Homeowners insurance helps to protect you as a homeowner, and it covers various aspects of your home. This includes the building, your personal property inside the home and medical expenses for injuries sustained by anyone on your property.
Policies vary, but most of them include a standard policy coverage which provides a general protection of the home and property. There are also optional policies which you may select to protect specific items that are important to you.
Although most homeowners have the right insurance, they do not fully understand how it works or what to expect in the event of a claim. The first thing to understand is that home insurance companies have different ways of calculating the value of something, and hence, the amount to be paid out.
Generally speaking, homeowner’s insurance is designed to help replace damaged, stolen, or destroyed personal property but different coverages and methods of calculations means amounts paid for the same items will vary. Here are the most frequently used methods:
Actual cash value vs. replacement cost
Actual cash value is the amount you would pay for a similar item at today’s cost minus depreciation. Depreciation refers to a decrease in value of an item due to age or wear and tear. Replacement cost on the other hand, is the amount you would pay for the same item at today’s cost. Here’s an example to of how it works:
Two years ago, you bought a piano worth $3,000. Unfortunately, your home and some property, including your piano, were damaged by a wild fire last week. You file a claim with your insurance company with the intention of replacing the damaged items, especially your piano, which you found out now costs $3100. So the insurance company ought to cut you a check for $3100, right? Well no, not really. The amount of money you will receive will depend on the type of coverage you have.
If your coverage is for actual cash value: the company will pay you $ 2500. The actual cash value of the piano today is $3,100 but the insurance company will pay you less because a depreciation of $600 is subtracted from today’s cash value of the item.
If your coverage is for replacement cost: the company will pay you $ 3100 because that is what it would cost you to buy a similar piano today. Replacement cost coverage replaces the item at exactly the current cost without factoring in depreciation.
Most insurance companies prefer to give a down payment equivalent to the actual cash value of item and require you to submit the receipt for the bought item before paying you the balance. From the above example of the piano, the insurance company will pay you $2500, which is the actual cash value of the item.
However, with replacement cost coverage, you will be paid $ 2500 first, which is the actual cash value of the item today, and when you submit the receipt showing the actual amount you paid, you will be paid the difference of $600.
Yet another method homeowners should know about is the market value This is refers to the prevailing price that buyers are willing to pay to own your house, regardless of how much it cost to build it. The market value of an item is largely affected by external factors such as state of the economy, demand and location, among others.
The replacement cost of your house on the other hand, is what it would cost to rebuild a house of the same size, on the same spot and with same quality of construction at today’s prices. Again, both of these methods can give two different numbers.
For example, a home located in a depressed city suburb may have a market value of $130,000. The same house, located in an upmarket part of the city, may have a market price of $310,000, even though it would cost the same to rebuild the house after a loss in either location.
In doing their valuation, insurance companies generally use replacement cost, not market value.