Suze Orman Money Matters

The devastating wildfires in Southern California last month offered a stark reminder: You need to make sure your homeowner's insurance policy will truly protect you and your family if your home is seriously damaged or destroyed.

Insurance Is No Assurance

Don't automatically assume you're protected -- according to one national survey, nearly 60 percent of homeowners are seriously underinsured. In the event of a major claim, the survey showed that the underinsured could find that the upper limit of their policy payout is 20 percent less on average than what they need to rebuild in today's market.

In other words, for every dollar needed to rebuild or repair a damaged home, the policy would only kick in 80 cents. That leaves the underinsured homeowner on the hook for the remaining 20 cents.

So don't be cavalier here. Just because you have a homeowner's insurance policy doesn't mean you have the right one. The difference between the right one and the wrong one could mean tens of thousands of dollars coming out of your pocket because you find out too late that your insurance policy is inadequate.

The Coverage You Need

To avoid that costly mistake, here are the key elements you need to make sure are included in your homeowner's insurance policy:

• Extended replacement cost coverage

More and more insurers are offering this as standard coverage, but make sure that you have this level of protection. With extended replacement cost (ERC), the maximum policy payout for a covered loss can exceed the stated limit on the policy by 25 percent or more.

For example, if your dwelling limit coverage is $300,000 and your ERC coverage entitles you to a maximum payout of 125 percent of your stated policy limit, you could in fact receive a total payout of as much as $375,000 ($300,000 x 125 percent) for a covered loss. Given how construction and material costs are constantly on the rise, having this extra padding in your policy provides a great cushion against unanticipated building costs.

It's important to realize that even with ERC you could be underinsured if your insurance agent didn't properly value your home when the policy was first drawn up. The best way for an insurance agent to make sure any and all special features of the home are accounted for is to base the policy on a full appraisal.

The Ultimate Insurance

One caveat regarding ERC: If you decide you don't want to rebuild on your property, your maximum payout will typically be limited to either the depreciated value of your home (known as "actual cash value," or ACV), or just 100 percent of your stated policy coverage. Even if you have ERC coverage, insurers usually won't release any funds beyond 100 percent of the policy limit if you plan to build elsewhere.

With that in mind, ask your agent if there's any chance that you can obtain a guaranteed replacement cost policy. As the name implies, with this level of protection your policy will pay whatever it takes to rebuild or repair your home to its pre-loss state, regardless of how much it exceeds the stated dwelling limit coverage on your policy.

For obvious reasons, fewer and fewer insurers offer this gold standard of coverage. But if you can in fact find an insurer willing to give you a guaranteed policy, it's the ultimate in home insurance.

No Skimping Allowed

On the other end of the protection pendulum, if you pull out your policy and see that your coverage is for replacement cost or pays only ACV, stop reading right here and upgrade your insurance immediately. I can't stress enough how seriously underinsured you are. In the event of a major loss, I can pretty much assure you that your policy will fall way short of what you need to repair or rebuild.

To be honest, I'd think twice about working with any insurance agent who sold you a policy with replacement cost or ACV in the first place; it's a huge yellow light to me that the agent didn't really work to protect you when you first purchased the policy.

Then again, you may be to blame as well if you simply asked for the cheapest coverage possible. Protecting your home is simply not a place to skimp.

Keeping Up with Change

After ERC, the next two items on your list of coverage must-haves are:

• Automatic inflation guard

Verify with your insurance agent that your policy includes an automatic inflation adjustment guard. This will increase your coverage limit each year to help you stay in line with rising building and material costs in your area. If it isn't part of your standard policy, insist that it be added as an endorsement.

Also remember to contact your insurance agent to update your coverage limits after any major renovation project. You want to make sure that your policy would repay you to rebuild your home up to your current standards; if you just replaced a 1970s kitchen with a 2007 state-of-the-art one, you want your insurance to cover the cost of replacing the current kitchen.

• Building code endorsement

If you live in an older home, ask for this extra endorsement to your policy. It will cover new construction costs associated with meeting current building code regulations if your home is severely damaged or destroyed. This extra coverage isn't a standard part of your policy -- even if you have ERC -- so make sure it's added.

Where Will You Live?

Finally, your policy should include:

• Additional living expense

In the event that your home is destroyed or needs repairs that make it impossible to live in, you'll naturally need to live someplace else during the rebuilding or repair. How much your insurance policy will pay out to cover these temporary living costs depends on your level of coverage.

Pull out your policy and look for the heading "Part D: Loss of Use/Additional Living Expenses." Typically, your coverage will be stated as a percentage -- generally 20 percent to 50 percent -- of your dwelling limit coverage. For example, if you have a $300,000 policy with a 20 percent additional living expense (ALE) coverage, you'd be entitled to a maximum of $60,000 for additional living expenses.

You also want to check what the time limit is for how long you can draw on this coverage. It's typically 12 months, but can be longer. Some policies state "a reasonable period of time necessary to replace or rebuild your home." Given how long it can take to rebuild after a major loss, I strongly suggest seeing if you can obtain a policy with the most liberal coverage for ALE.

Even if your home is destroyed tomorrow, you still need to keep current with your mortgage payments. That means you could be saddled with your old housing costs as well as your new (temporary) housing costs, which is why you need the best ALE coverage possible. You don't want to feel pinched.