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How to read a home insurance policy

Few people could easily write a check to rebuild their home in the case of a devastating event such as a fire. A home insurance policy will cover financial losses due to the damage or destruction of a house.

But if you don't understand what your policy does and doesn't cover, you could end up footing a large part of the bill.

Many consumers don't realize how important it is to understand the details of their insurance contracts, says Jayda Leder-Luis, a spokeswoman for the Massachusetts Office of Consumer Affairs and Business Regulation.

As a result, nearly 2 out of 3 homeowners don't have enough home insurance, according to Nationwide.

If you don't want to be one of them, follow these six steps to make sure your policy measures up.  

how to read a home insurance policy 1.Understand the policy's structure.

A home insurance policy has three basic parts.

  • On the Declarations Page, you'll find a basic summary of your coverage and the costs associated with it.
  • The Insuring Agreement is the main part of the policy, and it features more detailed information about your coverage.
  • The Conditions of the Policy is a section that lays out your responsibilities under the terms of the insurance contract. You'll also find out how to appeal denied insurance claims in this section of the policy.

2. Know the basic types of coverage.

Home insurance has several different components.

  • Property coverage includes provisions for the physical structure of your house, so if your home is destroyed or damaged, insurance would give you the money to rebuild.
  • Contents coverage reimburses you for the loss of possessions inside of your home that are damaged, destroyed or stolen.
  • If you have other buildings on your property such as a detached garage or a shed, your home insurance policy could include coverage for other structures as well.
  • Additional living expenses coverage pays for living costs if you have to move out temporarily while your home is being rebuilt.
  • Liability coverage pays costs resulting from the injury of someone on your property.
  • Medical expense coverage pays medical bills for someone who’s injured in your house.

3. Pay attention to exclusions and limits.

There are some perils, or risks, that a home insurance policy won’t cover. These are your policy’s exclusions.

For example, you’ll most likely need to buy a separate insurance policy to cover damage from floods, earthquakes and landslides.

However, your policy may also have some exceptions to the exclusions. These are circumstances in which your insurance would pay for damage that would otherwise be excluded from coverage.

For example, your policy might not cover mold damage, so that would be an exclusion. However, your policy might cover mold damage only if it’s caused by water damage from a busted pipe. In that case, you would have an exception to the exclusion.

There are other losses that your home insurance policy will only pay for up to a certain amount. For example, there is generally a $1,500 total limit on coverage for all of your jewelry, says Carole Walker, executive director of the Rocky Mountain Insurance Information Association.

If the value of your gems or other possessions exceeds your policy's limits, you can buy a rider or endorsement, which is an add-on policy that increases your coverage.

4. Know the meaning of 'replacement.'

If your possessions are damaged or destroyed, your home insurance policy gives you the option of buying replacement cost coverage or receiving the actual cash value for your possessions.

Replacement cost coverage means you'll get reimbursed for what the item would cost to replace in today's market even if today's cost is higher than what you paid initially.

Actual cash value means you'll get what your damaged or destroyed items are worth minus depreciation -- the general loss in value due to wear and tear.

You should also make sure you have replacement cost coverage for the physical structure of your home. With it, if your house is damaged or destroyed, you would be able to rebuild it with the same quality of materials.

The cost of rebuilding your home has nothing to do with your home's market value, which is the amount at which the home would sell.

5. Know your deductible.

A deductible is an amount of money the policyholder agrees to pay before an insurer pays out on a claim.

Home insurance deductibles can either be a dollar amount or a percentage of the insured value of your home.

If your deductible is a dollar amount, such as $1,000, you'd pay the first $1,000 in damage and then your insurer would pay the rest. You would pay the deductible every time you file a claim.

If your deductible is a percentage of your home's insured value, you'd pay that percentage before your insurer paid out on the claim.

For example, if your house is insured for $100,000, a 2 percent deductible would mean you'd pay the first 2 percent -- or $2,000 -- in damage.

Your policy will also indicate if you have more than one deductible. Some insurers also charge separate higher deductibles for certain perils, such as hurricane or wind damage.

6. Note important dates.

When reading over your policy, always pay special attention to when the policy was issued, when it goes into effect and when it ends. Also note when premiums are due, as well as how soon you must file a claim after an incident. 

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