What Is Hazard Insurance and What Does It Cover?

If you’re working with a lender to buy a home, you’ve probably encountered the term hazard insurance and might have wondered what it meant.

Hazard insurance refers to insurance coverage for your home’s structure itself.

Lenders have a financial interest in your home until the mortgage is paid off and hazard insurance insures your home against losses due to a number of common hazards, which protects both you and your lender.

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Is homeowners insurance and hazard insurance the same thing?

There’s some clear overlap between hazard insurance and homeowners insurance.

Hazard insurance specifically relates to protecting the dwelling structure whereas homeowners insurance refers to a more comprehensive set of protections, including the dwelling, but expanding coverage to include personal property coverage, personal liability coverage, and a handful of additional coverages.

By contrast, hazard insurance refers only to coverage for the dwelling that secures the mortgage.

Hazard insurance is also part of a standard homeowners insurance policy and the protection offered by a standard home insurance policy will usually satisfy your lender.

However, hazard insurance — on its own — can be more challenging to find.

While less common and typically used for rental properties as opposed to owner-occupied homes, a dwelling fire policy, called a DP-1, DP-2, or DP-3, could meet the requirements of your lender and is available for owner-occupied dwellings in some states.

In most cases, however, a dwelling fire policy doesn’t provide enough financial protection for the homeowner and a standard home insurance policy is a much better fit.

Do you need both hazard insurance and home insurance?

While hazard insurance (dwelling fire policies) can be purchased as a standalone product from some agents and insurers, the coverages offered by hazard insurance are also part of a standard homeowners insurance policy; you don’t need both.

In fact, having both is likely to complicate claims because the insurers will have to work out which company is primary and which is secondary in the claim, which can slow the process considerably.

Of course, by purchasing both, you’d also be paying for duplicate coverage. Just buy one.

Most homebuyers are better served by the additional protections provided by a homeowners insurance policy rather than a simplified policy that focuses primarily on the dwelling.

There are a few cases where you might need additional coverage beyond the protection offered by a home insurance policy.

In areas at risk from flooding, it’s common to find flood insurance as a requirement of your mortgage agreement. A standard home insurance policy does not cover damage due to floods.

Wind is another consideration. In most of the US, wind coverage is included in a home insurance policy.

However, some insurers in some states do not provide wind coverage in high-risk areas (or may not write home insurance policies at all in those areas).

If your policy doesn’t provide wind coverage, you’ll need to purchase a separate policy for this hazard. Local insurance agents will know where to source coverage in these cases.

Different types of home insurance

There are also different types of home insurance policies, some of which differ based on the type of structure.

For example, a condo insurance policy provides hazard coverage, much like a home insurance policy for a single-family home, but the coverage differs because you don’t own the outside of the building.

Manufactured homes use a different type of home insurance policy as well.

For single-family homes, the most common type of homeowners insurance policy is called an HO-3, although HO-5 policies are becoming more popular with homeowners.

An HO-3 policy or its equivalent provides hazard insurance for the dwelling on an all-perils basis, which means that all risks are covered — except for excluded risks, which typically include flooding, neglect, earth movement and a handful of other exclusions.

HO-5 policies are different because they extend coverage for all risks to your belongings as well, whereas an HO-3 limits the number of covered perils for your belongings.

What does hazard insurance cover?

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Assuming your hazard insurance is part of your home insurance policy, you’ll find two primary ways of providing coverage for the dwelling itself.

The first is called a named peril policy. The second is called an open peril policy.

Named peril coverage

With a named peril policy, the dwelling coverage is provided only for the perils named on the policy. A peril is a risk, meaning something that can damage your home and cause a loss.

The named perils on a home insurance policy can vary, but in most cases they follow what’s known as broad form coverage, which is an accepted standard in the insurance industry.

Broad form coverage includes damage due to most common risks, like fire, lightning, wind and hail, and falling objects, like tree limbs.

Water damage is also covered, although coverage depends on the source of the water.

With most insurers, you’ll find about 16 distinct named perils that are covered by the policy.

Any risk that is not a named peril is excluded from coverage — and some risks are specifically excluded, like intentional acts, flood damage, and earthquake damage.

