Get the right sum insured

For those people fortunate enough to own their own home, the property usually represents their most important and valuable asset. Purchasing the right amount of insurance is essential to protect their home from the hardship that would result from loss or damage caused by fire, or by hurricane.

The basis of insurance is the idea that one person may not be able to afford the loss of a house or car, but a large group of people can afford to replace one house or car out of many houses or cars. Insurance lets a large group of people pool their money to cover against the possibility of loss or damage to their homes or cars so the few people who actually suffer such loss or damage can draw from that pool to repair or rebuild.

Insurers set their rates on the basis that they are insuring whole buildings, not just the part most likely to be damaged. It follows that a policy holder who insures his house for less than its true replacement cost is not making the proper contribution to the insurance pool and any recovery from the pool should be in proportion to the amount contributed.

For example, if you pay a premium based on a sum insured of $100,000, when it would cost $200,000 to rebuild your home you are only contributing half of the amount you should be to the insurance pool used to pay for losses. You should therefore be repaid only one half of any damages resulting from causes covered by the policy if you have to make a claim.

All insurance policies have what is commonly called an Average clause (this clause can have other names, but the effect is the same). This clause says your insurer will do the following sum when working out what should be paid for a claim:

(Sum Insured/Actual Cost to Replace) X Cost to repair damages = Amount that will be paid

If it is agreed it will cost $75,000 to repair your house, they will offer:

($100,000/$200,000) X $75,000 = $37,500

Because you had only insured the house for half of what it should have been insured for you are getting only half of the cost of repair, even although the damage did not exceed the sum insured. In the event of a total loss you will get the sum insured, but then this will be only half of what you have lost.

Each item on your policy is separately subject to this Condition of Average, so check not only the building sum insured, but also the contents sum insured.

On most policies there is no deductible for damage by fire. But, if the loss had been due to a hurricane or windstorm there is a deductible which is usually a minimum of 2 per cent of the sum insured. In the above example, the insurer would further reduce the amount paid to you by 2 per cent of $100,000, or $2,000, and you will receive $35,500 toward your loss, whereas if you had insured for the correct amount of $200,000 you would have received $71,000 toward the damage from the storm.

Another thing to remember is insurers will not pay more that the cost to replace or repair, so you should not over insure. If you do, you will be paying more premium than you need to, with no benefit to yourself.