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Hazard and flood insurance: How it can and cannot help you

At a glance:

  • What is hazard insurance?

  • What is flood insurance?

  • What to consider about hazard and flood insurance

  • Summary of hazard and flood insurance

You can't prevent your home, apartment, or personal property from being devastated by natural or man-made disaster unless you can see it coming far enough in advance and are able to move it from harm's way.

However, you can take steps to protect yourself from the financial loss that results from such perils. Even if you have taken all the precautions to keep your property safe, there is still a risk of loss over which you have no control.

This is where hazard and flood insurance can help you.

What is hazard insurance?

There are many kinds of hazard insurance available to help mitigate your financial risk. Next to automobile insurance, the second most common form of hazard insurance that covers hazards to your house and property is known as homeowner's insurance (HOI) or property insurance.

Very often mortgage lenders require that homebuyers also purchase some forms of hazard insurance as a condition of the loan at the time of closing, to protect the lender from financial loss if the home is destroyed by hazards the owner has no control over, such as flood or fire.

You don't need to own a home to get insurance to protect your home and personal property. It is also available for those who are renters, temporary tenants, and owners of residential condominium units.

While hazard insurance is available to provide a financial buffer against the financial risk of damage to your property, not all property insurance covers all possible hazards, so it needs to be tailored to the property risks prevalent in your area.

There is more than one type

There are different types of hazard insurance: basic homeowner's insurance, comprehensive homeowner's insurance, and specific hazard insurance. They differ in which risks, or hazards, are covered. Basic homeowner's insurance covers damage to the home.

Comprehensive homeowner's insurance covers the home, the real property, and the personal property in it, as well as adjacent structures like a garage, and also provides liability insurance in case somebody is injured on the property.

Generally, HOI protects you (and usually the lender who holds your mortgage) against loss due to fire, theft, vandalism, lightning, smoke, and someone driving a car through a wall into your living room. Such HOI is called an "open perils" policy, which covers all perils not specifically excluded elsewhere in the policy.

What is not included

As with any insurance, it is important to know what is included and what is excluded from the policy. Most policies exclude natural disaster risks such as floods or earthquake damage, but specific hazard coverage (riders) may be added to a basic or comprehensive policy for those risks.

Riders should be used to plug the holes left in the HOI. After a disaster occurs is not when anyone wants to learn that they are at financial risk for far more than they thought. Go over your policy with your agent. Ask questions about what is and isn't covered. Despite claims to the contrary, insurance language isn't always in plain English.

Standard HOI also excludes damage due to work needed to bring your house up to code; any government action, such as confiscation or destruction; power failures and water damage; and earth movement, such as mudslides. It excludes damage caused because of neglect — your failure to take reasonable measures to save your property during or after a loss.

In this Oct. 5, 2019 photo, Daniel Leonard and his father Joe, right, stand near a heap of lumber on their family's property.  The massive storm killed more than two dozen people in northern Florida, destroyed hundreds of homes and brought catastrophic damage to the region’s timber industry. (AP Photo/Bobby Caina Calvan)
Daniel Leonard and his father Joe, right, stand near a heap of lumber on their family's property after a massive storm. (Photo: AP Photo/Bobby Caina Calvan)

For example, although insurance might cover repair of your wall if someone drove a car through it, it might not cover subsequent damage to your personal property if you didn't block the hole with a tarp in a specified amount of time. Damages caused by war and nuclear hazard or explosion from any source are typically excluded.

Most HOI excludes damage from an "act of God," defined as a natural disaster no one could have prevented, such as a tsunami, volcanic eruption, wildfire, tornado, or hurricane.

So homeowners in California might seek additional earthquake or wildfire insurance, while homeowners on the Gulf Coast might seek both hurricane insurance and separate insurance for water damage, and homeowners in the tornado belt might wish to insure separately against wind damage.

How to start looking for it

Homeowner's insurance is typically readily available, but it's wise to seek both best price and good service. Each state's insurance department or secretary of state's office makes information available on typical rates charged by major insurers within the state, and many states provide the frequency of consumer complaints against insurance companies.

Check with your state insurance department or with the National Association of Insurance Commissioners to help you choose an insurer in your area and to get a complaint history. Many companies also have online insurance quote services.

What is flood insurance?

The most common kind of specific hazard insurance is flood insurance. As you can imagine, the risk of flood varies dramatically from one area to another, even within the same city. In order to price the insurance fairly, the National Flood Insurance Program treats each flood area separately.

Consequently, flood damage, both to real and personal property, is always excluded in HOI and must be purchased separately as a rider. Though sold by individual insurance companies, flood insurance is underwritten by the government.

