Published in Mint on 1 July 2015, Written by Kapil Mehta
A friend owns a house in South Delhi where she has regularly paid insurance charges to the maintenance agency. Last year her home was gutted by a fire. The insurance claim of Rs.20 lakh was denied on two counts: the insurance had been bought by the maintenance agency which had no insurable interest in the property and, in any case, the home had been vacant for a few months.
Though home insurance has been around for years, it’s not well understood by homeowners, agents and, I daresay, insurance salespersons themselves. The number of home insurance policies sold and claims paid is small. This will change. I have seen more interest in home insurance over the past six months than in the past six years. The devastating Nepal-centred earthquakes that shook many areas in India are a turning point. A home is the most significant asset that people own—that’s why insuring it is important, next only to buying term and health insurance.
The four considerations when buying home insurance are: determining the sum assured, setting the basis on which damage will be valued, buying relevant extensions, and being aware of the warranties.
The sum assured is set at the value of the property if it is destroyed. The norm is to consider the total cost of construction and exclude land costs. So, for a given quality of construction, it does not make a difference where your home is located. Most struggle with this concept because in their minds the home is worth crores whereas the construction cost insured is in lakhs. A rule of thumb for high-quality construction is Rs.3,000-4,000 per sq. ft. Buyers need to be careful about underinsurance. If you insure your home for less than the cost of construction, then any claim paid will be proportionately reduced. For example, if the actual construction cost is Rs.50 lakh but you buy insurance of Rs.20 lakh, then only half of any future claim will be paid.
The basis on which damage is valued is key. This can be on the market, reinstatement, or the agreed value. The phrase “market value” is a misnomer because it refers to an approach where only the depreciated value is paid. For example, let’s say you have a wooden cupboard that cost Rs.20,000 to make. If this cupboard is damaged five years later, you will be entitled to about half the cost or Rs.10,000. This comes as a surprise to homeowners. In “reinstatement value” insurance, the cost of replacing a damaged item or making it new is paid. Reinstatement value is best for the building’s structure. For household contents, “agreed value” is ideal because the insurer agrees upon the value of items beforehand. There is no room for dispute.
There are several extensions that are must-buys. The most obvious is an earthquake damage extension because this is often excluded. It would be ironic if the incident that caused most people to buy home insurance is excluded in the first place. An escalation extension is also useful, particularly when you buy a cost-effective long-term cover. In multi-year insurances, inflation results in the sum assured becoming less than the replacement cost of the home. This exposes you to underinsurance. The escalation extension addresses this by automatically increasing the value of items by 10-25% each year. Another useful extension is the omission-to-insure. This covers alterations and additions, within limits, to your home during the year without the need to inform insurers mid-term.
Finally, warranties are commitments you make if the violation results in your claim being rejected. A standard warranty is to inform the insurer if you leave the house unoccupied for over thirty days. This impacts people with second homes the most. Some friends have a mountain home that they visit a few times each year. In standard home insurance, no claim will be paid to them unless they have informed the insurer that the house is largely unoccupied. If you have a basement, then this needs to be documented. That’s because basements are prone to flooding and riskier. Another implicit condition is that of insurable interest. You cannot insure the structure of a rented home—the landlord must do that. An insurer will not question these fundamentals when you buy the insurance but these will come to the forefront when you make a claim.
Many unresolved areas remain. Consider an apartment in a multi-story building that is damaged by a pipe burst. A neighbor’s wall needs to be broken up for repair but the neighbor refuses to cooperate. Home insurance will not pay damages because the repair has not been carried out. Consider the insurance of household contents. What if all the items have not been separately specified? What if jewelry values change with fluctuating gold prices?
Policy wordings are vague and restrictive. Consider these extracts from existing contracts: Riots, strikes, and malicious damage are covered excluding those by “total or partial cessation of work or the retardation or interruption or cessation of any process or operations or omissions of any kind”. I don’t know what that means. Or, damage due to storms, cyclones, typhoons, and inundations are covered excluding those resulting from “other convulsions of nature”. This one had me scurrying to my daughter’s geography book. Fortunately, the contracts reassure us that loss due to “missile testing operations” and “bushfires” are covered. Sadly damage due to “fungi” and “bacteria” are excluded.
A few insurers have begun to develop the market with new products. For example, agreed value as a concept can now include land cost and allow homeowners to abandon the unrepairable property. Or by allowing underinsurance in certain cases to be corrected by paying premiums retrospectively.
According to Swiss Re, an insurer, the floods in Jammu and Kashmir last year destroyed 200,000 houses. The loss from housing was $4.4 billion and less than 5% of this was insured. In the same year, average insured losses in North America were over 60% of the total loss. Clearly, we have a long way to go and there is a case to make home insurance mandatory.