Reading the Fine Print on Your Homeowners' Policy

Also, umbrella policies and more on auto insurance.
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If your home is your castle and you are its king or queen, you hope you never see a fire engine parked on your front lawn. Unfortunately, it does happen. I'll never forget driving through the Oakland, Calif., hills a few years ago after a tremendous fire burned up entire neighborhoods. I landed in San Francisco the day after the 1989 earthquake. In the Marina section, homes were burning, sidewalks were buckled, cars were trapped in garages -- it was an ugly mess. Millions of dollars up in smoke.

Hopefully, all the homeowners in these tragedies had good insurance. I asked a couple of experts to help me give you a summary of some key points about homeowners' insurance.

Let's begin with the most important one: "Whether you own or rent a residence, you need an insurance policy," says Arthur Sachs, who has his own property/casualty firm in Westport, Conn.

These policies typically have two sections covering property and liability.

Insuring Your Property

"When it comes to insuring your property, take the highest deductible you can afford," says Sachs. The $100 deductible of the past is simply not a good buy. Even the $250 deductible that is commonly seen may not make sense. By going to a $500 or $1,000 deductible, you reduce your premiums and you protect your future premiums by not asking the insurance company to cover small losses you probably could cover yourself.

A common pitfall in insuring a home is failing to adequately cover the cost of reconstruction. Any good agent will make sure your policy contains a guaranteed home-replacement endorsement. In effect, this says the insurance company will pay the actual cost of reconstruction in the event of a total loss, even if it's more than the coverage limit on the policy.

However, some companies limit the maximum they will pay out to 125% of the policy amount. When you're going through the trauma of losing your home, you don't want to have to discuss a discrepancy between the amount you insured the house for and the amount it's going to cost to rebuild. That discrepancy gives the insurance company undesirable leverage in its negotiations with you. Moral: Be wary of the insurance agent who tries to "save you money" by suggesting you lowball the amount you insure the house for and rely on the policy's home-replacement guarantee provision.

Once you have settled on a proper limit for insuring the structure, you automatically get an additional amount (typically 50% to 70%) to cover your contents. Again, make sure this is adequate to cover the full replacement cost of your household contents, and have your agent confirm that losses will be settled on a replacement-cost basis rather than on a cash-value (depreciated) basis.

Finally, remember that certain classes of contents have caps on the amount you can collect in the event of theft. The main categories to be concerned about are jewelry, furs and silverware, but similar limits apply to certain collectors' items like guns, coins and stamps. Again, as with any exclusion or limitation, this is an invitation to buy additional insurance.

Liability Coverage

Now let's look at the liability section of the policy. It includes the more obvious kinds of claims -- for instance, slips, trips and falls. "It also will protect you against injuries you may cause off the premises of your home," says Sachs. "For example, if you accidentally cut somebody off on the ski slope, causing an injury, your liability coverage could cover any damages. If your policy is properly endorsed, it also should cover you for any 'mental' injury you may cause through slander, false arrest or the like."

The most important part of your policy is the "exclusion" section. This section discusses what the policy does not cover. When you find something excluded that you want covered, you generally can buy a rider or a separate policy. Two common examples are business activities and injuries to employees. If you run a business out of your home (or elsewhere), you need a separate business policy. If you employ a live-in nanny, you need a workers' compensation policy in most states.

Umbrella Policies

There is still one very important building block regarding liability insurance: an umbrella policy. In his email to me, reader

Hugh Campbell

put it this way: "Please tell your readers to purchase a personal umbrella policy which is in excess of auto and homeowners' liability coverage. It is relatively inexpensive. Mine is $240 a year for $2 million."

"You don't have to be a millionaire to be sued like one," adds Peter Levinson, president of

Edward A. Goodman Co.

, a property/casualty firm in White Plains, N.Y. "That's why excess liability coverage, commonly called umbrella insurance, should be part of everybody's coverage."

An umbrella policy provides you with liability coverage for damages for which you or members of your household may be legally responsible. For instance, if somebody gets injured on your property and the damages are beyond what your homeowners' policy will pay, you'll still be covered. It also covers you for libel, slander or infliction of bodily injury.

How much is enough? The answer is very individualized. A common rule of thumb is to cover your net worth -- whatever you could lose in a lawsuit.

Reader

Kevin Jones

has a common concern: "I have an umbrella policy, but it limits protection to $1 million. Thanks to this market, I am now far above this limit. Is there an insurance product that will protect assets over this limit?"

Kevin, ask some property casualty agents, and you will find higher coverage. Levinson says there are companies that offer more. For instance,

Chubb

will cover up to $10 million, he says.

More on Auto Insurance

Following last week's

column about auto insurance, reader

Dale Simmons

of Lakeland, Fla., raised an important point about insuring yourself against other drivers who are uninsured or underinsured. "My wife was in a very serious accident several years ago when we lived in New York state, and our underinsurance was a lifesaver for us," he writes.

The best explanation of this insurance comes from

Peter C. Neumann

, an attorney in Reno, Nev. Peter's email was two pages long, so I can't share all of his comments, but here are some highlights:

"Many people do not realize that uninsured motorist coverage in most states does not include both 'uninsured motorist coverage' (where you are in an accident with a totally uninsured driver)

and

'underinsured motorist coverage' (where you are in an accident with a driver who has

some

insurance, but it turns out to be inadequate).

"Most of my clients are not aware that, even if they have relatively large bodily injury liability limits that cover them for any judgments that result against them, they are probably simultaneously carrying very small uninsured/underinsured motorist coverage. ... You have to ask for higher uninsured/underinsured motorist coverage and pay an added premium for it. But the cost is minimal compared to the protection you will get."

Thank you, Peter. And thanks to all who sent email and to the others who helped me write on this critical subject.

Next week, I'll answer the question that many have asked: How much life insurance do I need?

Have a healthy and profitable week!

Vern Hayden is a certified financial planner with American Planning Group in Westport, Conn. His column is not a recommendation to buy or sell stocks or to solicit transactions or clients. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds. While he cannot provide investment advice or recommendations, Hayden welcomes your feedback at

Hayden@cwixmail.com.