Ask the Contractor: Insurance - replacement cost vs. market value
This past week several calls rang in from homeowners wanting to know what the cost per square foot is to rebuild. They were all in the process of renewing their insurance. This is a very common question and one whose answer is based on the complexity inherit in the construction industry.
Square-foot pricing is a ratio of the total costs of a projects components divided by the size of the livable portion of a house in most instances.
Since the components that make up a project can be so different from project to project, it is impossible to predict a price per square foot with any accuracy. Defining the total cost of a project’s components, without first going through a design process — should something happen to their current home — or at a minimum a detailed written project scope, will most certainly lead to a level of speculation that could generate issues with insurance coverage.
There are a number of decisions that will need to be made about coverage when you purchase a new policy and/or are reviewing your current policy. One of the most import ant is whether to insure your home for its replacement cost or its market value. Understanding each option will help you make an informed choice that safeguards your home and your family’s financial future.
WHAT IS REPLACEMENT COST?
Replacement cost is the cost necessary to repair or replace your entire home. When you insure your home for its replacement value, your insurer will reimburse you for the cost of rebuilding or repairing your home, based on the size and structure of the home that was lost or damaged. The most accurate way to determine the replacement cost of your home is to hire a building contractor or other building professional to produce a detailed estimate. Only the cost of the property’s structure and its associated systems, fixtures, and finishes will be included in the estimate; land value is included in a home’s market value, but should not be included in the amount of insurance you buy.
In the event of a loss, replacement cost coverage will help your family return to their home and usual quality of life with minimal financial interruption. For the best protection, experts recommend that you insure your home for at least 100 percent of its replacement cost.
Replacement value can change over time, so you should review your policy annually to make sure its coverage meets your needs. Inform your insurer if you have upgraded or improved your home, because these alterations may increase your home’s estimated replacement cost. Also, you’ll want to stay informed about changing market conditions in your area. Rising labor, materials, and transportation costs can directly affect your home’s replacement value. For maximum protection, consider a policy that includes an inflation clause that automatically adjusts coverage and premiums to account for changes in construction costs.
WHAT IS MARKET VALUE?
Market value is the amount that a buyer would pay to buy your home and its land in its current condition. Unlike your home’s replacement value, its market value is influenced by factors beyond the material and labor costs of repairs or reconstruction, such as proximity to good schools, local crime statistics, and the availability of similar homes. Also, the land itself will be included in the home’s market value, although it will not be covered by the homeowners’ policy.
In some cases, market value coverage may be the most practical option. Take the example of an ornate older home. In today’s market, the cost of rebuilding or restoring artisanal woodwork, masonry, and plastering to their original condition may be much higher than the home’s purchase price. Therefore, the replacement policy premiums for the home would be high. (Special policies are available for some historic homes, but these also come at a higher price.) For a cash-strapped homeowner, buying a policy based on market value offers the best chance to recoup at least partial expenses after a loss.
When you insure a typical home for its market value, you are at risk of having incomplete coverage. For example, imagine that a family buys a home for $175,000 and takes out a homeowner’s policy for the same amount. The replacement cost for the home, though, is $225,000. If a fire or other insured event destroys the house, the insurance settlement would be $50,000 less than the actual replacement cost of the home. The family would either have to make up the difference themselves or build a new, less expensive home.
Every two or three years it is important to take the time to check the value of your insurance policy against rising local building costs. Your insurance agent should be able to assist you with your review of your coverage.
Check the latest building codes in your community. If your home is severely damaged, you might have to rebuild it to comply with new building code standards, which may require a change in design or building materials.
Do not insure your home for the market value. The cost of rebuilding your house may be higher (or lower) than the price you paid for it or the price you could sell it for today.
Some banks require you to buy homeowners insurance to cover the amount of your mortgage. Make sure it’s also enough to cover the cost of rebuilding.
Increase the limit of your policy if you make improvements or additions to your house. You may upgrade features in your home to fit your tastes and lifestyle. These enhancements can significantly increase the replacement cost of your home. Again, your agent can help you in your determination as to whether additional coverage is needed.
Remember to tune in to YCCA’s Hammer Time every Saturday and Sunday morning at 7 on KQNA 1130 AM, 99.9 FM, 95.5 FM or the web at kqna.com. Listen to Sandy and Mike talk about the construction industry, meet your local community partners and so much more. It is a great way to start your day.