Simple Money: A No-Nonsense Guide to Personal Finance - Tim Maurer (2016)

Part IV. PLANNING FOR THE UNEXPECTED

Chapter 18. HOME AND AUTO: Don’t Overpay to Be Underinsured

WHY do I need to read this chapter?

Of all the insurance products that are commonly bought and sold, home and auto insurance receive the least amount of scrutiny from buyers. Because we are required by law to have coverage if we own a house or vehicle, we tend to see these insurance products as pure commodities. This is why solicitations to save 15 percent in 15 minutes or to name our price actually work. Most people consider all home and auto insurance policies to be equal, as though price is the only consideration.

The end result is that most people are overpaying to be underinsured. Through the lens of the Simple Money risk management method, we can clearly see how to set our limits for home, auto, and the oft-forgotten “umbrella liability” coverage.

Auto

Let’s start by looking at automobile insurance coverage, where I tend to see the most mistakes and, therefore, the biggest opportunities for improvement. The biggest mistake is having too little liability coverage, or in insurance parlance, “bodily injury liability” coverage. We began addressing this issue in our risk management primer in chapter 14.

Let’s say you’re driving home from work and you have an automobile accident. You weren’t doing anything really dumb, like texting and driving, you just didn’t brake soon enough and slammed into the car in front of you. Unfortunately, the person driving the car you hit was hurt and sued for damages—and won, awarded one million dollars. Who pays, and how much?

The answer is buried in your auto policy’s “declaration pages,” summarizing your coverage. Look at the numbers next to the label “bodily injury liability.” It likely offers two numbers and reads something like $50,000/$100,000. Those numbers represent the amount that the insurance company will pay per person and per accident, respectively. So, in this case, since there was only one person in the car in front of you, of the million-dollar award, your insurance company would pay a total of $50,000. I hope you have an extra $950,000 lying around, because the rest is on you. In this example, you’ve covered a smaller risk and left yourself wide open to a massive, catastrophic financial risk.

Another number that often follows these first two—for example, $50,000/$100,000/$25,000—represents the amount of property coverage you have. As you might expect, this is the amount the insurance company will pay to repair any property that your at-fault accident might have caused. I don’t need to tell you that it would be easy to do more than $25,000 worth of damage. Low limits here could put you on the hook yet again.

Another aspect of liability is hopefully in your auto policy—the “uninsured/underinsured” coverage. Often listed in the same fashion as your bodily injury liability coverage—like $50,000/$100,000—this policy component allows you to pay for the lacking coverage of someone with whom you have an accident. Maddening though it is to pay for coverage someone else neglected to acquire, this is an important piece of the auto insurance puzzle.

The second biggest mistake I see in auto policy structuring appears small—it’s the size of your policy’s deductible. The deductible is the risk assumption tool (chap. 14) that is built into most insurance policies. It is the amount you will pay out of pocket in the case of an accident, before the insurance company steps in. The lower your deductible, the higher your premiums. The higher your deductible, the lower your premiums.

Insurance agents are notorious for defaulting to very low deductibles, which works nicely in their favor—they receive outsized premiums in exchange for very little risk, especially since most drivers won’t even place a small claim. Therefore, if (and only if) you have sufficient emergency reserves (chap. 7), you may lower your premium by raising your deductible. In fact, in many instances, I’ve seen drivers increase their catastrophic risk (by raising their liability limits) without increasing their overall premiums because they also increased their deductibles.

Typically, two different deductibles are mentioned on your auto policy—comprehensive and collision. Here’s an easy way to remember which is which: The collision deductible is applicable when you have one—a collision. Comprehensive entails just about everything else—a tree falling on your car, hail denting your hood. Windshield repairs are the most common claim that falls under the comprehensive label, and some insurers actually have a separate deductible for those occurrences.

