Homeowners Insurance: What amount of coverage is needed?

How much would it cost you to restore your life if you lost everything you owned in a fire, flood or other disaster?

That’s the question you should ask yourself when you consider how much homeowners insurance you need.

When buying homeowners insurance, you always have to think about the worst-case scenario and make that your target coverage. Odds are high that any claim you make will be for much less, but a good policy should protect you in the event of a total loss.

Most insurers offer several levels of coverage. On the lower end of the spectrum are the “named perils” policies. These only protect against the risks specifically outlined in the policy such as fire, theft, vandalism, lightening, etc. A basic named perils policy usually covers 11 risks, and a broad named perils policy usually covers 17. An “open perils” policy is more valuable because it covers all possible perils, except the ones specifically excluded, such as earthquake or water damage.

This is the best level of coverage, but it does cost a little more.

There are three basic types of coverage provided in homeowners policies: home structure, possessions and liability.

Home Structure Coverage
This is the most basic coverage provided and is typically required to obtain financing. To determine how much coverage you need on your home’s structure, you have to calculate current replacement costs (avoid cash value policies). Some people make the mistake of basing their level of coverage on the market value of their home, but that’s often not enough.

Particularly now, when home prices are falling so rapidly, it may cost significantly more to rebuild your home than your home is worth on the market. Talk to a local contractor or contact a building association to find out the going cost per square foot to rebuild a home like yours.

Remember to update your policy as costs change with inflation, or you could end up underinsured in just a few years.

Possession Coverage
Determining how much coverage you need for the contents of your home requires a complete inventory of your possessions. Estimate how much they would cost to replace at current prices (not what you paid). Most policies will cover your possession at 50 to 75% of the coverage of your home’s structure, but you can buy coverage more if needed. Make sure to buy a policy that provides replacement protection, not “actual cash value.” Cash value coverage factors in depreciation and rarely provides enough to replace what’s been lost.

Liability Coverage
Liability coverage protects you if someone is injured in your home and sues. Standard liability protection in homeowners insurance is usually between $100,000 and $300,000, but that may not be enough. You need at least as much coverage as your net worth (assets minus debts) if not more. If you need more coverage, buy an umbrella liability policy. An umbrella policy provides extra protection to your home and auto insurance. You can usually add on a $1 million umbrella policy for a few hundred dollars a year.

What’s Not Covered?
It’s important to know what is not covered in a standard policy so that you can buy extra coverage if needed. Some natural disasters, like earthquakes, floods and mudslides, are not covered. You can buy earthquake and flood policies to add onto your homeowners insurance if you live in a risk area. Additionally, you’ll need to take out a rider to cover pricey items like jewelry, art, antiques, etc. The value of these items can push you over the standard maximum coverage in your policy.