It’s a question we get all the time, “how much coverage should I have on my house?” It’s also one of the most critical mistakes we find when working with new clients… they’re drastically underinsured.
The important point to consider when trying to determine the value of your house for insurance purposes is to remember, the insurance company is responsible for repairing or rebuilding your house after a loss.
The market value of your house (or the amount it's worth if you decided to sell it) is not as important as the replacement value of your house, which is the amount it would cost to rebuild if it were totally destroyed, by a fire for example.
Note. Homeowners coverage insures both the structure of your residence and your personal property (furniture, clothing, electronics, etc.), including personal property that is not located in your home.
It’s important to note, the homeowners policy has dollar limitations on certain high-value items, such as jewelry, fine art, furs and collectibles (coins, baseball cards, etc.). If you own these types of items, make sure you talk with your insurance advisor about getting coverage added to your policy.
Tip. When insuring the structure, you want to make sure you have enough coverage to rebuild your home if it's destroyed. In other words, the limit on your policy should be equal to the cost to replace your home at today’s cost of building materials and labor.
How do you find out what it would cost to totally rebuild your house?
Well if you’re working with an experienced, knowledgeable insurance advisor, you can expect to have an answer within a few hours of your request. If you don't have an insurance agent - and you should - you can contact your local builders association.
Tip. In the home construction world, building costs are calculated on a square foot basis. As such, to determine the cost to rebuild your home, take the square footage of your house and multiply by the average square foot building rate in your area.
Remember, for the purposes of your homeowners insurance, disregard the market value (what your house is worth if you sell it) and focus on the replacement cost (what it will take to completely rebuild your house after a loss).
This leads to the second most common question we get on this subject…
Why is my house insured for so much more than what I paid for it?
Many homeowners equate the value of their home to its market price, especially if the home was a recent purchase. While market value is a valid calculation of a home’s worth for buying and selling, it has little to do with the cost of rebuilding.
And even homes that were just recently built can have a replacement value that differs from the replacement cost value. Numerous items are taken into account when your insurance advisor prepares the Replacement Cost Evaluation for you.
The estimate you’re being provided is the amount to reconstruct the home at today’s costs, and accounts for the following:
- Economies of Scale – It costs more for a contractor to build one home at a time because materials are not purchased in bulk. A single household item that matches the one that’s been destroyed will nearly always cost more than if it had been part of a larger purchase.
- Top-down versus bottom-up – Repair work for a partially destroyed home is done from the top of the home down. This is more time consuming and labor-intensive.
- Demolition and debris removal – This step is necessary before reconstruction can begin and adds to the total cost.
- Use of labor – When a builder constructs many homes at once, they can efficiently schedule labor for carpenters, plumbers, electricians and other workers. For a single rebuild, labor is not as efficient and contributes to higher costs.
- Access to worksite – Worksite access is easier for brand new construction. For reconstruction, obstacles such as neighboring homes, trees, lawns, fences and other landscaping prevent easy access. This makes it difficult to transport materials and can drive up labor costs.
- Building code changes – Changes to building codes may require costly updating, even for undamaged parts of a home. This could include updating wiring or other utilities and is costly, especially for older homes.
- Natural disasters – After a natural disaster, the cost of building materials and labor rise because of increased demand. Over the past 20 years, there has been a significant increase in the frequency and severity of weather events, resulting in a high number of losses that require repairs.
- Protecting undamaged parts of the home and contents – Keeping a partially destroyed home from further damage until permanent repairs can be made adds to the overall cost. This could involve covering a damaged roof or holes in walls.
- Specialized labor is more costly – Reconstruction is often completed by contractors who specialize in rebuilding as opposed to new construction contractors. Their specialized labor tends to be more expensive.
- Replicating old construction methods and materials – A standard homeowners policy provides for replacement with like kind and quality, which means replicating a home as it stands today. In older homes, interior walls are often made of plaster instead of drywall and exterior brick walls are made of solid brick instead of modern brick veneer. Homes constructed prior to 1940 were built with full dimensional lumber, which is larger and more costly than typical modern lumber. Because of features and materials such as these, older homes, especially those built prior to 1940, cost more to replace.
If you’re not convinced by now about the importance of insuring your house for its replacement value as opposed to what you paid for it, or its market value, the insurance industry has one last incentive to convince you otherwise.
Note. This one is more of a stick than a carrot. Your homeowners policy has a section which outlines how your claim settlement will be reduced IF the amount of insurance you have on your house at the time of the loss is less than 80% of the full replacement cost.
For a full explanation, get your copy of our eBook The Costly Coinsurance Penalty: How to Avoid this Expensive Mistake.
Suffice it to say, you’re best served by working with an experienced, knowledgeable insurance advisor that can help guide you through the process of determining the amount of coverage you should have on your house, and making sure you’re not in violation of the policy requirements.
If you’d like to learn more, contact one of our Licensed Advisors or complete the form on this page. We’re here to help.
To continue learning about your insurance protection, return to our Resource Center.