Broad form named peril policies are also called HO-2 policies. An HO-1 basic form policy, although becoming rare, may also be available from some insurers and offers a scaled-back list of named perils when compared to HO-2 policies.

Open peril coverage

With open peril coverage, instead of looking at what’s covered, you’re focused more closely on what’s not covered.

Open peril policies provide coverage for all perils, with the exception of the exclusions listed on the policy.

Most home insurance policies sold today provide open peril coverage. However, it’s important to make the distinction that open peril coverage only applies to the dwelling in many cases.

Coverage for your belongings, called contents coverage or personal property coverage, is often limited to a named perils basis, like found on a HO-2 or HO-3 policy.

Open peril policies come as either HO-3 policies that are open peril for the dwelling and named peril for your personal property or as HO-5 policies that are open peril for both the dwelling and your personal property.

It’s worth noting that your home insurance policy doesn’t provide coverage for your vehicles, even if they are parked in the garage or under a carport.

How much hazard insurance do you need?

When you purchase hazard insurance for your home, part of the process includes choosing an insured value for your home.

There are 3 different numbers that can come into the decision, often creating confusion for consumers: rebuild value, loan value, and market value. The one you’ll want to focus on is the rebuild value for your home.

The lender requires that you have coverage sufficient to pay your outstanding loan balance in the event of a total loss.

However, the lender isn’t concerned about your equity in the home.

It’s important to choose an amount of coverage that will protect both the loan balance and your equity — as well as any upgrades or additions you may have done.

Fortunately, your insurer can help you choose an insured value by using software to calculate the cost of rebuilding your home with “like kind and quality of materials”.

What you’ll find in most cases is that the calculated cost of rebuilding your home is higher than the loan balance.

Choosing the calculated rebuild value as your insured value also avoids triggering the coinsurance clause, which is a section in most home insurance policies that reduces coverage percentages for homes that are underinsured by a certain amount (usually 20%).

Another common source of confusion is the market value of the home. When purchasing home insurance, the market value of the home may or may not match the cost of rebuilding the home.

Often, there’s a divergence, but homeowners should almost always choose the rebuild value over the market value.

Types of hazard insurance

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Your hazard insurance coverage can also come in a few types, in this case referring to how claims are covered as opposed to which types of claims are covered.

These coverage types can also be split on the same policy, with one type of coverage applying to the dwelling and another type of coverage applying to your belongings.

Actual cash value

For dwelling coverage, actual cash value (ACV) is a rare find, but the term refers to a coverage amount that is adjusted for wear and tear due to age.

As an example, chances are good that your auto policy provides actual cash value coverage, meaning the coverage amount goes down over time.

Roof coverage may also use ACV or a similar depreciation schedule because roofs are considered “wear items”, much like tires or brakes on a car.

For the rest of your home’s structure, expect coverage to be without a deduction for depreciation on most policies. Notably, coverage for manufactured homes is usually ACV for the entire structure.

Replacement cost value

The dwelling coverage on most home insurance policies is most often provided without a deduction for depreciation.

This type of hazard insurance for homes is called replacement cost value (RCV) coverage.

In this case, if your home is insured for $300,000 and you have a $1,000 deductible, the insurer will pay up to $299,000 to rebuild your home in a covered claim using like kind and quality of materials.

Extended replacement cost

Popularized by insurers for upmarket homes, extended replacement cost (ERC) coverage is now available from several broad market insurers and provides coverage limits higher than the cost of rebuilding your home.

The benefits of this type of coverage have several real-world applications. Calculating the cost of rebuilding a home can be tricky business.

While insurers have become more accurate with the help of technology, there’s always the “what if” factor to consider.

What if fuel prices double, affecting the cost of materials and transportation? ERC can help cover the unexpected cost overrun.

What if labor costs double or specific materials are difficult to source? ERC can help with that unexpected increase as well.

Often you can choose the amount of extended coverage you need, with premiums increasing slightly depending on the amount of extra coverage.

What is the cost of hazard insurance?

The average cost of home insurance in the US is about $1,100 per year.

However, you’ll find huge variances depending on where you live, the insured value of your home, and several other data points.

The cost of hazard insurance for your home is based on a number of factors, some of which may seem unrelated to your home.

