Remember when you last purchased homeowner’s or any other type of property insurance? I’m sure a good amount of your time was spent talking about what deductible (the portion of a claim you are responsible for) option you were comfortable with. This is an important conversation to have because we all want to know if we are actually going to need our insurance, how much we will have to pay.
I’ve learned over the years that very rarely do any agents inform their clients about a provision within property insurance policies that can cause a deductible to increase exponentially during a claim.
What I’m talking about here is called co-insurance, which is a familiar term if you have ever owned an individual health policy, but this type of co-insurance is different. It has to do completely with the value that is used to insure a home or any other property.
Let’s say you are buying a home this month and you call your insurance agent to get a quote. He or she will have several ways of determining the value that your home is insured at. If a copy of a recent appraisal is available, that can be used. If a recent appraisal is not available the agent can enter details of the property into a software program that can calculate the replacement cost of the home.
For illustration purposes your home was appraised at $250,000 and that is how much you insure your home for with a $1,000 deductible. You set up your homeowner’s insurance to be billed to your escrow account with your property taxes and don’t think about it again.
Fast forward 10 years… a big storm rolls through your neighborhood and your home is hit by lightning. Your roof starts on fire! You and your family get out of the house and run to the neighbors. You quickly call the fire department, they arrive in time to put out the flames before your home is completely destroyed.
Devastated, you call your insurance company to file a claim. A friendly voice on the other end of the phone assures you that everything will be taken care of. A claim adjuster will be out in the morning to assess the damage.
The next day you meet the adjuster and he walks through the charred remains of your biggest asset. He recommends a few contractors and restoration companies for you to call to start cleaning up the mess. He writes you a check for $1,000 toward extra expenses. Before he leaves, he says he will call in a couple of days to let you know the total amount of the damage and he hands you a packet of information.
Two days later you get one of the worst calls of your life. The adjuster informs you that the total damage from the fire to your home is $100,000. Only there is an issue…the replacement value of your home is now $320,000 but your coverage has not been updated since you first took out your policy 10 years ago, so the insurance company is going to evoke the co-insurance clause of your policy since you are not in compliance.
Here is how you are affected: the co-insurance clause states that your property at all times needs to be insured to a minimum of 80% the total replacement value. Since you were carrying $250,000 in coverage on your home, you were at 78%.
This clause was devised by insurance companies to make sure that people were insuring their homes to value. Otherwise the company would not be collecting the appropriate premium to be able to pay claims. Co-insurance is basically a penalty that is applied to a claim to help the insurance company recoup money it should have collected in premiums.
See why agents don’t get into this conversation?
Back to our example. There is a simple formula that is used to apply the co-insurance penalty. It is:
The amount of coverage you DID have on your home
The amount of coverage you SHOULD have had on your home X The amount of claim – Your Deductible
$250,000
$320,000 X $100,000 - $1,000 = $77,125
Your insurance company is only going to pay $77,125 of your $100,000 claim! Your deductible just jumped exponentially from $1,000 to $22,875!
All of this could have been avoided by an annual review of your insurance coverage. A good agent will re-evaluate your homeowner’s policy on a regular basis and recalculate your replacement value. The amount of premium to have $320,000 of coverage vs. $250,000 would have been at most $100 per year, which is far less than the co-insurance penalty.
If you have an agent that has been offering a review appointment with you and you have been too busy to accept that offer, I highly recommend that you make that appointment as soon as possible.
For those of you who only hear from your agent when he needs to sell something else or your bill is late, contact my office for a free, no-obligation consultation.
Jason Hornung – The Net Worth Doctor
www.thenetworthdoctor.com
Jason@thenetworthdoctor.com
1-866-514-8884 Toll Free
520-514-8884 Southern Arizona Local
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