Chapter 11: Property, Home, and Automobile
Insurance 11/10/2012 11:54:00 AM
One buys insurance to transfer most of the risk to an insurance company in
return for paying a premium. The required premium depends on both the
statistical probability of the loss (or expenses) and the expected amount of
the loss (not the same as insured face value since property is rarely totally
Property Insurance: insures your physical properties – your home,
clothing, furniture, appliances, jewelry and so on – against damage or
Home insurance and automobile insurance – the two major areas in
which the average Canadian family is exposed to potentially large and
Def’n: Protects the family against the risk of loss, damage, or destruction of
the home, its related outbuildings(garage), and its contents (clothing,
Also covers third parties for injuries suffered on the property
o Two question that are important before buying Home Insurance
What are the risks that are covered?
How much home insurance do I need?
o List of typical risks/damage/destruction:
Theft and break-in
Glass breakage, window breakage
Weight of ice, snow, sleet
Collapse of building
Smoke Aircraft or other vehicles
Faulty electrical wiring
How much insurance do you need?
o How much insurance do you need (Contents of the Home)?
1 way: estimate the value of the contents as some percent
(usually 20%) of the value of the structure (which is the home
excluding the land)
o Example: for a home valued at 100,000 one would buy
20,000 insurance coverage for the contents
2 ndway: estimate the insurance coverage for the contents is to list
and value every item
o recommended by companies and agents. List must be kept
separately in a safety deposit or other location.
o How do you value the contents of the home?
o Two forms of home insurance policy
Depreciated Value: value of replacement or repair for the item to
the condition it was in when lost or damaged. Standard insurance
policy usually pays the depreciated value. Calculated by subtracting
from the price of a new item an allowance for depreciation based on
the age of the item that is to be insured.
Replacement value: value of a damaged or lost item is the cost of
buying a new item of the same quality.
Depreciated value is less than the replacement value, replacement
value requires a higher premium
Damaged or Lost items: Lost/Destroyed: Must be replaced with
new ones of comparable quality, if the insured chooses not to
replace, the claim will be settled at the depreciated value only.
Damaged items: repairs must be made to return the items back to
the best possible condition, if one chooses not to make the repair,
one will be paid the depreciated value only. (replacement cost
o Replacement Value of a Home
Not the current market value/fair market value as it includes the
value of the land and foundation—this is b/c in most cases, the land
and foundation of a home cannot be destroyed by typical disasters. Insure the replacement value of the home – what it would cost to
replace the home’s structure if the home were totally destroyed.
More practical to pay for an appraisal of the home indicating the
appraiser it is for buying home insurance. Give you both the
depreciated value and replacement value of home’s structure.
Some insurance companies automatically set the amount of the
home insurance equal to the amount of the mortgage on the house.
Some banks/loan companies require this insurance amount to be in
place before they will grant you a mortgage. – protects the lender’s
interest only , not the owner’s interest in the structure
o The 80% Rule
Most insurance companies will not pay the full loss on partial
damage unless the insured has bought insurance to cover at least
80% of the home’s replacement value.
If the insured buys less than that, the insurance company will only
make payments proportional to the percentage of required
minimum coverage taken.
o Example: replacement value: 100,000 and bought home
insurance for 70,000 (less than 80%). Their home suffered a
loss equal to 30,000
o Insurance company will pay (70000/80000 x 30 000) = 26
Sometimes replacement value increases over time and you have to
check your policy periodically to ensure that you have the minimum
o Example: bought a house 5 years ago with replacement
value of 150,000. Bought insurance coverage of 125,000.
Current replacement value is 180 000. Fire damage of
10,000. Their insurance company will pay:
180 000 x 80% = 144, 000
144000/125000 x 10,000 = 8681
The insurance company will only pay $8,681
o Inflation Protection Provision
If your policy does not take inflation into account, then the real
value of coverage may decline over time IPP: automatically increases the coverage amount each year in
accordance with the increase in some inflation index such as
Consumer Price Index (CPI) – might have to pay additional
premium for this provision
If you live in an area where housing costs are expected to rise
faster than the average rate of inflation (represented by CPI) then
IPP may not provide adequate coverage and additional coverage
may be provided by insurer for extra premium
Part of a claim that you must pay first before the insurance
company will pay anything.
o Example: you have 2000 insurable loss with 500 deductible,
you first have to pay the 500 for the insurer to pay the 1500.
The higher the amount of the deductible, the lower the premium
that you have to pay. Three reasons why premiums will be lower if
deductibles are higher
o Since you have to share part of the damages/loss, insurer
doesn’t have to pay as much on claims
o The insured will try harder to avoid damages, losses and
accidents against which he is insuring valuable property if
there is a significantly large deductible
o There is a fixed cost of admin for settling any claim that is
largely independent of the size of the claim. The insurance
company would rather avoid numerous small claims, and will
charge a high premium on policies with low deductibles to
encourage customers to deal with their own smaller losses.
o High deductible policies make more economic sense than low deductible
policies. By buying a policy with a large deductible, you are spending your
insurance money to cover large losses, reducing the premium cost per
dollar of insurance and can therefore afford a higher total coverage.
o Rule of Thumb: many financial experts recommend a deductible equal
to 3% of your net worth. For example, if one’s net worth is 50,000, one
should seek an insurance policy with a deductible equal to $1,500.
Third Party Liability Insurance o Protects you from the liability to other people for injuries suffered on your
property or by anything attached or related to your property.
o You are required to ensure that your property does not pose sa danger to
a reasonable person.
o However, there