by or in the care of the insured injures an individual off the insured premises.

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General Provisions Applicable to Section I and II

The policy applies only to losses that are incurred during the period of the policy. It can become void if the insured intentionally misrepresents or conceals any material fact concerning the insurance. Any new endorsement made by the insurer in the term of the policy broadens the policy without any additional premium.

Either party can cancel the contract. The insured can cancel immediately, but the insurance company may only cancel under certain condition and has to give advance notice of cancellation.

Certain conditions have to be met by the insurance company for cancellation:

Nonpayment of premium(requires 10-day written notice)
During the first 60 days, the insurance company can cancel a new policy for any reason, but after 60 days the insurance can only be canceled if there is a material misrepresentation by the insured or if the risk dramatically changes (requires 30 days written notice)
If the policy is written after one year, it may be canceled on the anniversary date for any reason (requires 30 days written notice).
An insurance company may cancel a policy with a five-day notice if the building covered is unoccupied, the building is damaged by an insured peril and repairs have not begun within 30 days, the building is salvageable and fixed items are being removed, or utilities have been discontinued for 30 consecutive days.

If the insurance company is not going to renew the policy, a policy cancellation notice has to be mailed 30 days before the expiration. Assignment of the homeowner's policy will not be valid without the insurance company’s written consent. The insured is required to assign his right of recovery against the third party to the insurer if the insurer pays for a loss that is caused by a third party.

Critical Provisions of Property Insurance

Settlement Options

Replacement- the insurer repairs or replaces damaged property of insured
Abandonment and salvage- a total loss
Pairs and sets- the insurer compensates for the decline in value
Loss settlement basis- can be either an actual cash value (ACV) or the replacement value
Insurable interest- an insurable interest for property insurance must exist both at the time of policy issue and at the time of loss

Coinsurance

Property insurance is usually 80% of the replacement value. If the dwelling is insured for at least 80% of its replacement value, the insurer will pay all claims up to the face amount of the policy minus the deductible.

If the dwelling is insured less than 80%, the insurer will pay according to the following formula: [(face amount ÷ 80% of replacement cost) × loss] – deductible = insurer’s portion

The maximum benefit that an insurer is able to pay is the face amount of the policy.

Follow these Steps to Determine Your Homeowners Insurance Needs

Step 1

The policy’s face amount must be 100% of the replacement-cost value of the home. Annual reviews should be scheduled to make sure that inflation has not increased the replacement value of the home beyond the face value of the policy. It’s important to make sure that the home is covered on an open peril basis to make sure that most risks are covered within the policy except those that are specifically excluded from the coverage. If the home is located in a flood or earthquake zone, flood or earthquake insurance should be added to provide adequate protection.

Step 2

All personal property should be scheduled and valued in preparation for any future claims that are caused by a peril. Endorsements should be added to any property where the value exceeds the normal coverage limit.

Step 3

Appropriate amounts of liability coverage should be chosen to protect the clients from any type of negligence lawsuits.

Step 4

An appropriate deductible amount should be chosen. Increasing the amount of deductible may help reduce the annual premium.

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