How Home Insurance Actually Works

What does homeowners insurance actually cover?

A typical homeowners insurance policy will provide three specific types of coverage:

Liability protection

This is the coverage you'll rely on if someone falls down the stairs in your home or your dog bites someone. If you're sued because someone gets hurt, your liability insurance will pay legal fees and cover the costs of any settlement or judgement against you.

A lawsuit could be very expensive to defend against, and losing one could leave you on the hook for hundreds of thousands of dollars in medical bills, lost wages, and other damages -- depending on the severity of the injury. Ensure you have sufficient liability coverage so your insurer, and not you, gets stuck with the bills. 

Protection for your dwelling and other structures

You'll also need coverage to protect yourself in case something happens to your home or other structures on your property, such as a screened-in lanai, a freestanding garage, or a barn.

Coverage for your dwelling could pay for repairs or rebuilding your home or other structures in the event that a problem is caused by a covered peril.

If your barn burns down or your home is damaged when a pipe bursts, your policy should cover you.

Protection for personal property

You likely have most or all of your possessions in your home -- and probably can't afford to replace everything you own.

Personal-property protection gives you the money you'll need to replace your stuff if it's damaged or destroyed by a covered peril or if it's stolen. 

Make sure your policy has all of these different types of coverage -- unless, of course, you can afford to defend against very expensive lawsuits, rebuild your home, or replace your property from scratch if something happens.

types of coverage's for a home policy

Many types of coverage's for a home policy exist such as

• HO3,
• DP1,
• DP2,
• DP3, or 
• Basic,
• Broad, and
• Special Coverage.

Read more about types of coverage for home policies here.

How does coverage work?

It's helpful to know not only what your policy covers, but also how coverage will work if something actually goes wrong. 

insurance payout for covered perils

First and foremost, you'll get an insurance payout only for covered perils. If the loss is caused by something not covered by your homeowner's policy, you won't be able to make a claim.

Many homeowners insurance policies exclude flood damage, for example -- so if your home floods, you won't receive any compensation from your homeowners insurer.

We strongly suggest everyone buys a flood policy, even if you don't "Technically" live in a flood zone. 

Compensation for policy limits

You'll also be compensated only up to policy limits.

If you have $25,000 in coverage for personal property, the most your insurance policy will pay out is $25,000 if every bit of your property is destroyed.

Make sure you have sufficient coverage and that your policy limits aren't set too low; otherwise, you'll have large out-of-pocket losses.

Look closely at your policy, too, as there are sometimes limits on coverage for specific items.

For example, even if you have $25,000 in coverage for personal property, you may be limited to $2,500 in coverage specifically for jewelry -- unless you buy an additional rider to cover your expensive baubles. 

Your coverage may also be limited if you have actual value, or depreciated cost coverage instead of replacement cost coverage. If you have actual value or depreciated cost coverage, you'll only be compensated actual value or depreciated cost instead of replacement cost.

If your house is worth $100,000 on the open market but would cost $300,000 to rebuild because it's has custom details, you'd absolutely make sure you have replacement cost coverage, which compensates you for the amount it takes to restore you to the position you were in before the covered peril occurred.

We always recommend replacement cost policies vs. Actual Cash Value OR Depreciated cost. It just doesn't make sense for most people to carry an actual cash value policy. 

you're responsible for covering the deductible

Finally, you need to be aware you're responsible for covering the deductible before your insurance will pay for losses.

If you have a $2,500 deductible, you'd have to pay for the first $2,500 in damage from a covered peril before your insurance would give you any cash, or make sure your damage exceeds the deductible.

Then you would get a check for depreciated cost - deductible. Once you actually prove you replaced/repaired the lost items you would then receive the difference or replacement cost.