What it means
A standard policy bundles several different covers into one contract. The dwelling section pays to rebuild the structure, the contents section covers what is inside, and the liability section pays legal costs and damages if a visitor is hurt or the owner accidentally damages someone else's property.
Most policies also fund temporary accommodation while a damaged home is uninhabitable. For a business audience the policy matters in two ways.
Many small business owners run the company from home and wrongly assume the household policy covers stock, equipment or client visits, which it usually does not. Lenders and landlords also treat proof of cover as a routine condition, so a lapsed policy can trigger a breach of a loan agreement.
Premiums are set from the rebuild cost, the location, the claims history and the deductible, which is the amount the owner pays out of their own pocket on each claim. Raising the deductible lowers the premium because the insurer is exposed to fewer small claims.
The sum insured should reflect rebuilding cost rather than market value, since land is not destroyed by fire and does not need insuring. The nuance that catches people out is the coinsurance clause, which requires the owner to insure a set proportion of full rebuild cost, commonly 80%.
Insure less than that and the insurer scales down every partial claim in proportion, even when the loss is far smaller than the sum insured. That single clause explains most of the angry disputes that follow a kitchen fire or a burst pipe.
Cover comes in replacement cost and actual cash value forms, and the difference is large. Replacement cost pays what it takes to buy a new equivalent item, while actual cash value deducts depreciation, so a ten year old roof might be settled for a fraction of the cost of a new one.
Flood and earthquake damage are typically excluded and need separate policies.
In practice
Real-world examples.
Example
A freelance photographer stores $18,000 of camera equipment at home and assumes the contents section covers it. After a break-in the insurer pays only the $2,500 sub-limit that applies to business property, and she moves the kit onto a commercial policy the following week.
Example
A couple buying their first house are told that completion cannot go ahead until a policy is in force. Their broker arranges cover for the $310,000 rebuild figure taken from the survey rather than the $525,000 purchase price, and the premium is lower than they expected because land value is excluded.
Example
A homeowner who extended the kitchen three years ago never told the insurer, so the sum insured still reflects the smaller house. When a burst pipe causes $40,000 of damage the insurer scales the settlement down under the coinsurance clause, and the family pay the difference from savings.
Think of it
“Homeowners insurance protects your home and stuff-coverage for your property.
Formula
Calculation
Claim payment = loss amount x (sum insured / (coinsurance percentage x full replacement cost)), less the deductible
A house would cost $400,000 to rebuild and the policy carries an 80% coinsurance clause, so the owner is expected to insure at least 0.80 x $400,000 = $320,000. The owner has insured the home for only $240,000. A storm then causes $60,000 of damage, and the policy has a $2,000 deductible.
The insurer applies the ratio $240,000 / $320,000 = 0.75, so the loss is settled at $60,000 x 0.75 = $45,000, and after the $2,000 deductible the owner receives $43,000. The $60,000 - $45,000 = $15,000 shortfall falls on the owner purely because of underinsurance, on top of the deductible, which is exactly what the coinsurance clause is designed to do.Case study
Seen in the real world.
The following case is illustrative and entirely fictional. Marchbank Joinery, an invented ten person cabinet making firm, was run from a converted garage attached to the owner's house. The household policy had been renewed automatically for nine years and the rebuild figure had never been revisited.
When a faulty extension lead started a fire, the loss adjuster valued the full rebuild at $520,000 against a sum insured of $312,000, well below the 80% the policy required. The structural claim was scaled by $312,000 / $416,000, or 75%, so the $180,000 of fire damage was settled at $135,000. The business machinery in the garage was excluded outright as commercial property.
The fictional owner covered the $45,000 gap with a loan and, at renewal, split the arrangement into a household policy indexed to rebuild cost and a separate commercial policy for the workshop. The extra premium came to a few hundred dollars a year against a shortfall that had taken most of the firm's cash reserve.
Watch out
Common mistakes.
- Insuring the house for its market value instead of its rebuild cost, which usually means paying for cover on land that cannot burn down.
- Assuming flood damage is included, when in most markets it needs a separate policy or an explicit endorsement.
- Never updating the sum insured after an extension or a run of building cost inflation, which quietly triggers the coinsurance clause.
Questions
People also ask.
Does homeowners insurance cover a business run from the house?
Only in a very limited way, since stock, professional equipment and visiting clients normally need a separate commercial policy.
Is a higher deductible always worth taking?
It does lower the premium, but only take one you could pay in cash tomorrow without borrowing.
What is the difference between replacement cost and actual cash value cover?
Replacement cost pays for a new equivalent item, while actual cash value deducts depreciation and settles at what the old item was worth.
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