How Much Do You Need?

Buying enough homeowners insurance should be a fairly straightforward matter of getting ample coverage to rebuild your house and replace its contents in the event of a total loss. You also want to protect yourself in case someone gets injured on your property and sues you for all you're worth. But how much is enough? That's not an easy question. Twenty minutes on the phone with a direct seller can yield a rough figure, based on your location, the size of your mortgage and the number of rooms in your house. But is that ballpark number really in the ballpark? To help you find a better answer, we've broken the process down into its components so you can better gauge your own needs.

There's Nothing Funny About "HO, HO, HO."
The insurance industry is nothing if not arcane. No better example is the system of naming the various types of homeowners policies with a stream of HOs: HO-1, HO-2, HO-3...you get the idea. Each HO refers to a different type of policy, broken up by what they cover and what they don't. These policies are pretty much industry standards, but the terms and coverage offered by any given company can vary.

HO-1: This is known as "basic" homeowners, and boy is it basic. Sometimes dubbed "named-perils," it only protects against 11 mishaps, including fire, lightning, windstorms, explosion, riot, theft, vandalism, smoke, and volcanic eruption. Many states are phasing out this kind of coverage, since it is so limited.

HO-2: These so-called "broad" homeowners policies protect against 17 named perils, adding things like falling objects, weight of snow and ice, freezing of plumbing and damage caused by faulty electrical and heating systems.

HO-3: This kind of "special" homeowners policy makes the most sense for the most people. While it costs more than HO-1, it is a lot more valuable. Instead of naming a bunch of unlikely perils like "riots," HO-3 policies protect against all perils except the ones explicitly excluded from the policy. Earthquake, flood protection, war and nuclear accident are almost always excluded.

HO-4: This is the policy that renters buy. It will protect your possessions against the same 17 named perils names in the "broad" coverage, but not the structure itself. To save a few bucks, you usually don't have to buy liability protection with these policies.

HO-6: If you own a co-op or condominium, this is the insurance for you. It covers personal property and provides liability coverage. But, similar to a renter's policy, it doesn't cover the structure, since the building will have its own policy.

HO-8: If you have a beautifully crafted older home, you may not be able to obtain a guaranteed replacement policy. The reason: Insurers figure the cost of rebuilding an older home with the original materials is prohibitively high. An HO-8 is your alternative. It covers you against the 11 named perils designated in an HO-1 policy, promising to repair the damage (but not necessarily using the same quality materials), or pay you the actual cash value of your home, minus depreciation.

Coverage for Your Home's Structure
The conventional wisdom used to be that you only needed to buy enough insurance to cover 80% of the costs of rebuilding your home, since it was unlikely that a home would be completely destroyed. But disasters of the early-90s, including the fires in California's Oakland Hills and Hurricane Andrew in the Southeast, disproved that wisdom. Your best bet is to buy insurance to cover 100% of rebuilding.

How much would that cost? When it comes to signing up for an actual policy, a company representative (or an agent, if you used one) will perform some complicated calculations to determine the official replacement value of your home. But while you are shopping around, you can come up with a rough estimate for how much coverage you'll need simply by multiplying the square footage of your home by the local building costs. You can ask your agent, appraiser or builders' association for local construction costs per square foot for your kind of home. Then, add on how much it would cost to replace any extras like central air or a Jacuzzi.

Once you arrive at a figure, you have another decision to make: How do you want to be compensated in the event of a loss? Typically you have two choices. The cheaper policy is called "cash value" insurance. It pays you cash for what the destroyed property was worth at the time of destruction, including depreciation. The more expensive option is "replacement cost" insurance, which covers what it would take to rebuild your house with similar quality materials. This type of policy, however, usually has a price cap of 20% above face value.

