Home Replacement Cost: What is it and why is it higher than the market value of my home?
One of the most common questions I receive from my personal insurance clients is “why is my homeowners dwelling coverage so much higher than what I could sell or even build a new home for.” Oftentimes clients will even think they are overinsured and are paying for unnecessary coverage. This is a great question and one I find myself discussing quite often with clients.
Your Home Has Three Values:
- Market Value: This is the value a buyer would pay to purchase your home. This value can change a lot based on the economy.
- Actual Cash Value: This is literally the current value of the building materials that make up your home – lumber, nails, drywall, roofing, brick, etc. The actual cash value of your home, known as ACV, decreases with time. As your home ages, the value of the physical components of your home depreciate.
- Replacement Cost: This is the estimated cost to rebuild your home from the ground up, including today’s cost of material and labor, demolition and removal of debris, building permits, architectural drafting, and more.
Why is Replacement Cost Higher than Market or Cash Value?
It is more costly to reconstruct a home in the event of a fire or total loss than it is to build a new home on a vacant lot or buy an existing home. Building materials, labor, and location all contribute to replacement cost. In addition, the cost of demolition and removal of debris due to a fire or other loss are factored into the equation. When constructing a new home on a previously vacant lot, the builder is working with a clean and improved lot. The builder’s crews can work quickly and efficiently without stepping over debris or tearing down partially damaged walls and ceilings. After a loss, the crews must work cautiously while removing damaged materials and preparing the building to receive new materials. This process slows down the construction time and drives up the labor cost.
How is Replacement Cost Calculated?
Insurance companies use software to calculate replacement costs. Your insurance agent will ask you a variety of questions about your home and complete a questionnaire using the information you provide. A reconstruction cost will be determined based on the home characteristics (size, type of finishing materials used, etc.). The calculation also takes into account local costs including permits, labor, and materials. The calculation uses data from similar homes, losses, and reconstruction efforts the insurance company has dealt with. The cost estimate does not take into consideration your “hook up” with a general contractor or your 10 percent discount at Home Depot as those options may not always be available or apply at the time of loss.
Consequences of Insuring for Less than Replacement Cost
In order to purchase replacement cost coverage , you must insure your home for a minimum of 80 percent of the cost of replacement as determined by your insurer. This is an industry standard. There are other less costly options, including a cash-value policy. However, if a loss occurs, you won’t receive enough money from the insurance policy to completely rebuild. So it is in your best interest to be up front with your insurance agent regarding the features of your home in order to obtain an accurate valuation and secure the right amount of coverage.
Our goal is to ensure you have the right amount and type of insurance for your unique situation so that you will be properly covered in the event a loss does occur. We welcome your questions about this topic. Please contact us to learn more.