Home

Homeowner’s insurance also has a liability feature that is no doubt underappreciated. Most policies are written with $300,000 of liability coverage. You might expect this to have an impact if one of the neighbor’s kids falls on your sidewalk and the parents sue you (and it does), but guess what? Your homeowner’s liability coverage actually follows you beyond the borders of your home. If you, like the legendary Chief Inspector Clouseau, accidentally destroy your neighbor’s “priceless Steinway” piano, it may be your liability coverage (attached to your home) that pays the bill. (Of course, since Clouseau was on the job in his incident, it may well have been the French sûreté’s policy that paid for the piano’s repairs.)

When most of us think of our homes, we’re actually thinking about our homestead—the house and the land on which it sits. But it’s important to recognize that in most homeowner’s insurance policies, it is specifically your dwelling, other structures, and personal property that are covered, not your land or landscaping. Coverage for your home is centered around the dwelling itself. The amount of coverage should be equivalent to what it would cost to rebuild the house from scratch if it burned to the ground, a complicating factor in the case of older homes with vintage molding or plaster walls. Other structures, like a detached garage, are typically covered for up to a certain percentage of the dwelling’s value, an important consideration especially if you have a finished outbuilding.

Another important consideration for your homeowner’s insurance is the coverage for the personal property within your home. “Full replacement value” is preferred over “actual cash value,” and I highly recommend conducting a video inventory of the home’s contents to ensure you get the full benefit of your coverage if it’s ever needed. (Of course, be sure to keep the video outside of the home.) Also pay special attention to any policy limitations. For reasons that appear obvious, homeowner’s policies replace items like cash, jewelry, and artwork only up to a limited amount (“Yes, I’m quite sure that it was $200,000 in cash that went up in flames. Oh, and Van Gogh’s ‘Starry Night.’ The original.”). Additional coverage on these types of property often requires a specific policy supplement.

You can purchase additional coverage for most risks to your home, but please read the fine print, because there are some notable risks typically not covered by your basic homeowner’s policy, according to Bankrate, such as a flood, mold, termite infestation, sewer backup, nuclear plant accidents, and most importantly, earth movement (such as an earthquake or sinkhole occurrence).1

Umbrella

As I mentioned in the chapter’s open, most people have homeowner’s and auto insurance because they are requirements of owning a home or automobile. This next type of insurance is missed by nearly everyone—because it’s not required—but it is one of the best Simple Money risk management tools, the excess liability “umbrella” policy.

You may recall the conundrum we had with low personal injury liability limits in auto insurance—if you had only $50,000 of liability coverage and were sued successfully for a million bucks, you’d be on the hook for $950,000. You might think the ideal alternative is simply to raise your auto liability coverage to $1,000,000, but most insurers will only allow you to increase your limits to $250,000 or $500,000. Similarly, you may want more than $300,000 of personal liability coverage attached to your home.

What is going to make up the difference? Excess liability coverage acts as an umbrella layer over your home and auto insurance, boosting your liability limits on either of those underlying policies if needed. The good news is that this coverage catapults you from being underinsured to adequately insured. The great news is that it’s surprisingly inexpensive. A typical household’s excess liability coverage will only cost between $150 and $250 per year, and may even result in reduced premiums for your underlying home and auto policies.

Interestingly enough, because the premiums on umbrella policies are relatively low but the claims, however rare, can be high, I’ve found that some insurance agents actually undersell umbrella policies. After all, if a claim hits, it can be bad for profit (chap. 14). So, if your agent tries to talk you out of an umbrella, that’s a good sign that he is looking out more for himself than you—time for a new agent.

Simple Money Home and Auto Guide

Looking for guidance on your home and auto insurance? Look no further, but please be sure to take into account factors that are unique to you and your geography:

1. Home and auto insurance receives the least scrutiny from buyers because it’s such a commoditized product. The result is that most people are overpaying to be underinsured.

2. The biggest hole in most home and auto insurance is lacking liability coverage, a hole that can be covered by increased liability limits and an “umbrella” policy. The increase in premiums may then be offset by increasing deductibles, but only if you have sufficient emergency reserves.