With replacement policies, make sure that you have an accurate estimate of the cost of replacing your home. (Remember, this cost could be significantly higher than your market price.) Construction and labor costs, as well as the cost of materials, can increase dramatically over the years and if you don?t update your cost estimate regularly, you might find yourself severely underinsured. Your best bet is to check annually with local contractors?not just your insurance agent?to see how much it would cost to rebuild your home. You can also purchase an inflation guard clause, but even then you still need to check periodically to make sure you?re covered properly. And if you have something extraordinary, like a fireplace made of Italian marble, make sure you get a rider. Your 120% cap is not going to cover expenses like international shipping.

Some companies still offer "guaranteed" replacement policies that cover the full amount needed to replace your home and its contents no matter how high the bill. This is becoming increasingly rare, however, and you?re more likely to find that the maximum insurance available to you is replacement coverage with a 120% limit. Bear in mind, even if you do have guaranteed replacement coverage, you will not be covered for the cost of upgrading your home to meet building codes that have changed since the policy was issued. (To cover your exposure in that case, you?d need to buy a rider). Unfortunately you also can?t rely on your insurance provider to stay up-to-date on building codes?it?s up to you.

Which sort of coverage you buy is a function of what makes you comfortable and how much you can afford. Or how good a deal you can find. Guaranteed replacement is obviously the best kind of coverage to have. But it can cost as much 10% to 15% more than cash value. The cost of guaranteed is usually much closer to the average cost of standard replacement value coverage. But that's because you have to meet strict requirements to qualify for guaranteed and it isn't offered at all in areas prone to disasters.

One more note: You'll need to keep your insurance company abreast of any improvements or additions you make to your house over the years so you won't be stuck with insufficient coverage. Also, it sounds obvious, but make sure you read all the small print before you sign any contracts. After disaster strikes, you don?t want to be surprised to find out that your hardwood floors (or some other item) was not covered.

Coverage for Your Possessions
Figuring out what the contents of your home are worth is certainly tedious. But the effort is worth it. Most companies cover your possessions for 50% to 75% of whatever your home's structure is insured for. If you have a lot of nice things you may need more.

To figure out how much coverage you need, you have to do an inventory, listing everything you own. Estimate the value of the possessions at current prices. If it all adds up to more than the amount your policy specifies, you'll have to purchase extra coverage. Performing an inventory may sound like a lot of work, but you'll need it to prove ownership when it comes time to file a claim.

Make sure your policy covers what it would cost to replace your possessions and not what insurers term the "actual cash value." Even policies that cover replacement cost for the structure may deduct for depreciation for your goods. That would mean you might only get a few hundred for your nine-year-old couch, instead of the $2,000 it takes to replace it. You also need to check the limits on certain personal items, such as jewelry, computer equipment, and antiques. Chances are if you own these things you'll need a rider to cover them.

Liability Coverage
Most policies come with $100,000 to $300,000 of liability coverage, but unless you have less than that in assets you should buy more. You can make a quick estimate of your net worth by adding these elements: 1) Your salary, 2) The value of the equity in your home (estimated market value minus what's left on your mortgage), 3) Your investments, 4) The value of any real assets (jewelry, art, land etc.) and 5) The value of your business, if you have one. Then subtract any other debts, such as credit card balances or student loans.

If the total tops $300,000, you should consider buying an umbrella liability policy. These sit above both your auto and homeowners policies to augment whatever levels of liability coverage you elected in those cases. Oddly, umbrellas also cover you if you are sued for libel, slander or defamation of character. A good strategy is to raise the liability coverage of both your homeowners and your auto policy to $300,000. Then buy a $1 million umbrella policy (or enough to cover your assets). It doesn't cost that much -- $200 to $300 should do it -- because the coverage only kicks in after you've exhausted the $300,000 liability limits in the other policies. (Go to the auto insurance section for a broader discussion of auto policies.)

