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Chapter 2 Property and Casualty Insurance for Homes and Businesses
Most people who own a home borrowed money to buy it. The loan
is called a mortgage. The mortgage lender requires the borrower to
carry homeowner’s insurance to cover potential property damage.
Two important concepts in homeowner’s insurance are
replacement cost and cash value. Replacement cost pays the full cost
of replacing a specific item with one just like it. Cash value (market
value) pays for an item’s current value—what you might get for it on
eBay, for example. The difference between the two is depreciation.
Depreciation is the loss of an item’s value over time. A sofa
that cost $2,000 new, for example, may lose $500 in value each year
based on the insurer’s calculations. It would have no cash value after
four years. But, its replacement cost would remain at $2,000 (minus
a deductible) because that is what it would cost to buy a new one.
It is important to be aware of these differences when considering a
homeowner’s insurance policy.
People who rent their house or apartment also need to carry
insurance. While they are not responsible for the physical structure,
they do need to cover their possessions. They also need to protect
themselves from liability in the event someone gets injured at the
house or apartment. An Insurance Research Council survey showed
that 96% of homeowners have homeowner’s insurance, but only 43%
of renters have renter’s insurance.
Policy Types
Most homeowner’s insurance products come in one of several
standard types of policies (HO-2 through HO-8). The policy types vary
in what they cover. Each contains a section on property protection and
a section on liability protection. Liability protection is identical across
all of the policies. With each policy type, the buyer can typically choose
replacement cost or actual cash value coverage for the home.
Four of the policy types are for individuals who own their own
homes, one is for renters, and another is for condominium owners. Yet
another policy is for homes that have low value. Figure 2-1 explains
each policy type. However, some states categorize insurance policies in
a different way. Visit your state’s insurance department website to find
out how homeowner’s insurance is categorized for its residents.
Real World Case
Maria’s parents splurged on a beautiful Oriental rug
for the living room. They spent $3,000 on it four years ago.
Unfortunately, it was one of the items destroyed in a small
house fire this past summer. Because they had replacement
cost coverage, the insurance company reimbursed Maria’s
parents, and they were able to replace the rug with one just like it. If they
had cash value coverage, the insurer may have valued the rug at a much
lower price because it had been in use for four years.