Question

Tom’s home is currently valued, on a replacement cost basis, at $400,000. The last time he checked his home was insured for $300,000 and he did not have an inflation guard endorsement. If he has a $40,000 claim due to a kitchen fire, how much will his homeowner’s insurance policy pay? How much would he be paid if his home were totally destroyed? In order to obtain full replacement coverage, how much insurance should Tom carry on his house?

Answer 1

Since Tom did not have an inflation guard endorsement, homeowner's insurance policy claim will get proportionally reduced.

1.The amount that homeowner's policy will pay for $40,000 claim due to a kitchen fire will be computed as :-

Amount to be received=Amount of Claim ×(Insured Value)/(Insurable Value)

Where amount of claim is $40,000, Insured Value is $300,000 and Insurable value is $400000,

therefore,
Amout to be received for kitchen fire
=$40,000*(300,000/400,000)

=$40,000*0.75

=$30,000

Amount Tom will receive due to kitchen fire will be $30,000

2. And If his home were totally destroyed Tom will receive,

Amount of Claim×(Insured Value÷Insurable Value)

Here amount of claim will be $400,000, Insured Value is $300,000 and Insurable value is $400000

therefore amout to be received for totally destroyed house will be

=$400,000*($300,000/$400,000)

=$400,000*0.75

=$300,000

Amount Tom will receive if his house were totally destroyed would be $300,000.

3.Tom should carrry insuarance of $400,000 in order to completely insure his house as the ratio of Insured Value /Insurable value will be 1.