Home Insurance

What It Means

A home insurance policy is a contract between an insurance company and a homeowner that protects the homeowner from financial losses that can result from damages to the structure of his dwelling and to the possessions stored in that dwelling. There are many different types of home insurance policies. A typical policy covers a wide variety of potentially costly damages to the house, the garage, and other structures on the property, such as storage units. Personal possessions covered in most insurance policies include furniture, appliances, clothing, and items stored in the garage (such as bicycles and power tools). Home insurance policies also cover injuries suffered by visitors to the property. For example, if a guest cut herself on the host’s chain-link fence and required stitches, the medical expenses would be covered by the host’s home insurance policy (assuming it was established that the injury was not caused by negligence on the part of the host or the guest).

The extent of the perils covered by a home insurance policy depends on the type of policy, but a typical policy will protect against windstorms, fire, and theft. Most people purchase “all-risk” (also called “open-peril”) homeowner’s insurance, which protects against all perils except those specifically excluded in the policy. All-risk policies often exclude damages caused by floods and earthquakes; protection from these natural disasters can be purchased separately. Most homeowner’s policies do cover damages resulting from volcanic eruptions and hurricanes, but the deductible for hurricane damage is usually quite high. (A deductible is a previously agreed-upon amount of money that the homeowner has to pay toward the repairs before the insurance company makes its contribution.) The deductibles for hurricane and storm-related damage are larger in high-risk areas such as the Gulf Coast states, which include Texas, Louisiana, Mississippi, Alabama, and Florida. Damages caused by war are excluded from all policies.

When Did It Begin

Homeowner’s insurance developed in the United States during the 1950s. Prior to that, American homeowners had to purchase separate insurance policies to cover losses from theft, damage to personal property, fire, and other perils that could affect a person’s home. Although it became possible in the 1950s to buy a single policy that insured against most types of damage to a home, these policies varied from company to company and were often difficult to understand. A crisis soon emerged for both insurance companies and consumers. On the one hand, insurers had limited access to data that allowed them to screen potential customers and to determine accurately the risk they were assuming by insuring homes in certain areas. Customers, on the other hand, had trouble comparing policies among companies because the language was incomprehensible to anyone not trained in the field of homeowner’s insurance.

To alleviate these problems, in 1971 Insurance Services Organization (ISO) was established as a nonprofit agency in Jersey City, New Jersey. ISO developed a comprehensive database that provided insurance companies with records on millions of insurance policies and on insurance fraud. This helped the companies limit fraud by screening both potential clients and employees. ISO also sought to help insurance customers by provided standardized language for insurance policies. As of 2007 there were seven standardized home insurance policies, numbered H0-1 through H0-7. The most commonly purchased homeowner’s policy is H0-3, also known as an all-risk policy. It protects against damage to all aspects of the home’s structure and contents and against injuries suffered by visitors to the property.

More Detailed Information

A home insurance policy is effective for a fixed period of time, which is called the term of the policy. After the term expires, the provider maintains the right to cancel the policy. Many providers will choose to do so if the insured party makes too many costly claims against the policy (a claim is a report of loss and a request for reimbursement). The price of the policy is called the premium. Insurance providers base premium amounts on the risks they assume when underwriting (granting) a policy. For example, if a person buys a home in a location where natural disasters are rare, her premiums will be relatively low compared to the premiums for a policy on a house along a waterfront. A house with a burglar alarm and a smoke-activated sprinkler system lodged above the kitchen stove will cost less to insure than a home without these precautionary devices. If they choose not to cancel a policy at the end of term, most providers will at least raise the premiums of those who make numerous claims on the policy.

