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How to Select a Homeowners Insurance Policy

A fire breaks out after lightening strikes.

A tornado rips your home's roof off.

A drunk driver slams into the side of your house.

Disasters can come in many shapes and sizes, and they can happen at any time and without warning.

If disaster should strike, the last thing a homeowner wants to worry about is how much coverage their homeowners insurance provides.

For this reason, it is important for homeowners to understand how their homeowners insurance coverage is determined.

What Homeowners Insurance Covers

One of the first questions homeowners should consider when filing a claim is what type of homeowners insurance policy they have. For those who own their home, there are four types of policies available:

HO-1 Policy: This is considered the "bare bones" policy and covers only 10 disasters: fire or lightening, windstorm or hail, explosion, riot or civil commotion, damage caused by aircraft, damage caused by vehicles, smoke, vandalism or malicious mischief, theft and volcanic eruption. The coverage provided by HO-1 policies is so minimal that it is no longer available in most states.

HO-2 Policy: This policy provides protection against the 10 disasters covered by the HO-1 policy plus six additional disasters: falling objects; weight of ice, snow or sleet; accidental discharge or overflow of water or steam from within a plumbing, heating, air conditioning or automatic fire-protective sprinkler system, or from a household appliance; sudden and accidental tearing apart, cracking, burning or bulging of a steam or hot water heating system, an air conditioning or automatic fire-protective system; freezing of a plumbing, heating, air conditioning or automatic fire-protective sprinkler system, or of a household appliance; and sudden and accidental damage from artificially generated electrical current.

HO-3 Policy: The most popular policy, this policy protects your home against all perils except those specifically excluded by the policy. Two common disasters excluded from most homeowners insurance policies are flooding and earthquakes.

HO-8 Policy: This policy is designed for older homes and typically reimburses policyholders on an actual cash value basis, which is the replacement cost after taking into account depreciation.

How Much Homeowners Insurance Will Pay

How much an insurance company will actually pay a policyholder depends on the level of coverage purchased by that homeowner.

There are three types of reimbursement levels for homeowners insurance policies:

Actual Cash Value

This level of reimbursement will pay to replace your home or possessions after subtracting for any depreciation.

Replacement Cost

This level of reimbursement will cover the cost of rebuilding or repairing your home or possession without deducting for depreciation.

Guaranteed or Extended Replacement Cost

This level of reimbursement offers the highest level of protection. A guaranteed replacement cost policy will cover whatever it costs to rebuild or repair your home to its exact state before the disaster occurred, even if the amount exceeds the policy limit. Having guaranteed replacement cost coverage provides protection against sudden increases in construction costs that can impact the actual cost to rebuild or repair your home.

Some insurance companies will offer what is called extended replacement cost coverage versus guaranteed replacement cost coverage. A policy with extended replacement cost coverage will pay a certain percentage over the limit to rebuild your home, which can cover any unexpected cost increases.