[Editor's Note: This is a guest post from R.J. Weiss, CFP, a financial advisor who blogs at The Ways to Wealth. We have no financial relationship.]
Most people don't deal with insurance because they figure they're set. That's until they have to file a claim. Often what they thought was covered–wasn't. As a licensed agent for over ten years, with a specialty in the high net worth market, there are five coverage gaps I frequently find. Fortunately, you can affordably insure against all of these gaps.
5 Most Common Gaps in Coverage
# 1 – Replacement Cost on Property & Contents
RJ Weiss, CFP
There are two primary types of property insurance:
- Replacement Cost
- Actual Cash Value (aka market value)
A replacement cost policy insures your property for the actual cost to replace. For example, if a fire destroyed your $5,000 sofa, you'll get reimbursed $5,000. Then, there's actual cash value or market value. This insures your property for the replacement cost minus depreciation. So, if that $5,000 sofa was 10 years old, it may be worth only $1,500 due to depreciation, which is what you'll get from the insurance company. That's why it's important to have replacement cost on both your property and contents.
# 2 – Guaranteed or Extended Replacement Cost
To make things more complicated, there are different types of replacement cost. What you want to look for is guaranteed or extended replacement cost. A guaranteed replacement cost policy would cover the full cost, no matter the amount. Extended replacement cost is a bit of a partial guarantee. If your home were insured for $500,000, a 150% extended replacement cost endorsement would pay up to $750,000 in case damages exceeded your policy value. Without either of those, your home is simply insured for the amount you said it was worth when you bought the policy.
Why does this matter? Most homeowners are underinsured. About 67% of homes nationwide are underinsured. The average amount homeowners are underinsured is 22%. While this study came from an insurer (Nationwide), similar results have been reported by property appraisers. Estimating the replacement cost of a home is a difficult task. Extended or guaranteed replacement cost provides low-cost extra protection in case of a total disaster.
# 3 – Water Sewer/Backup Coverage
The next coverage where many home insurance policies fall short is water or sewer backup coverage. Any backup of water from sewers or drains is excluded on a home insurance policy. Fortunately, most companies add this back in as an endorsement. However, it's important to check the amount of coverage you have, as this limit is separate. Most often, the amount of sewer or water backup is just $5,000 to $10,000. For someone with a larger finished basement, that may not even cover the cost of cleanup, let alone the need to replacement the contents.
#4 – Uninsured & Underinsured Motorists
Uninsured and Underinsured, also known as UM/UIM, are two separate coverages on your auto policy. Uninsured motorists covers you if you're hit by a driver without insurance. Underinsured gives you coverage when the at-fault driver doesn't carry enough insurance. This coverage is vital for doctors not just because you tend to drive higher value cars. More importantly, it can protect your income. If you were to get in an accident which caused you to miss time at work, there's a high likelihood you would exceed the at-fault drivers limits. With UM/UIM coverage you insurer would then kick in to cover the total damages. It's important to review your current UM/UIM limits, as many insurers offer minimal coverage. Also note, this amount is often different than your total liability limit.
[Editor's Note: Bear in mind that with Uninsured/Underinsured motorist coverage, you may be insuring against risks you have already insured against. For example, if someone in your car is hurt, the guy at fault doesn't have insurance, and he sues you, then your liability coverage should kick in. If you are hurt, you have health insurance. If you are disabled, you have disability insurance. If you die, you have life insurance. If your car is totaled, you have comprehensive insurance or can afford to replace it with cash. My general recommendation for insurance is to insure only against financial catastrophe, but to insure well against it. UM/UIM policies often have limits of $15,000/$30,000. While it would be unpleasant for me to have to fork out $30K, I can certainly afford to do so. The catastrophe is the $1.5 Million liability or my own disability or a $200,000 injury. Now UM/UIM isn't particularly expensive stuff, so if you will feel better buying it, go right ahead, but be sure to read the fine print so you really understand what you're getting. Also, if you're going to buy it, it makes a lot of sense for a high income professional to buy a benefit much higher than the typical one. As I edited this article, I wasn't even sure if I owned this coverage, so I went and read my policy. I do own it. My limit? $300,000/$500,000, the same as my liability coverage (not including the umbrella.) The cost is about $90 a year for our two tanks. But insurance with low limits isn't insurance at all. If you're going to insure, insure well. I think I'll keep it for now.]