Homeowner’s insurance is not required by law in the United States. The overwhelming majority of Americans who buy homes, however, do so with a home loan (also called a mortgage), and mortgage lenders require borrowers to purchase homeowner’s insurance as a precondition of granting the loan. Lenders do this to protect their own interests, because until the loan is paid off, the lender owns part of the home, so if the house were to be destroyed, it would be a loss for the lender. With insurance, in the event that the home is destroyed, the insurance company would be required to pay off the rest of the loan, and the lender would recoup its loss. In most cases, the premium for the home insurance policy is included in the borrower’s monthly payments to the mortgage lender.

A mortgage lender may not require homeowner’s insurance if the value of the land on which the house is built is equal to or greater than the balance (the amount remaining) on the borrower’s loan. For example, if a borrower had only $40,000 left to pay on his mortgage, and the plot of land on which his house was constructed was appraised at $50,000, then the lender may not require him to continue maintaining a home insurance policy. In such a case, if the uninsured home were destroyed and the borrower could not pay the balance owed on the loan, the bank would foreclose the loan, or repossess the property, and thereby immediately recoup the value of the outstanding balance on the loan.

Although home insurance policies exclude some notable disasters, they do cover a wide range of costly damages. For example, most policies include protection against water damage (other than that caused by floods or homeowner negligence). For example, if an early frost hit, causing a homeowner’s water pipes to freeze and burst, the insurance company would pay for repairs. If a policyholder had tile damage resulting from a chronically leaking hot water heater, however, the insurance company likely would not pay for repairs. If there were ice damage from hail or from the weight of ice gathered atop the house, most policies would cover the necessary repairs. Policies also protect against violence and vandalism. This means that if a teenager threw a rock through an expensive picture window or drove across a homeowner’s lawn, expenses for repairs would be covered by the insurance policy. Most home insurance policies also include a provision called “loss of use,” according to which the owner of the policy is reimbursed for the expense of having to live in another residence while his home is being restored following a disaster.

Many homeowners seek additional coverage such as extended replacement cost coverage. Such coverage pays a certain amount above the policy limit, usually 120 to 125 percent, to repair or rebuild a home that has been destroyed by a peril covered in the policy. Most policies account for inflation (the overall rising of prices throughout the economy), which means that the company agrees to pay a higher amount for repairs later in the policy as such costs rise. Some events, however, cause repair prices to rise well beyond the rate of inflation, in which cases extended replacement cost coverage is a great benefit. For example, if a hailstorm caused significant damage to 1,000 roofs in a given neighborhood, roofers in the neighborhood might conspire to charge exorbitant rates for repairs because the demand was so high. While an insurance agency might properly assess damages at $5,000, a roofer may ask for $6,500. In such a case, extended replacement cost coverage would make up the difference.

Recent Trends

At the start of the twenty-first century, premiums for homeowner’s insurance were rising significantly throughout the United States because of an increase of claims for damages caused by severe weather conditions such as hurricanes, hailstorms, droughts, floods, and wildfires. Whereas in the early 1970s insurance companies paid between $2 billion and $3 billion annually for property damages, from 1995 to 2005, companies paid an average of $15 billion per year in property damages. Three times in that span annual damages totaled more than $25 billion, including a record high of more than $45 billion in 2004. That year $30 billion was paid out for hurricane damages alone. After the catastrophic losses in 2004, the National Association of Insurance Commissioners scheduled a meeting in New Orleans for September 2005 to discuss the effects of global climate change on insurance premiums. That meeting was canceled because of Hurricane Katrina, which flooded and severely damaged the city.

No state has been hit harder by severe weather than Florida, where insurers paid $25.1 billion in 2004 and another $10.8 billion in 2005. According to some reports, the storms of 2004 completely exhausted the claims-paying capacity that Allstate Floridian Insurance Company, one of the leading issuers of homeowner’s insurance in the state, had built (by collecting premiums from customers) over the previous 10 years. Following the two successive years of crisis, hundreds of thousands of homeowner’s policies were canceled in Florida. In the wake of the disasters, many companies refused to write new homeowner’s policies, leaving Floridians to purchase insurance from the state-owned Citizens Property Insurance Corporation.