Friday, October 16, 2009

Don't Forget to "Renovate" your Homeowners Coverage

Given the current economic times, flat or decreased housing sales & tight credit, many homeowners are putting money back into there homes in the form of remodeling projects. These can be anything from just general maintenance jobs to full blown additions. Usually forgotten in this process is the Homeowners Insurance Policy (HO) and that can be a very costly error.

Often people will spend thousands of dollars on major modifications to their home and not even consider if or how their insurance may be affected. If the modification includes any kind of structural modification or addition, there could be serious impacts to their coverage. This oversight could lead to serious complications later on down the road should some type of major loss occur and valuation questions start coming in to play.

Most HO policies are written on a Replacement Cost (RC) basis. As part of the conditions of the RC coverage it is incumbent upon the insured to maintain an accurate RC insured value; else they could be in violations of the terms of the contract and loss settlement penalties could be applied. For example, let’s say you have an insurance policy on your home with an accurate RC limit of $200,000 and a $500 deductible. In the spring you put on a $75,000 addition but fail to report the addition to your insurance company. The following fall, there is a major fire and the ensuing damage results in a $100,000 loss. When the insurance company adjusts the loss they note the addition and inform you they are going to apply a co-insurance penalty to the loss.

Co-insurance is the minimum amount of insurance on a % basis of the actual replacement cost value of the home you are required to carry in order to maintain the RC settlement option. This % can vary by insurance company and policy, but typically as it relates to HO insurance policies it is 100%. If you do not maintain the proper limit, the insurance carrier can apply the co-insurance penalty which as a factor determined by dividing the amount of insurance carried by the amount of insurance required. The factor is then applied to the amount of the loss to determine the actual settlement amount less your deductible.

In our example we will use a 100% co-insurance requirement. Therefore to determine the co-insurance factor we will take the amount of insurance carried - $200,000 and divide it be the amount required - $275,000. The resulting factor is .72 or 72% (200/275 = .72). We then multiply that against the amount of the loss, in this case $100,000, and subtract the $500 deductible; the result is a settlement amount of $71,500 (100,000 * .72 = 72,000 - $500 = $71,500). A $28,000 mistake that could have been avoided.

Besides the valuation pitfalls, there are many other reasons to contact your independent insurance agent regarding any planned renovations before you get started. Depending on the extent of the renovations and your insurance company, you may eligible for credits or a change in rating tier based on the specific company underwriting guidelines. You may need to add a specific rider to your policy or change coverage all together to allow for the unique exposures (i.e. Theft of Building Materials) related to building renovations. Your agent can assist you with the process of hiring a contractor, especially with regard to evaluating the contractors insurance as it relates to your specific project.

So before you pick up your hammer, pick up the phone and call you independent insurance agent. Spending a little time now can you save you immensely down the road!