While homeowners may feel they have an adequate understanding of their coverage, when it comes time to file a claim, they may realize they did not have the type of policy they thought they did. For this reason, it is important to know about the different levels of coverage and how an insurance company will calculate their contribution towards home repairs or replacement, the replacement of your personal belongings, and what type of damage or disasters are covered. Understanding these differences ahead of time will help you properly protect yourself as a homeowner.
Replacement Cost Policy vs. Actual Cash Value Policy
So while standard home insurance policies protect you against the loss of or damage to the structure of your home and personal belongings, it is important to understand your level of coverage and how insurance companies calculate what they will pay for your losses. The most favorable type of policy for homeowners is a replacement cost policy. This is what most people think of when they talk about home insurance. With this level of coverage, the insurance company will pay the full cost for replacement or repair, minus the deductible. While these replacements must be of a similar kind and quality, this type of policy does not take age or depreciation of items or the home itself into consideration.
However, there are also actual cash value policies, which do consider the depreciated value of your home and personal belongings. At this level of coverage, the insurance company will pay the replacement or repair cost less depreciation and the deductible. This type of policy is most beneficial to insurance companies since they are only obligated to reimburse a portion of the actual cost of replacement.
For example, if your television and other electronics are stolen, a replacement cost policy would pay to replace the stolen items with new ones of similar kind and quality, minus your deductible. However, an actual cash value policy would cover less, issuing payment for the replacement value, minus the depreciation of the items and your deductible. With an actual cash value policy, this would be equivalent to the price an insurance company estimates you could get for the items, considering their age and use, if you were to sell them in the marketplace.
However, if for some reason a homeowner with a replacement cost policy chooses to cash out and not complete the repairs or replace the items that were lost, the insurance company will more than likely reimburse them only for the depreciated value, minus the deductible.
Open Peril Policy vs. Named Perils Policy
Another important aspect of a home insurance policy is what type of damage or losses are covered. An open peril policy provides coverage for all risks except for those specifically listed as excluded. For example, standard home insurance policies may exclude coverage for home maintenance items like the replacement of an old roof, worn paint, or rotted gutters. Additionally, insurance policies may exclude perils which require additional policies, such as flood or automobile insurance. With these types of policies, the wording will explicitly state what is not covered. Homeowners 3, or HO-3, policies are the most popular type of policy, and are open peril policies as outlined by the Insurance Information Institute (III).
Other times an insurance company may issue a named perils policy. These types of policies will list the specific perils that are covered, such as fire, wind, hail, theft, or vandalism, to name a few. These are more basic insurance policies, most commonly Homeowners 1 (HO-1) and Homeowners 2 (HO-2), though HO-1 policies are no longer offered in most states according to the III. Separate coverage may need to be purchased for any perils not listed on the policy.
Open peril policies are typically more comprehensive and therefore more expensive, but may offer greater peace of mind. However, some homeowners may prefer to pay for coverage to protect only against the most likely causes of loss or damage. While there is greater risk involved with these types of policies, it is up to the homeowner to weigh the long terms costs of more expensive premiums versus the potential for loss.
Please note, home insurance policies in Texas may differ from these standards. Texas residents researching the different types of policies available to them are encouraged to contact their insurance agent or the Texas Department of Insurance for more information.