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When buying coverage, you may insure your
property and belongings for actual cash value or replacement
cost.
Replacement Cost
Replacement cost is the amount needed to
replace or repair your damaged property with materials of
similar kind and quality, without deducting for depreciation
(the decrease in the value of your home or personal property
due to normal wear and tear).
Actual Cash Value
Actual cash value is the amount needed to
repair or replace damage to your home after depreciation.
For example, your insurance company would deduct for the age
and condition of a 17-year-old roof with a 20-year life
expectancy.
Here is how the two types of coverage
work in practice.
Let's say you bought a new television in
1994 for $700. In 2005, a lightning strike destroys the TV.
A policy for actual cash value will only
pay an amount that reflects the TV's current value - say
$300.
A replacement cost policy would cover the
entire cost of a new TV of the same type - say $900.
However, you initially will receive only the actual cash
value for your set ($300). When you buy a new television and
present the receipt, you will receive the balance ($600).
For this reason, it is important to keep
all receipts! Replacement cost coverage is triggered only
when you replace the item that was damaged or lost. Your
insurer will require proof of purchase for full
reimbursement.
Your agent must offer you replacement
cost coverage for your dwelling. If you reject this
coverage, you must sign a statement on the application form
indicating that you don't want it. Standard replacement cost
depends upon the dwelling limit stated on your policy.
Insurance companies design most homeowners policies to
require the policyholder to insure the dwelling for at least
80 percent of its replacement cost. And while it is rare,
you can insure your home for less than 80 percent. If you do
so, you will be charged a co-payment penalty, in addition to
your deductible, when you file a claim. Some companies offer
guaranteed replacement cost dwelling insurance - an option
that costs only a few dollars more, and insures your home
for an increased amount, even if it exceeds policy limits.
Many companies will not offer guaranteed replacement
benefits for older homes.
Inflation Guard
Inflation or room additions can increase
the replacement cost of your home and its contents, while
the actual cash value of your home may decrease over time.
An inflation guard endorsement gradually increases your
dwelling's coverage limit annually to keep your insurance
coverage up-to-date with current prices and inflation. It
also may keep the policy value in line with increases in
local building costs per square foot. If your policy lacks
this endorsement, you are responsible for periodically
updating your coverage with your insurance agent or company.
No matter how you insure your home, you
should keep track of its replacement cost evaluation. Check
with your agent or company once a year to make sure your
policy provides adequate coverage.
Most insurance companies cover the
contents of a home (i.e., personal belongings) on an actual
cash value basis. Though you can insure your belongings at
replacement cost, you pay a higher premium. Be aware that
even if you obtain replacement cost coverage for the
contents, you may be paid only actual cash value until you
provide receipts for the replaced items, at which time the
difference between the replacement cost and actual cash
value would be.
Most companies limit the amount to be
paid out on certain types of items. These include such
things as firearms, jewelry, antiques and electronics. Make
an inventory list and review with your agent to find out
whether any of your items have limited amounts of coverage.
You may want to buy higher limits for these items, for an
additional premium.
How Much Insurance to Buy
When you buy a home, you need enough
insurance to protect the structure and your personal
possessions in the event of a loss. Some insurance policies
are written with a limit that is equal to at least 80
percent of the value of the home. This means that if your
home is damaged, you will have to pay for the damages up to
the deductible. If you insure at less than 80 percent, you
will have to pay a co-insurance penalty as well, which means
that you will be responsible for more of the cost of the
damages.
Regardless of what percentage you choose,
this should not reflect the cost of the land on which your
home is built. Unfortunately, some banks and other lending
institutions want you to buy insurance for the entire amount
of the mortgage, including the cost of land.
For example, if you buy a $50,000 lot and
build a $100,000 home, your mortgage would total $150,000,
but you need insurance only for the $100,000 home. Your
insurance company would pay $100,000 if a covered peril such
as an accidental fire destroyed your home, but it would not
pay for the lot. Remember: You need to buy enough insurance
to protect your insurable interest, or the amount needed to
replace your house.
You should contact the Department of
Financial Services Consumer Helpline toll-free at
1-800-342-2762 if your bank tries to make you insure the
entire mortgage amount if it includes the lot.
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