Riders: You May Need One or More If…
You Own Jewelry
You Own Art & Antiques
You Own a lot of Silverware
You Own Oriental Rugs
You Have a Home Office
Building Codes Have Changed
Zoning Laws Have Changed
You Live in an Area Prone to Floods and Earthquakes

You Own Jewelry
If, in a violent windstorm, a tree branch blows through your bedroom window and crushes your $2,500 Rolex, there's no problem. A windstorm is one of those "named perils" in your insurance policy. But if your timepiece is stolen, watch out. Basic insurance policies exclude theft from named perils when it comes to jewelry, and they limit coverage to a maximum payout of $1,000. Better to purchase a jewelry rider, also known as a "personal-articles policy" at some companies, which costs about $1.50 per $100 of coverage. (If you keep your jewelry in a safe deposit box, you can shave 40% to 50% off the cost of the rider, according to the Independent Insurance Agents of America.) The policy should itemize each piece of jewelry insured, including its appraised value. That way, if a piece is lost or stolen, you and your insurance company have already agreed on its worth. Another advantage of a jewelry rider, or any rider for that matter, is that it covers you for a loss that occurs off your property. So if you lose your wedding ring playing touch football at the local high school, your jewelry rider covers its replacement.

You Own Art or Antiques
Basic policies usually limit contents coverage to 50% to 75% of the face value of your homeowners policy. For most people, that's enough. But if you have a lot of expensive antiques or fine art, you may want to purchase a rider that covers those items separately. Considering what they cover, fine-art riders are surprisingly inexpensive, costing about 25 cents per $100 of coverage. Another advantage of having a rider to cover fine art is that a loss claim won't count against your total contents coverage.

You Own a lot of Silverware
Silverware is covered for all named perils except the most likely one: theft. If someone breaks into your home and takes off with the family silver, you're usually limited to $2,500 worth of coverage -- unless you have a rider. The cost of a rider to cover you is less than $1 per $100 of coverage.

You Own Oriental Rugs
Most standard homeowners policies limit the reimbursement for damage to Oriental rugs to $5,000 on any one rug and $10,000 total. At less than $1 per $100 of coverage, an Oriental-rug rider can save you a lot of wear and tear.

You Have a Home Office
If you fancy computers, or if you have a home office, there's a good chance your homeowners policy doesn't cover the full cost of your investment in technology. Some homeowners policies limit coverage for office equipment and furniture to $1,000. In addition, the liability portion of a policy won't cover you if a client falls on the stairs

For smaller home offices, where the value of the equipment is under $10,000, you can simply add a rider to your homeowners policy. Rates vary from state to state, but it should cost about $75 to $100 a year to increase coverage to $10,000. You can also buy a commercial package policy to cover everything in your home office, including employees. Cost: about $100 per $5,000 worth of equipment. The RLI Insurance Co., in Peoria, Ill., for example, charges between $150 and $280 per year for its basic In-Home Business Policy, depending on where you are and your type of business. For this, you get $300,000 in general liability for your business, $5,000 on- or off-site property coverage, plus additional coverage for loss of income and medical expenses.

Building Codes Have Changed
Replacement-cost coverage doesn't cover the cost of meeting new building codes. This is a particular concern if you own an older home. You may be required to construct a sturdier foundation, install costly windows and more layers of insulation if you have to rebuild. If building codes have changed since your home was built, consider buying what insurers call code-and-contention coverage. Some companies, such as Safeco, include code coverage in the terms of their basic policy. Otherwise, the coverage will add 10% to your base premium.

Zoning Laws Have Changed
Some policies also make it difficult to rebuild off your original site -- even if you have to. Many homeowners learned this after the fires that tore through Southern California in 1993. When the smoke had cleared, many residents learned that they couldn't rebuild on their original site because their neighborhoods had been rezoned as hazardous areas. If the cost of rebuilding on a new site was more than the face amount of the coverage, tough luck. Most policies paid only up to the policy's face amount. To protect yourself, make sure your policy states that you can build your exact house, no matter what the cost, on a different lot. If it doesn't, you'd be wise to purchase a new policy that specifically allows you to do so.

Flooding or Earthquakes
These aren't covered under a standard policy. While you can buy extra insurance to cover earthquake damage, if your home is in an area vulnerable to flooding, call the Federal Insurance Administration at 800-427-4661 and ask about the National Flood Insurance Program.