# 5 – Umbrella Insurance
The topic of umbrella insurance has been discussed on White Coat Investor. For a few hundred dollars a year, you get coverage over and above your current liability limits. This extends to both your home and auto insurance. This protects you against the rare, large lawsuit that may come your way. Making it one of the smartest buys in insurance for the high-net-worth individual.
The reason to buy insurance is to protect yourself against the risks you can't handle on your own.These five common insurance gaps can all cause tens to hundreds of thousands of dollars in damage. Fortunately, they're all insurable against.
What do you think? Which of these insurances do you not have? Which ones will you now buy after reading this? Any you will drop? Comment below!
The “# 5 – Umbrella Insurance” is a really appealing way of staying protected.
I’m reading more of this.
Thanks for sharing.
Thanks for reading. Glad you found it helpful.
Weiss writes: “The reason to buy insurance is to protect yourself against the risks you can’t handle on your own. These five common insurance gaps can all cause tens to hundreds of thousands of dollars in damage.”
A high income professional reading this site ought to be able to self-insure against any of the usual five-figure risks, so I’d pare down these recommendations accordingly. Only #4 and #5 should be particularly relevant to a doctor with his financial house in order. Should a doctor on the fast track to financial independence really care if he’s out of pocket $3,500 on a ruined sofa because his homeowners policy was a just-the-basics actual-value policy, or even $35,000 on a house full of furniture? He should be able to cover that out of petty cash.
But having seen the experiences of family and friends, I do think un/underinsured motorist cover, to match your liability policy limits (for a high-income professional this should be in the $250,000 range) is worthwhile, and mainly for a personal injury / disability / missed work angle. The claims criteria for this line of coverage are substantially different from what it takes to make and maintain a claim under a long-term disability policy, and could give you the option of covering a long but temporary work absence without having to get the LTD company involved at all. It can also help cover the often-higher costs associated with a disability stemming from a sudden, catastrophic injury (like an auto wreck), relative to the costs those associated with a more “orderly” entry into disability (e.g. diagnosis of cancer or a degenerative disease). I’ve known ophthalmologists who have become disabled in both ways, and the one injured in an auto wreck needed — and claimed under — more insurance lines than the one who was diagnosed with cancer. The latter was still able to negotiate the sale of her practice as a going concern (and at a pretty decent price) while she was undergoing a round of radiation treatments.
I think the difference between a just the basics actual value policy and a replacement value policy can become a financial catastrophe when the whole house burns down. Sure, you can cover the furniture, but what about everything your house? That’s a little tougher, even for a millionaire.
I’ll give you half a point back on the question of upgrading to a replacement value homeowner’s policy. There are plenty of Americans who could be running things on a financially prudent basis, given their circumstances, yet find it catastrophic to have been 20% underinsured after a house fire. There may even be a portion of site’s target demographic that finds itself in similar circumstances. For present purposes, I take “catastrophic” to mean “would lead to a sudden, unplanned, material adverse effect on one’s standard of living or future life plans.”
My preferred solution, however, is not to own that much house. This also happens to solve for a lot of other financial stresses as well. If the improvements and contents alone (i.e. the part that burns down in a house fire, meaning not the land), cost so much that a 20% haircut would be catastrophic to a high earner, that high earner is probably spending far too much on “house” relative to his savings and income. The sticker price of a house also includes the land value, of course, so you have to filter that out for present purposes; you can find plenty of million dollar homes in places like Palo Alto where the improvements value is a pittance, and a 20% haircut on that would not ruin the homeowner.