Primarily insurers are looking at the insured value of your home. Expect a home insured for $150,000 to have lower premiums than a home insured for $300,000.

Location

Location is also a big factor, with homes in high-risk areas costing more to insure.

Bear in mind that increased risk can come in many forms, including tropical storms on the east coast and gulf coast, tornadoes in the central US, ice and snow in the northern states, and wildfires in the western states.

Broad data and individual factors

Insurance rates are based on both broad data, like the frequency of claims in your area, and on individual factors, which can include your claim history, your driving history, and even your credit history.

If you have a trampoline or a pool, expect rates to be higher. Some breeds of dogs can also affect rates — or even cause your insurance application to be denied.

Policy features and coverage limits

Other features of your policy and the coverage limits you choose can also affect the cost of insuring your home.

Most policies provide personal liability coverage. Higher personal liability coverage limits can push premiums higher.

Add-ons, such as sewer backup coverage, can also nudge premiums north. When purchasing hazard insurance, it’s helpful to think about the lender’s requirements as secondary.

If you choose home insurance coverage that protects you well, that coverage will usually exceed any requirements set by a lender.

Shopping around can help save money and is a better way to approach budget concerns than cutting back coverage to meet lender requirements.

Be sure to ask for discounts as well. Some insurers offer dozens of ways to save.

Why would hazard insurance go up?

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Inflation is a primary reason for hazard insurance costs to rise over time. Materials and labor costs are steadily rising, which affects the cost of rebuilding your home.

But there can be other reasons for your premiums to increase that aren’t quite as easy to explain away.

As discussed earlier, insurers are looking at broad trends, regional or local trends, and at individualized data.

Any and all of these can affect your rates at renewal time. Most home insurance policies have a 1-year term, after which they automatically renew — usually.

Weather-related claims

If your area is seeing an uptick in weather-related claims, you might see a rate increase at renewal. The same could be true if your area sees an increase in break-ins and thefts.

Number of claims

On an individual level, if you have a claim or perhaps more than one claim, it’s not unusual for rates to increase at renewal.

Prior to the claim, you may have been rated as an average risk. After the claim, you may be rated as a higher risk.

Some sources report an average increase in home insurance rates of about 10% following a home insurance claim.

Averages are important to consider, though, because many insurers won’t raise your rates at all for some types of (first) claims.

Auto insurance claims

Auto insurance claims can also impact your home insurance costs, particularly if you have an excessive number of claims.

Insurers periodically rerun what’s known as a CLUE report, which tracks insurance losses, when assigning rates at renewal.

They may also check your credit history, a rating factor used by many insurers. Signs of credit trouble can lead to higher insurance rates.

State-controlled rate increases

In many cases, rate changes reflect a change in your risk profile. Maybe you moved into a preferred group in one rating area but a higher-risk group in another area.

There are a lot of moving parts in an insurance rate. However, all these changes have to fit within a rating schedule approved by the state.

Insurers can’t simply raise your rate because they feel like it. Insurance is regulated at the state level and if an insurer needs to adjust rates across the board, the insurer has to submit a rate plan to the state insurance commissioner for approval.

As in any business, operating costs often increase over time, so you can expect your insurer to have some across-the-board increases at some point.

It’s nothing personal. Often, these rate increases are approved by the state because it’s important that insurers remain solvent so they can pay claims.

Buy hazard insurance to protect your home and your belongings

When buying hazard insurance for your home, you’ll need to meet the minimum coverage requirements set by the lender — but set your sights a bit higher.

The lender is concerned about its collateral for the loan, your home. You’ll want to consider the big picture when protecting you and your family against a large financial loss.

That means you’ll probably want a full-featured homeowners insurance policy, such as an HO-5 policy, that protects your home and your belongings, as well as provides personal liability protection and some of the welcome extras, like paying for additional living costs if a covered claim forces you to leave your home temporarily.

When you purchase coverage, your lender will usually split the annual cost of your hazard or home insurance premiums into your 12 monthly mortgage payments by using an escrow account, which makes it easy to get started with the right coverage.

Also, you may want to consider buying both home and auto insurance from the same insurer.

This combination is commonly used to create a discount on both policies and the savings may be more than enough to pay for the extra coverage you’ll get with a full-featured home insurance policy.

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