Different types of policies are available

Standard flood insurance policies are available for high-risk properties, and preferred risk policies are available for low- to medium-risk properties. A homeowner can rate their risk, get an estimate of premiums, and find an agent on the National Flood Insurance Program Website.

Understand the "single peril" aspect

Flood insurance is "single peril" insurance, protecting against losses to buildings and their contents, not to the land itself.

To qualify as a flood, the waters must cover at least two acres or affect at least two properties, though the flood can have many causes. Flood insurance is available only to communities that participate in the National Flood Insurance Program. The government sets limits to the amount of coverage available to you. Regardless of the type of insurance, you cannot exceed $250,000 in real property coverage and additional $100,000 in personal property coverage for a residence.

Some people are required to have it

Most people who live in a high-risk area will have standard flood insurance because it is a condition of obtaining a mortgage. But flood insurance is often a wise choice even for those in low- to medium-risk areas as well, since the preferred risk policies are relatively inexpensive. You should consider the risk for flash flooding, lake overflow, mudslides, or sewer backup.

Be aware that flood insurance does not cover water damage from rain coming in through a hole in the roof caused by the same storm that flooded the streets. Flood insurance is not hurricane insurance. Be aware of the "single peril" definition for this and all special hazard insurance. Again, read and understand the exclusions.

David Key looks at the back yard of his flooded home in Prairieville, La., Tuesday, Aug. 16, 2016. Key, an insurance adjuster, fled his home as the flood water was rising with his wife and three children and returned today to assess the damage. (AP Photo/Max Becherer)
David Key looks at the back yard of his flooded home in Prairieville, La. (Photo: AP Photo/Max Becherer)

What to consider about hazard and flood insurance

With hazard insurance, premiums are usually based on the appraised value of the property, the age of the building, construction methods, and known natural hazards in the area. Homeowners may have to weigh the benefits against the higher premiums in deciding whether to self-insure or to obtain additional special hazard insurance such as flood, earthquake, or hurricane riders.

For a worse case scenario, where your home is completely destroyed or rendered uninhabitable for a time, a homeowner can get insurance for property replacement and living expenses for the period of time you are out of your home.

Home replacement options

Hazard insurance policies have one of two home replacement options: guaranteed replacement cost coverage and straight replacement cost coverage. Guaranteed replacement pays to rebuild your home even if the amount to rebuild exceeds your policy limit. A complete replacement cost policy will reimburse you the amount it costs to replace the property and its contents with something of a similar type and quality at current prices.

That would even include rare and custom work, such as a home theatre or marble flooring. Homeowners would be wise to take photos of all valuables, keeping them in a convenient location, preferably not in their house. Guaranteed replacement cost coverage is not available everywhere but is recommended if you can afford it.

Straight replacement is less expensive, but it will only cover costs up to the policy's insured value. You must periodically review your policy to make sure your coverage has kept pace with home improvements and inflation and make sure that you have sufficient coverage to rebuild. An inflation guard will increase the amount of insurance to keep pace with inflation. Extended replacement cost coverage will extend the limit of reconstruction costs an additional 20–25% if they run over.

Regardless of whether you choose guaranteed replacement or straight replacement, you might also wish to have the option, not offered by all insurers, of receiving a cash settlement in case you do not wish to rebuild in the same location.

Loss of use coverage reimburses you for some of your living expenses while your home is being repaired or rebuilt. Usually, it pays motel bills or rent, restaurant meals, and certain other basic living expenses, including the cost of storing some of your personal property, minus the amount you would normally have spent on daily living expenses. The period of the loss of use is often limited and is often capped at 20% of the amount for which the home is insured.

"Actual cash value" basis

Some HOI policies insure personal property on an "actual cash value" basis, which reimburses the policy holder the replacement/repair cost of the property destroyed, less an amount for depreciation, for wear and tear on the item. Depreciation can be quite steep, as anyone who has ever driven a new car out of the showroom knows.

If the worth of your personal property is significant, investigate the cost of replacement insurance. Also consider separate coverage for valuable items. Standard HOI will set coverage on personal property much lower than replacement value. If your home contains items of unique and high value, you should consider purchasing insurance riders for these.

Summary of hazard and flood insurance

Hazard insurance protects the homeowner against the risk of damage to or loss of their home and property. Knowing the inclusions of your homeowners insurance helps you to avoid paying for the same coverage twice.

Knowing the exclusions helps you to determine what special hazard insurance you need. Knowing the inclusions and exclusions of your policies protects you, the homeowner, against unpleasant and potentially financially damaging surprises should disaster strike.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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