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Home insurance premiums are a big expense, and the factors that go into them can be complicated. So how is home insurance calculated? Insurance companies use complex systems that analyze the risk of a claim.

Insurers use loss data (claims paid in the past) along with construction cost data to look at everything from the weather in a particular ZIP code to the cost to replace a granite countertop. Home insurance calculators available to the public use similar, but usually more simplified approaches. In addition, the company’s operating costs are part of the formula.

Read on to learn more about the factors used to calculate home insurance costs and what you can do to lower your rates.

KEY TAKEAWAYS
  • Homeowners insurance companies each use a proprietary insurance calculator to set their rates, which is why they differ so much.
  • Risks like weather and crime in an area affect home insurance rates.
  • Insurers use data about the age of the home, construction type, and your personal claim history in addition to broader factors.

How are home insurance premiums calculated?

A home insurance calculator typically categorizes policyholders by area and risk exposure (the level of risk they are taking on). Here are the steps insurance companies use to calculate home insurance premiums:

1. Find the pure premium

If an insurer wants to set its premium for a group of homeowners, it first divides the losses associated with that group by its exposure. If during the previous year, the losses for properties valued at $100 million totaled $500,000, that result would be 5% or five cents per dollar of property value, just to cover losses. This figure is called a "pure premium."

2. Calculate the expense ratio

Next, the insurer determines its administrative and other costs, like commissions and taxes, and builds in its desired profit. That is usually expressed as a percentage and is called the "expense ratio." 26.5% is the industry average according to S&P Global.

3. Set the premium price

Insurance companies use a calculation of the pure premium and the expense ratio to get the gross premium. From there, that premium will be adjusted based on your personal factors.

What is the formula for calculating homeowners insurance yourself?

If you felt confused reading about how insurers calculate home insurance premiums, you're not alone. However, there is a way you can come up with your own quick estimate.

Multiplying the square footage of the home by the cost to rebuild is a quick way to determine how much dwelling coverage you'll need. For example, let's assume your home is 2000 square feet and the average cost to build per square foot is $150 (this cost will vary depending on your location, home type, etc.) So, 2000 X $150 = $300,000 dwelling coverage.

Since we recommend insuring 100% of your rebuild cost, plug that dwelling coverage number into our home insurance calculator along with your ZIP code, liability coverage amount and chosen deductible. You'll then be given average home insurance costs.

Why is my homeowners insurance premium so high?

Home insurance costs are determined by a lot of factors, and each company calculates them differently. That can explain why your rate is higher than that of your neighbor.

David Meltzer of East Insurance Group in Baltimore, Maryland, says underwriting software is used to generate the rate. "We're able to advocate for the insured when there's a claim, but the days of agents setting rates for clients have long passed."

Furthermore, insurance pricing is very fluid and changes continuously, making it difficult to figure out what determines home insurance costs.

"The thing is, insurance carriers are aggressively trying to take business from other carriers, and are willing to cut prices to get the business," Meltzer says. "They keep their algorithms top secret.”

That said, there are a few things that can contribute to high insurance rates:

  • A high risk of natural disasters
  • Risks on the property, like a pool
  • A history of home insurance claims
  • High-end materials in the home

How to lower homeowners insurance costs

There are several ways to save money on insurance — any insurance — including a few that pertain only to homeowners coverage. First, try the same methods you'd use to save on auto insurance:

  • Ask how much you can lower your premium by raising your deductible. You won't want to make multiple small claims anyway, so paying for coverage you're unlikely to use isn't always the best use for your insurance dollars.
  • You might pay less by bundling your coverage with one insurance company.
  • Ask about discounts. There aren’t as many discounts for home insurance, but some are pretty big.

Next, look at these tips specific to homeowners insurance.

  • Consider making your home safer with a monitored security system (studies show that this can get you a 20% discount on your premium), motion-sensing lights, and upgraded locks, windows and doors.
  • Don't insure for your home's purchase price. If the house burned down, you'd be rebuilding your structure and replacing landscaping - but the actual land does not need to be insured. Insure your home for the calculated replacement cost instead.
  • Request a Comprehensive Loss Underwriting Exchange (C.L.U.E.) report for your property. If the cause of claims by the previous owner has not been resolved, your own rates could be affected. If it has been resolved, you can have the report corrected, saving you (and subsequent owners) on home insurance premiums. To fix an error, fill out the form on LexisNexis, the company that compiles C.L.U.E. data, or call them at 800-456-6004.
  • You should also request your personal C.L.U.E. report, which contains your personal claims history. Review it for errors - like a credit report, it may not be accurate, and fixable mistakes could be costing you.
  • Look into umbrella coverage for extra liability protection. It's relatively cheap (usually between $200 and $300 per year), and Meltzer says that some insurers' software is designed to offer lower rates to those with this coverage. "We're told that umbrella policyholders are viewed as more responsible," he says.
  • Finally, if you're willing to give up some information to your insurer, it may reward you. Similar to the "black boxes" some drivers install on their cars in exchange for lower car insurance premiums, "smart" home products including security cameras, thermostats, carbon monoxide, and fire detectors can net you up to 20% off some or all of your homeowners insurance premium.
  • Look to home improvements to lower insurance. Updating your roof or adding weather protection like storm shutters can reduce your rates.

Factors affecting homeowners insurance premiums

How is homeowners insurance calculated? As noted above, the way insurers weigh these factors when setting rates is ever-changing and a highly-guarded secret, but here are common factors that determine rates:

  • Replacement cost of the home (higher cost = higher rates)
  • Age of the home (newer homes can be cheaper to insure)
  • Home square footage (larger homes are more expensive to rebuild and have higher premiums)
  • Number of primary inhabitants (larger households increase potential liability)
  • Construction type (fire-safe materials like masonry are cheaper to insure than wood)
  • Roof type (fire-retardant asphalt or metal is preferable to wood shakes)
  • PPC (Public Protection Classification, which measures the proximity of fire station, police, hydrants, etc. A "1" is the best; a "10" is the worst.)
  • Area claim history (if neighbors file lots of claims, it can increase your rates)
  • Personal claim history (if you file more than average claims, your rates will be higher)
  • Pets (a dog with a bite history or breeds considered more dangerous can increase rates)
  • Owner's credit score (statistics show that people with lower scores file more insurance claims)
  • C.L.U.E. report of the property, which lists claims filed by the previous owners in addition to you. If the cause of the claims has not been resolved, your rates will be higher.
  • Security or alarm system (alarms and monitoring help decrease rates)
  • Fire alarm system
  • Deadbolt locks
  • Neighborhood crime rate (higher crime areas cause higher insurance rates)
  • Attractive nuisances (swimming pools, ponds, machinery, playground equipment, trampolines) increase liability potential and insurance premiums

If one or more of the factors listed here is costing you money and can't be changed (like your location), check with other insurers. A different company might not rate your Rottweiler or neighborhood the same way, and you could pay less for your coverage.

Frequently asked questions

How much should you spend on homeowners insurance?

What you should expect to spend on homeowners insurance depends on where you live, the types and amounts of coverages you need, and other factors that determine insurance rates. The average home insurance rate for $300,000 dwelling coverage and $300,000 liability with a $1,000 deductible is $2,779 annually. Yours may be more or it may be less.

What is the 80% rule in insurance?

The 80% rule in home insurance is a standard that most insurance companies will only cover the repair or replacement of a home if you have purchased at least 80% of the replacement cost. We recommend purchasing dwelling coverage equal to 100% of the replacement cost if you can afford it.

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