A numerical example: If we peg “catastrophic” as an unplanned loss of $100,000 (low in my book, as less than 6 months gross salary for most physicians), and assume per your post that an actual-value homeowner’s policy underinsures you by ~20%, that implies owning house with a replacement construction cost of $500,000. This value, in turn, implies a cartoonishly oversized house of 3,500+ sq. ft. AND plumbing fixtures coated in gold leaf. If someone is living in a house like that — paying to heat, cool, light, clean and maintain the thing — without having enough in the bank to make a $100,000 loss seem non-catastrophic, he’s doing it wrong. He should go back and live in his resident house a few more years until you’re financially secure.
By contrast, a schoolteacher might regard a loss exceeding $25,000 as catastrophic, which makes it worth insuring against a 20% haircut on a $150,000 replacement value.
A lot of the points you make in this blog, overall, relate to the extraordinary power that high earners can have over their financial lives, relative to the average American, if they just tap the brakes for a moment on the hedonic treadmill. I don’t think the actual cost difference between a just-the-basics homeowner’s policy and a more tricked-out one will make much of a difference to the people here, but I treat it more like a diagnostic indicator: If you need that level of coverage truly to avoid catastrophe, you have some other questions you need to be asking yourself.
Excellent points. The more your means, the more you can self-insure.
Hi Ben. Thanks for your excellent comments.
Looking back on the sofa example, not the best example to use on my end. As Jim pointed out, it only starts to add up when you have to replace everything in your home.
At the end of the day, it comes down to, if you can self insure against a risk do it. Obviously insurance companies are going to price a risk so they make a profit.
I can care less about the things or furniture in our house. Anything of real value is in the bank or bank safe. The only thing of real value is the house itself but I question how the house insurance premiums are sort of based on the home appraisal? Last year.. our premium was suppose to go up because the home appraisal came back at 1.5million.. but originally bought for 900k several years ago? It was $2k difference from our original annual premium. Really?! Are builders paying that much to build a brand new home? There’s a new neighborhood going up just a couple of blocks away from our house… similar if not more square footage but selling in the 700-900k range. So I had increased the deductible to the highest possible which was $10k and requested a replacement cost of $1.1million to bring the premium back down. Is there a more reliable way to determine the actual replacement cost of the house? I kind of feel like overpaying/over-insuring for house insurance more so out of fear of under-insuring?
So if your house burned down you wouldn’t put anything back in it? You’d leave it empty? Whatever you’d put back in it is worth something and probably worth enough to insure against.
I have two friends that are contractors and they can give you a general cost per square foot of building a house in your area.
Statistically do we know what the odds are for the house to burn down or be wiped by a hurricane? I imagine its on the low side? I can save the difference in the premiums paid… which is about a $2k difference annually… and yes.. buy new furniture from scratch if we wanted to. This is probably comparable to a high deductible health care plan coupled with a HSA accounts. If you and your family are healthy and can afford the higher deductibles… its probably more advantageous to pay lower premiums and save the difference. Otherwise go with a more costly plan if you think you’re going to use it.
I also wonder about the value of the home that insurance companies use. I bought my house for $610K, and State Farm insisted it be insured for $750K due to replacement cost. (And I know that I did not get that great of a deal on the house). And now their value goes up every year, so that 7 years later, I’m insured for $820K. So my premium goes up every year, and since my deductible is 1% of home value, my deductible goes up every year. I think this is a bit of a scam, but I haven’t fought it.
This REALLY bites if they charge you for say $900K, lose house pay 90K deductible, but new house only costs 700K but you don’t get to pay only 70K deductible. I’d clarify this or even price rebuilding the house you’d want… If my house were totaled we’d replace it with something half this size now nest empty. But I guess if house only needs 80% repair, cost of scrapping it plus building new even if cheaper home might exceed repair?
Having recently shopped for homeowner’s insurance, I can tell you that the water/sewer backup rider can be vastly different between different insurers. Some have a limit of only $10K or $25K which is terribly low if you have a nice finished basement. Others (State Farm for instance) will insure you for damages up to the general policy limit…much better. Of course, State Farm’s rider costs a lot more than another company which has a $10K cap, but at least you know you are getting more coverage for that price.
It’s critical you know what you are getting especially if you live in an area prone to basement flooding.