Have Right Amount--and Right Policy--When Insuring

True or false?

* A $200,000 homeowners insurance policy will reimburse you for up to $200,000 in casualty losses.

* If you have $200,000 in casualty insurance and a $100,000 loss, you’re covered for the full loss.

* A replacement cost policy will guarantee that you get your house rebuilt.

You’ve probably guessed by now that the answer to all three questions is frequently False.

Thanks to an insurance industry concept known as coinsurance, a policyholder who insures for less than the replacement value of his or her residence runs the risk of being heavily penalized. This is a lesson that many homeowners in the San Fernando Valley learned the hard way after the Northridge earthquake Jan. 17.

A simple example illustrates what coinsurance is all about. The Smiths have a home that would cost $125,000 to rebuild, but they have only $100,000 in casualty insurance. If the Smiths have an $80,000 casualty loss, many insurance policies will pay out just $64,000. The assumption is that the Smiths were self-insuring 20% of their residence by insuring just 80% of the cost of rebuilding their home.

“You may think that if you pay for a $100,000 policy that you are getting $100,000 in coverage. But that’s not the way that it works,” said Cindy Ossias, senior staff counsel at the California Department of Insurance. “Most companies have some sort of coinsurance penalty if the home is not insured up to a certain extent.”

For many homeowners, that means “they’re screwed in the event of a partial loss,” Ossias warned. “If you only insure 80% of (a home’s) replacement value, you are stuck with the other 20%.”

Mary Crystal, regional manager for the insurance industry’s Western Insurance Information Service in Los Angeles, voiced little sympathy for people who are underinsured. “I can’t imagine too many people opting to underinsure,” she said. If homeowners have a loss that isn’t fully covered, “they could have done something to prevent it.”

But avoiding undercoverage is easier said than done because many policies are complex and difficult to decipher. “There’s too much for the average person to understand,” Ossias said. She and three other attorneys in her office recently reviewed her policy and had trouble making sense of it. “If we had these problems, how would a typical person get through it?”

Ossias explained that there are three basic types of homeowner policies:

* Actual cash value policies pay out for losses based on the fair market value of the insured residence. This older type of coverage is particularly unattractive, Ossias said, because the policyholder may not get enough money to rebuild if the market is down.

* Replacement cost policies are most often associated with the coinsurance problem. Despite the name, the replacement value won’t necessarily cover the cost of replacing a residence, Ossias said. If construction costs go up after a disaster that severely damages a home, for example, a policy might not cover those higher costs.

If you really want your home “replaced,” you may have to insure for more than market value, Ossias said. For example, she has a property that would cost $1.2 million to rebuild because of architectural details. The market value, however, is just $625,000.

* Guaranteed replacement cost (GRC) policies provide for rebuilding or replacing a lost dwelling in “like kind and quality,” no matter what the cost and regardless of policy limits. These policies help homeowners avoid the pitfalls of coinsurance. Don’t be fooled by the word guarantee though. Some companies guarantee the replacement cost only if a property owner rebuilds and does not purchase a replacement dwelling.

What’s more, GRC will probably not cover the additional costs of replacing a structure under updated and more expensive building code requirements. Another caveat is that GRC policies guarantee costs only to a certain percentage. And not everyone is eligible for a GRC policy. Condominium residents or owners of homes that are of certain size or age may be ruled out of GRC coverage.

No matter what kind of insurance you have, calculating the value of anything can get sticky--especially when it comes to estimating construction costs. The Department of Insurance warned consumers in October, 1993, that insurance companies often hire analysts who make estimates favoring the insurers.

What are some ways to avoid problems of coinsurance and underinsurance?

Make sure that your policy has an adequate inflation adjustment to account for increased replacement costs, advised Marsha Davis, a public affairs coordinator for State Farm in Westlake. She also suggested that homeowners get a checkup every year from their insurance agent to make sure that there is enough insurance to cover all possible losses.

Policyholders may also request extra coverage that pays for replacing a structure according to any new and more expensive building codes. Also, to get the best coverage, make sure that you have guaranteed replacement coverage not just for casualty to your residence, but also for the contents and in the event of an earthquake.

Davis said it also helps if homeowners do a pictorial inventory that accurately records the condition of the home that may need to be replaced in case of a disaster.

Some other things to keep in mind:

For casualty policies, deductibles are generally fixed; the industry standard for earthquake insurance is about 10%. There are companies that offer larger and smaller deductibles, depending on the needs and wants of the insurance purchaser.

It is vital to look at the way the deductible is calculated and applied by the insurance company. Losses that relate to the structure, landscaping or interior contents may not be lumped together for the purpose of calculating whether an insured has reached the 10% deductible.

Some policies also exclude from the deductible any damage sustained to masonry structures, such as block walls, brick veneer or chimneys. If the insured premises has multiple structures--such as a home and an unattached garage--there may be a separate deductible for each structure. This can be a rude surprise for many property owners who don’t have what’s known as a “blanket deductible.”

Of the 15 largest home insurers in Southern California, only three base their earthquake insurance rates on where a property is located, according to a study released in February by Consumers Union, the nonprofit organization that publishes Consumer Reports.

Prices for a $200,000 earthquake policy with a 10% deductible ranged from $231 to $600 a year. So it pays to shop around. Keep in mind, however, that earthquake insurance generally must be purchased with standard insurance, and the package price will vary from one company to another.

In addition to basic earthquake insurance, there is also extended coverage. The three most common forms are for structural engineering costs, demolition costs and reimbursement for any upgrades that need to be made to a damaged building because of upgraded ordinances.

Western Insurance offers several free insurance-buying brochures that consumers can receive by calling (800) 397-1679. Help is also available from the National Insurance Consumer Helpline at (800) 942-4242. Consumers may also call the California Department of Insurance, which offers licensing backgrounds of insurance agents and other consumer information, at (800) 927-HELP or (213) 897-8921.