You just sustained a fire loss to your home but, thankfully, no one was injured. The fire department reached your home quickly enough that only the garage, family room and part of the kitchen were damaged. It is an emotional process to see your home and your possessions lost, but you have home insurance, and that should take care of the financial loss. The insurance adjuster arrives to the home and after sympathizing with your loss they calculate the damage to the home to be $100,000. However, the story goes from bad to worse when the insurance adjuster hands you a check for $80,000. Suddenly you become disappointed, then angry and frustrated. How could this be? Why do I pay for insurance if it doesn’t take care of me when I need it? I don’t have an extra $20,000! This is when the insurance adjuster mentions a phrase you never want to hear again, “Insurance to Value”.
What is “Insurance to Value”
Insurance to Value is a provision in most home insurance policies that states you must insure your home to a specified percentage of the value of the home. This requirement is normally 80%-100% of the cost to replace or rebuild the property (not the market value). In return to complying with this provision, the insurance company usually offers lower rates. However, if the Insurance to Value requirement is not met, you are considered “underinsured” and can be penalized when a property claim is filed. The penalty is calculated using the formula below.
Insurance Carried on Property
————————————– X Damage Amount = Amount Paid by Insurance
Insurance Required on Property
Let’s revisit our example to see why the Insurance to Value provision caused the insurance company to pay $20,000 less than the $100,000 of damage you suffered in the fire. After letting you blow off some serious steam, the adjuster explains that the amount of “Insurance Carried” on your home insurance policy was $200,000 but the “Insurance Required”, based on your 100% Insurance to Value provision, is $250,000. Thus, you are underinsured by $50,000 or 20% and your $100,000 of fire damage is only covered for $80,000*.
————————— X $100,000 (Damage) = $80,000 (Paid by Insurance)
How Can I Protect Myself
I know this example may sound extreme but it can and does happen. It is estimated that 60% of homes are underinsured by as much as 20%. Here are some tips to protect yourself from being underinsured and from being disappointed if you have a home insurance claim.
1. Contact your agent to find out what your “Insurance to Value” requirement is on your home insurance policy. The impact can be significant if it is 80% or 100%.
2. Have your agent calculate the replacement cost value of your home and find out if you are underinsured. Even if you have to pay a few extra dollars to increase the coverage on your home insurance, it is much better than going through a claim that leaves you paying thousands of dollars out of pocket.
3. Make sure to contact your agent anytime you upgrade, improve or make an addition to your home because this may change the amount of insurance you are required to carry. See more on this subject in our prior blog post “Don’t Improve Your Home Without Improving Your Insurance”.
4. If you are shopping your home insurance, make sure to ask what the Insurance to Value requirement is and how a partial loss and total loss claim would be handled. Not all insurance companies handle this the same way and this is a great example why shopping insurance solely on price can be dangerous.
Were you aware of this important home insurance penalty? Please leave questions and comments below.
* This example assumes the actual cash value settlement option is less than the Insurance to Value option