Making sure your home insurance keeps up with your equity

A changing housing market changes more than the price of houses. When people were moving in and out of houses fairly often to take advantage of rising prices and lower interest rates, as they did several years ago, they didn't have to think about what it meant to stay in the same house very long.

Now that people are acting less like nomads and staying put longer, they need to think about some other things, like insurance.

A home that was adequately insured a few years ago may not be so well insured today. Stories of a doubling in value of homes that were bought five to eight years ago are not unusual. So if you're congratulating yourself on all that added equity, check to see if your homeowners' insurance has kept up. Even if the price of the house has not increased much, the cost of labor and materials to replace all or part of it has definitely gone up.

Most insurance policies require that, to be considered fully insured, property be covered at 80 percent of its replacement value. But even at inflation rates of 4 or 5 percent, it doesn't take long to slide under that 80 percent level.

If that happens, you enter the land of what the insurance industry calls ``coinsurance.'' This means that to the extent you are insured for less than 80 percent, you are considered a coinsurer.

Let's say you bought a house five years ago for $50,000. Because of a good location and a demand for housing in your area, it's now worth $90,000. But your homeowners' insurance only goes up to $40,000 (80 percent of $50,000). If there is a total loss, you already know -- to your regret -- that coverage will only go up to $40,000.

Even a partial loss can be trouble if you're underinsured with some companies. Instead of being insured for $72,000 (80 percent of $90,000), as you should be, you're only insured for 55 percent of the $72,000. So if there is $10,000 worth of damage, the insurance company may only pay 55 percent of it, or $5,500, leaving you with $4,500 to pay out of your own pocket.

If you are insured at 80 percent, then you will be reimbursed for actual cash value of the property at the time of loss, without regard to depreciation.

One way to avoid slipping under 80 percent is to insure your house for something above the 80 percent level, say 85 or 90 percent. This doesn't guarantee inflation won't catch up with you, but it does give some room for prices to rise before you can do a periodic checkup of your insurance coverage.

Some insurance companies recommend that this checkup be done every three years. This would include a thorough evaluation and reappraisal of your home and the cost of replacing it at today's prices for labor and materials. In between, you can make an adjustment based on changes in the consumer price index and make any needed updates, as for a new room that may have been added in the meantime. Of course, this will mean correspondingly higher premium payments.

The easiest way to make sure insurance coverage keeps up with replacement value is to buy insurance with automatic escalator clauses or add such a clause to an existing policy. Depending on your insurance company, your coverage will be automatically increased, either by a predetermined amount, say from 5 to 8 percent a year, or by following an index of actual building and labor costs.

There is, however, such a thing as being overinsured. The whole idea behind insurance is to protect against unacceptable losses, the ones you can't afford to pay yourself. Small losses -- broken windowpanes are the most obvious example -- occur more often, so insurance companies charge more to cover them.

The answer to this is to ``self-insure'' against small losses, through a higher deductible. If you can set aside $500 in a money market fund, for example, and take a $500 deductible on your insurance, you could cut the premiums by as much as 20 percent (compared with a $100 deductible policy). Assuming no damage, you save on insurance premiums while the $500 of ``insurance'' in the money fund pays you interest.

You may even be able to handle a $1,000 deductible. If so, you could cut the premium by 25 percent or more.

So what do you do with all the money saved? Well, you could add it to your vacation fund or buy something for the house. Or you could buy more insurance. That may seem inconsistent after talking about buying less insurance, but this is a different animal.

This breed is known as an ``umbrella policy,'' and more people are buying these umbrellas in $1 million multiples. You can get a $1 million umbrella policy to cover your car and home for as little as $70, and probably no more than $120 a year. This protects you against the cost of a lawsuit that might come from an accident involving your car or property.

The growing tendency of people and their lawyers to take other people and their lawyers to court over these things has led to an increased number of damage awards approaching or exceeding $1 million. If you're concerned about the possibility of being sued for more than $1 million, you can buy up to $8 million of protection for about $250.

To get this policy, your basic insurance policy already has to include the maximum liability coverage in amounts set out by your insurance company. This may be $100,000 for residential and $250,000 to $300,000 for autos. Some states have different laws, so the requirement could be $250,000 per person and $500,000 per accident. While the umbrella may be cheap, meeting these minimum coverages to qualify could be expensive for you.

Still, if the umbrella covers the legal costs as well as any damage award up to the policy limit, it could be worth the expense.

If you would like a question considered for publication in this column, please send it to Moneywise, The Christian Science Monitor, One Norway Street, Boston, Mass. 02115. No personal replies can be given by mail or phone. References to investments are not an endorsement or recommendation by this newspaper.

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