In general, we do a terrible job of assessing the risks we face in everyday life. But let's not be too hard on ourselves. After all, recent research indicates that much of this is due to our genetic hardwiring. We're simply predisposed to miscalculate the odds that this or that event will occur. And I suppose if we sat around all day trying to imagine what horrible disaster was lurking around the next corner, we'd never get much of anything accomplished anyway.



One of my biggest professional challenges as an insurance consultant and attorney is to try to get individuals and organizations to understand that the main purpose of insurance and risk management is protection against financial devastation NOT merely financial irritation (having to come up with $500 may be irritating but coming up with $500,000 would be downright devastating). Since this article deals with homeowners insurance, I've made my points by examining the potential financial devastation exacted when people make three huge and all too common miscues when purchasing this type of coverage.

Confusing real estate value with replacement cost

According to Marshall & Swift/Boeckh, a worldwide provider of building cost data, 58% of all homes are undervalued by an average of 21%. I believe this is due primarily to neither the general public nor many in the insurance industry understanding how to properly estimate the replacement cost of a house. The problem is exceptionally egregious where an older home's real estate value may be, for instance, $200,000, but to rebuild the home would cost much more than that.

To go a step further and illustrate the financial hardship this could ultimately cause, let's assume that your house is insured for $200,000 (because you figure you could sell it for that amount). If it is one of the 58% that is underinsured by 21%, you have an uninsured exposure of $42,000. Therefore, if your house burns down, you get a check for $200,000 instead of the $242,000 required to rebuild. I don't know about you but coming up with an extra $42,000 qualifies more in the catastrophe category than the irritant category. And even if you have a guaranteed replacement cost rider on your house, there is still a very good chance you will not be fully reimbursed due to other policy penalties for being vastly underinsured.

Trying to save money by buying minimum liability limits

Let's be honest, the chances of you getting sued for a million dollars (or more) are pretty remote. Unfortunately, few folks ever ask themselves what would happen if they did and how much would it actually cost to protect them from this possibility?

Do you have a pet? Consider that almost 1/3 of all homeowners claims come from dog bites. Have a pool? Approximately 45,000 people a year are injured in swimming pools. The trouble with liability claims is that they are so difficult to quantify. Until disaster strikes, you have no idea how much you may be sued for. Despite the fact that the risk may be remote, your potential exposure is unlimited. My advice is to buy as much liability insurance as you can. Won't that be expensive? Heck no! One major insurance company in Pennsylvania charges only $10 a year more for a $1,000,000 limit than for a $500,000 limit.

The most common objection I hear is that people feel they will somehow become a target of an unscrupulous plaintiff's attorney if they "over insure". Believe me, you already have a target on your back. That's why you need to create as big of a buffer zone as possible between your insurance limits and your personal assets. This is NOT the place to skimp. Insisting on a low deductible

Let's take a few steps back and revisit what I wrote earlier. Insurance should be used to protect you from financial catastrophe not financial inconvenience. Your deductible allows you to save money by self-insuring against small losses while still protecting yourself from financial oblivion. Yet there are a significant number of homeowners who still want a $250, $500, or even a $1000 deductible.

My rule of thumb for choosing a deductible is simple; if you had a loss tomorrow, how much difficulty would you have in coming up with the money to cover your deductible. If the answer is none or very little, you need to raise your deductible.

For many years this didn't make as much sense as it does today. The savings associated with raising your deductible was relatively minor compared to the number of claims you could submit with no negative repercussions from your insurance company. However, as more and more homeowners figured that out, the insurance companies wised up too. Recently, most companies have begun surcharging your policy after 1 or 2 claims, no matter how small.

OK. That stinks but it's really not devastating. Not until you try to get a quote on homeowners insurance for that new house you want to buy. If you've had multiple claims, your current company may use this as an opportunity to dump you. Now you're forced to scramble to get coverage before the deal falls through. And if you are able to get coverage, you may find yourself paying 5-10 times what you planned on. While maybe still not devastating, it's certainly traumatic.

The three instances I pointed out in the paragraphs above are hardly an exhaustive list of all the mistakes I've seen made over the years. However, they are certainly some of the most common, dangerous, and avoidable.