Be ready for anything. Expect the unexpected. Those phrases may sound like lessons from basic training, but they apply just as well to property insurance coverage. And at least one recent study shows that Americans aren't as prepared as they should be to prevent a financial disaster.
A 2007 survey by the National Association of Insurance Commissioners (NAIC) found that a large percentage of U.S. homeowners are unclear about what their insurance actually covers. Most standard homeowners insurance policies protect against a wide range of losses, but not every scenario is claim-worthy. In fact, some causes of severe home damage are typically not covered. Even when insurance does pay, how much you're reimbursed depends on the type of coverage you have. By skipping over the details and assuming you're fully protected, you may be leaving yourself open to a financial catastrophe.
Here are five of the most commonly misunderstood areas about homeowners insurance. Take a few minutes to review your policy and assess your risk. In most cases, buying more complete coverage adds relatively little to your overall insurance costs, and could save you a massive expense down the road.
According to the NAIC study, about a third of all U.S. homeowners mistakenly believe their insurance covers flood damage. That widespread misunderstanding was never more apparent than when thousands of homeowners along the Gulf Coast (including some servicemembers at a major Air Base in Mississippi) were devastated by flooding from Hurricane Katrina.
"In areas especially prone to floods, mortgage lenders may require homeowners to purchase flood coverage through the National Flood Insurance Program," said Kathy Conyers, director of flood operations for insurer USAA. "But that doesn't mean you should dismiss the possibility of flooding if you live in a lower-risk area. Floods can happen anywhere."
Unusually heavy rains, snowmelt, and even failures of manmade infrastructure can cause flooding in otherwise arid environments. The disaster in a small Northern Nevada town in the early days of 2008 is a perfect example. When a levee holding in an irrigation canal ruptured, floodwaters displaced more than 1,000 families and caused millions of dollars of damage to homes. Due to the area's desert climate, most homeowners in the Nevada town did not carry flood insurance, leaving them to cover their own losses. You can purchase NFIP coverage through your insurance company representative. Policies are available in three forms: dwelling (most homes), general property (apartments and businesses) and condominiums.
Startling Sewer Stench
If there's anything worse than having floodwaters drench your floors, it's having raw sewage invade your home. It can happen when the community sewer system backs up due to overuse or failing infrastructure. Since the origin of this ghastly incident is outside the home, it's not usually covered by the standard insurance policy.
While the likelihood of a sewer backup is higher in older neighborhoods with outdated infrastructure, backups have been known to occur in new communities as well. When it does happen, the cleanup process can be messy, difficult and expensive.
The good news is that it's easy to protect against this loss with additional coverage from your current insurance provider. The coverage is inexpensive, usually just $20-$40 per year.
Mold Taking Hold
Mold in the home is another pesky intruder that's commonly misunderstood by homeowners. It's often an after-effect of major water damage, but mold can also grow inconspicuously in any place moisture is high — near leaky pipes, neglected roofing or air conditioners, even as a result of a humid climate. Again, the cleanup and associated expenses are usually not covered by standard homeowners insurance policies.
"Supplemental mold insurance is available in a small number of states, but the best defense against mold is prevention," said Mick Noland, a USAA product manager for homeowners, renters, fire, and Valuable Personal Property (VPP) insurance products.
Noland recommends taking proactive steps to prevent water damage from happening in the first place. Keep an eye out for damp walls or carpets; repair water leaks promptly; replace rubber washing machine hoses with steel braded hoses; and turn off water and drain pipes when leaving home for an extended time. Finally, if you're stationed near the coast or in an especially humid area, consider purchasing a dehumidifier to reduce the level of moisture in your home.
Quaking in Your Boots
California holds the distinction of being America's most populous state, and counts a large contingent of military personnel among its residents. It's also the earthquake capital of the nation. Yet about 35 percent of the people NAIC surveyed didn't know that their normal homeowners insurance doesn't cover earthquake damage.
Like flood insurance, earthquake insurance can be purchased separately. But even in the most vulnerable areas, coverage is optional. California operates its own statewide program, the California Earthquake Authority, while in other states supplemental policies are available through some private insurers.
Californians may be the most at risk, but earthquakes have been reported in all 50 states are threats (by scientific standards) in Oregon and Washington, as well as along the New Madrid seismic zone including Missouri, Tennessee, Arkansas and Mississippi.
Just as important as understanding what your insurance covers is knowing how you're covered. That is, how (and how much) will the insurance company reimburse you for a covered claim? In this regard, there are two primary types of homeowners policies. One pays the full "replacement cost" of your property; the other pays only "actual cash value," or what the property is worth after depreciation.
USAA's Noland provided a simple example. Imagine that you paid $2,000 for a big-screen TV, which was destroyed in a hurricane several years later. With replacement cost coverage, the insurer would pay for you to buy a new $2,000 TV. But with cash value coverage, you'd only receive what the TV was worth today, which would be much less.
"Now consider if the storm damage extended to items throughout your entire home — the difference in your claim settlement could be enormous," said Noland.
Most major insurance companies include replacement cost coverage in their standard homeowners policies. However, cash value coverage is still available as a way to reduce your premiums. Make sure you know what you're getting.
No matter where you live or what your budget, it pays to remember that not all insurance policies are the same. If you're shopping for a good deal, always read the fine print to compare apples to apples. By assessing your risk and obtaining adequate coverage, you'll be one step closer to true financial readiness.
Joseph "J.J." Montanaro is a CERTIFIED FINANCIAL PLANNERTM practitioner with USAA Financial Planning Services, one of the USAA family of companies. Montanaro is a West Point graduate and served in the U.S. Army for six years on active duty. He is currently a Lieutenant Colonel in the U.S. Army Reserve.