For most individuals and families across America, the home they own or plan to own will likely become their most valuable asset and as such, they must mitigate the financial risk that is associated with homeownership.
This risk represents more than the cost to repair or replace your home and its contents but also represents your personal liability if a third-party happens to suffer injury or property damage while on or in your home. When most people consider their risk, the primary question “how much homeowners insurance do I need” needs to be answered.
In most cases, because most home purchases are financed through a mortgage lender, the homeowner doesn’t have a choice regarding purchasing homeowners’ insurance, but they do have choices when it comes to the limits on certain coverages, deductibles, and the company they choose to purchase their policy from.
In the typical homeowners’ insurance policy, structures (dwelling and unattached structures) are insured at replacement cost value while personal property (contents and personal belongings) is insured for actual cash value.
Replacement Cost versus Actual Cash Value
Replacement cost represents the amount it would cost to repair your home or replace (rebuild) your home if it was considered a total loss. In this valuation, depreciation is not taken into consideration unless the insurance contract has specific language defining it.
The amount of your home replacement cost should be enough money to cover the labor and materials to rebuild your home. It should also include the costs to cover debris removal and architectural plans.
Most homebuyers don’t consider debris removal costs which can be substantial depending on the amount of debris that must be hauled away after your home has been totaled by a tornado, fire, or other covered peril.
Actual cash value represents the amount it would cost to replace damaged or stolen property for its value at the time of the loss. With actual cash value, depreciation is the primary consideration and often leads to passionate debates between the insurance company and the homeowner who has filed a claim. For example, if your 3-year-old 60-inch flat-screen TV is stolen, the insurance company would cover your loss for the cost of a new TV that is similar to your stolen TV minus three year’s depreciation and subject to your deductible.
The Typical Homeowners’ Insurance Policy (HO3)
It’s logical to know what a typical homeowners’ policy will cover before we decide how much of each coverage we need. Although there are several forms a homeowners’ policy can be written on, the form used most frequently is the HO3 form.
This form is popular because it offers a package of comprehensive coverages (similar to your auto policy) with a selection of coverage limits and deductibles.
Here are the coverages provided in the HO3 Homeowners’ Insurance Policy:
Coverage Type of Coverage Valuation What it Covers Typical Limit of Coverage Deductible Applied
Coverage A Dwelling Replacement Cost Covers the structure of the home and any attached/built-in appliances Claims are generally based on replacement cost of the home (land or lot not covered) Yes - Flat amount or % of structure value
Coverage B Other Structures Replacement Cost Covers any structures on the property not attached to the house such as fences, barns, workshops Usually 10% of dwelling limit. Can be increased if needed. Yes
Coverage C Personal Property Actual Cash Value Personal belongings inside and outside of your home 50% of dwelling limit but can be increased or decreased as needed Yes
Coverage D Loss of Use Limit of Coverage Pays for temporary relocation expenses while the home is under repair 20% of dwelling limit Yes
Coverage E Personal Liability Limit of Coverage Pays for medical expenses and legal expenses if found liability for injuries or property damage to a third-party Typically available limits are $100,000 to $1 million No
Coverage F Medical Payments Limit of Coverage Pays medical expenses for third-party injuries regardless of fault Typical limits are $1,000 to $10,000 No
How Much Homeowners’ Insurance do I Need?
Rather than thinking about a specific amount of insurance coverage on your home, we recommend that you consider each coverage as well.
Since we’ve established that your home will be insured for its replacement cost at the time of policy application, that amount can also affect the amount of coverage you have on other coverages unless the carrier you are applying to allows you to change those limits.
Let’s look at each coverage that is available to you and determine how much coverage you should consider for each.
- Coverage A – Dwelling – This coverage limit should at least cover the replacement cost of your home. The purchase price is not the replacement cost of your home; primarily because the purchase price includes the land your home is built on which is not covered by your insurance policy. Although your agent or insurance company will determine your home’s replacement cost, you can calculate this amount yourself by using free estimators such as AIG Homeowners Replacement Cost Estimator.
- Coverage B – Other Structures – Other structures are structures like a workshop, gazebo, or free-standing garage that are not attached to your home. The automatic coverage is equal to 10% of Coverage A – Dwelling. Many companies will allow you to increase this coverage if needed but in most cases, decreasing the coverage will not reduce your premium.
- Coverage C – Personal Property – Typically referred to as contents, the automatic coverage offered in the HO3 policy is 50% of your dwelling limit. Depending on the company you choose, this coverage can be increased for an additional premium or decreased where it may or may not decrease your premium. It’s import to speak with your agent or company representative about sub-limits that are placed on certain valuable property.
- Coverage D – Loss of Use – Loss of use claims are typically used to reimburse the insured if he or she must temporarily relocate while the insured home is under repair or being rebuilt as a result of a covered peril. The automatic limit for loss of use is 20% of the dwelling limit.
- Coverage E – Personal Liability – Your liability limit is extremely important and most companies automatically put a limit between $100,000 and $300,000. Your personal liability limit should be equal to or higher than the total of all your assets that would be subject to liquidation if you are found liable for damages in a claim for personal liability. If you need more liability coverage than your company will offer, you can purchase umbrella coverage up to $5 million or $10 million.
- Coverage F – Medical Payments – Your medical payments coverage provides coverage to pay for medical expenses related to bodily injury caused to a third-party that happens on or in your property without regard to fault. Typically the applicant can choose a limit of coverage between $1,000 and $50,000 depending on the insurer.
When you are applying for insurance to cover your most valuable asset and your risk of personal liability where you have choices when it comes to limits and deductibles, too much coverage is better than not enough coverage. After 25 years in the insurance industry, I cannot think of one instance when a client whose home had been a total loss, complained that the insurance company paid them too much money.
Frequently asked Questions
What personal belongings have sub-limits?
There are 11 categories with sub-limits or special limits. Here are some examples:
$1,500 on watercraft
$1,500 on trailers not used with watercraft
$2,500 on business property on premise
$2,500 on firearms and related equipment
$1,500 on jewelry, watches, furs, and precious or semiprecious stones
If I have a boarder in my home, does my insurance cover his personal property?
No, your boarder’s property is not covered under your homeowners‘ insurance policy. Your boarder should purchase a renters policy if they are concerned about their property.
What kind of insurance should I buy for an historic home?
Older homes contain certain elements in the construction of the home that is better addressed using an HO8 homeowners policy rather than an HO3.
What can I do if I live on the coast and a company doesn’t offer windstorm coverage?
In states that have a very high risk for tropical storms and hurricanes, the state will typically offer windstorm coverage in its high-risk program.