Katrina disaster trains a spotlight on homeowner's policies

Homeowner's insurance is an afterthought for many consumers. While insurance is required to secure a mortgage, few expect to use their policy for anything more than slight damage from a leaky water heater or a few broken windows in a hailstorm.

But natural disasters like hurricane Katrina shed new light on the need to reexamine your insurance policy and sign on the dotted line after you've determined the breadth of coverage you need to protect your assets in a worst-case scenario.

Even with a maximum of comprehensive coverage, which provides additional living expenses in the event of a loss, those hit hardest by Katrina are probably looking at a long claims process and an even longer rebuilding process.

The destruction is expected to lead to labor and building-materials shortages. Those same shortages complicate the insurance equation, because typical policies do not cover the price hikes.

"If you have lived in a home for a long time and the real estate and building costs have escalated in your area," says Eric Goldberg, assistant general counsel for the American Insurance Association, "then it may surprise you to learn how much it would cost to replace your home and your belongings.

"It's important to revisit your policy every year to make sure your coverage is adequate," he adds.

What policyholders affected by Katrina should expect to receive from their insurance companies in the worst of times depends on what they paid for in the best of times.

Insurance companies make checks payable to the homeowner and the lien holder - the bank or mortgage holder. The homeowner receives a cash settlement that represents the equity in the home. However, if the homeowner purchased only enough coverage to pay off the mortgage and has no equity in the home, he may get nothing.

"The homeowner's policy works quite well in matters such as Katrina - except for flood damage, which is excluded from the policy," says Scott Simmonds, principal of Insurance Consultants of Maine, Inc. in Saco. "That's where flood insurance steps in." He adds that "Most of the time the bank wants to see the home rebuilt, though, and won't take the money and run."

Flood insurance aside, homeowner's policies come in three types. "Actual cash value" policies are the least expensive because they account for depreciation. So while your mortgage debt is wiped clean, you may only get $100 for the 10-year-old sofa you bought for $1,000.

"Replacement cost" policies are just that. They reimburse claimants for the cost to replace an item. You may receive $1,500 for that 10-year-old sofa. The cost of these policies increases as you build equity in your home and add new possessions.

The replacement policy also covers the replacement cost to rebuild your house - unless a building and labor shortage sends prices through the roof. That's where the "extended replacement cost" policy comes in. Extended replacement cost policies offer a 20 to 25 percent cushion over the policy limit to account for such shortages.

It will be weeks, even months, before insurance adjusters can reach the worst-hit areas to assess Katrina's damage fully. Insurance catastrophe teams are up and running, and insurers have begun advertising on TV and radio to tell customers how to contact them. Consumers may also hire a public adjuster.

"If you hire a public adjuster instead of working with your insurance company's adjuster," warns Diane Koken, president of the National Association of Insurance Commissioners, "make sure that person is registered in the state. Public adjusters are compensated based on a percentage of what they recover for you."

When policyholders are displaced, the immediate need is additional living expenses to pay for food, housing, and other essentials. Typically, insurers provide such funds up to 20 percent of the amount of the policy.

The insurer will pay additional living expenses to a policyholder whose home is now uninhabitable. For example, if homeowner's monthly pre-loss expenses were $2,000 (mortgage, utilities) and are $5,000 post-loss (living in a hotel, eating out), the insurer will pay the $3,000 additional cost.

Insurance industry veterans say it is difficult to estimate how long the claims process could take, but policyholders can ease the process by making an inventory of items and gathering any available documentation. Ms. Koken says carriers understand that many will have no documentation to offer.

"Sometimes banks and credit card companies have records," Ms. Koken says. "We can also prepare affidavits."

The claims process is shortened when a home has been completely destroyed, because adjusters report a total loss. Homes that can be repaired require a more in-depth assessment.

But that's the short-term challenge. Long term, experts see labor and materials shortages that were common in Florida when four hurricanes hit the state in 2004.

"Adjusters are having a hard time finding adequate gasoline supplies to get in and out of the affected areas," Mr. Goldberg says. "Long term, contractors and building materials could be in short supply. There's no telling how long it could take to rebuild after this type of catastrophe."

As E. coli-infected waters cover most of New Orleans, insurance adjusters will deem many homes total losses. But could a flooded home that wasn't filled with dangerous bacteria be saved?

It depends on the severity of the flooding, says Martin King, a technical adviser for the Association of Specialists in Cleaning and Restoration, the trade association for cleaning and restoration specialists.

"If the flooding only produces six inches of water, then you could replace a portion of the walls, finishes, trims, and floors," Mr. King says. "But another consideration is potential mold growth. In high-humidity environments, mold grows within 48 hours, even in portions of the house that were not directly damaged by the water."

Whether or not mold is apparent or is detected within walls and in cavities that are not readily visible, the interior finishes would require remediation - cleaning, repair, or replacement.

Ultimately, King says, saving a flooded home boils down to the cost of repair versus the cost of replacement.

"It is very seldom cost-effective to completely strip an interior of all its finishes, appliances, and plumbing in a major flood," King says. "In most cases, it's more economically feasible to tear down the shell and build anew."