A Look at Basic Coverage for Homeowners

The real inhibitor to shopping for insurance is the difficulty in understanding the basic coverage, never mind comparing companies. Actually, with homeowners insurance, as with many consumer policies, understanding one policy may be enough: “They’re all within half an inch of being like everyone else’s,” says Charles A. Foster, vice president of property insurance for United Services Automobile Assn. in San Antonio, which serves military officers, past and present. “Nobody wants to have a policy any different.”

This doesn’t mean there aren’t choices, starting with the “perils” insured against--fire, windstorm, riot, theft, etc. A policy may cover losses from some perils, many perils or all but a few. War and nuclear disaster are excluded because potential losses are incalculable. Few policies cover losses caused by neglect (leaving windows open in storms), or by flood or earthquake (losses are high, but few areas are at risk, and it’s unfair to make everyone share the cost).

May Be an Inducement

The tougher choice is how much loss to cover. Insurers usually start by calculating what it would cost to replace the house with one of like quality, considering the quality of construction, cost of construction in the particular area and square footage.

Many insurers follow an “80% rule,” or sometimes 90%: If a home is insured for at least that percentage of its value, the insurer will cover the full amount of any partial loss--a kitchen fire, say, or a collapsed roof. (For total loss, which is rare, it pays up to the limit specified.) If coverage is not at least 80%, the company pays only part of a partial loss, following an knotty calculation involving the percentage insured for and a deduction for depreciation.

A common explanation is that a home’s foundation, which is rarely destroyed, is worth about 20% of a building’s cost. But most cost calculations don’t include foundations. The rule may simply be an inducement, “encouraging people to insure closer to the (replacement) value of their house,” says Foster. “Before (the rule), people insured for 50% and said ‘I’ll take my chances.’ ” The greater coverage also serves the carrier “to bring in more premium income,” says Dave Hurst, spokesman for State Farm Fire & Casualty Co. in Bloomington, Ill.

In some states, one can buy “guaranteed replacement” coverage--better than plain 100% replacement because the company promises to pay more, without limit, if the replacement ends up costing more. In other states (California, for example), companies may limit the overpayment: State Farm’s is 125%.

Some Overinsuring

Odder yet, many mortgage lenders require that the coverage equal the amount of the mortgage. Thus, in prime real estate markets where sale prices and therefore loans could run high, one might be asked to insure a modest house in a popular neighborhood for $200,000 or more although it could be rebuilt for $125,000.

This practice is not, as some insurers say, required by federal government guidelines. Nor is it necessary for the security of the lender, whose investment is predicated on the property’s market value: “As long as I get that house replaced,” says Bill Forster, loan service manager for County Savings Bank in Santa Barbara, “I have no problem.”

If lenders have nothing to gain, neither do homeowners: The insurer is not likely to pay more than the replacement value set on the policy. “Why make someone pay more (premium),” says Foster, “when he can never collect? If the replacement value is really $70,000, and I have $100,000 (on the policy), the most I’ll pay is still $70,000.”

The insurer does profit, of course. State Farm’s Hurst explains that “we’re kind of caught in the middle, and we do wind up overinsuring some people. We don’t absolutely refuse to go above replacement cost.”

Amid debate about possible collusion among insurers, lenders and mortgage brokers, some states--California included--have passed laws forbidding lenders to require more than replacement cost coverage. That’s not always the end of it: Lenders are urging modification of California’s 1987 law to specify that the replacement value be determined by the lender rather than the insurer, which could return the question to square one.

As for the dwelling’s contents--the consumer’s possessions--most policies include coverage of 50% to 75% of what the building is insured for, but unless one buys optional replacement cost coverage, the insurer pays the cost of replacing the things minus depreciation. This option is an “endorsement,” an addendum that raises a particular coverage and “becomes part of the policy itself, with the same deductible and the same perils excluded,” says Hurst.

By contrast, “floaters” are optional coverages which may literally be separated from the policy (and not included in the mortgage lender’s copy). Usually providing extra coverage on specific items of extra value (art, jewelry, furs), they generally have no deductible, and, whatever the policy’s exclusions, cover all but a few perils.

Most policies also cover liability for injury to others. This kind of “banana peel” insurance reimburses visitors for slips on the walk and usually travels with the policyholder, paying someone he hits with a baseball several cities away.

This coverage apparently costs the insurer very little: The difference in premium between $100,000 and $300,000 coverage is $10 or $15. But it has a lot of potential: In 1985, to the industry’s horror, a Minneapolis woman got a $25,000 settlement from Prudential Insurance because she contracted herpes from a policyholder at his home.

Many companies also offer small discounts--2% to 15%--to older homeowners, nonsmokers or homes with fire, smoke, or burglar alarms. More substantial savings come with high deductibles: the higher the deductible, the lower the premium. A deductible on a homeowner’s policy of $250 (the most common) saves the policyholder up to 25% over a $100 deductible, says Hurst, and going to $500 saves another 10%.

Depending on the company, one could conceivably choose a deductible in the thousands, limited only by what one could afford to risk. With homeowner’s insurance, as with other casualty coverage, the rule is that one should “self-insure” as much as possible.