When homeowners look at their insurance coverage, one of the most common questions we hear is: “Why is my home insured for more than it is worth?”
The answer is that your home’s market value and its replacement cost measure two very different things.
Market value is what someone might pay to purchase your home and property. Replacement cost is an estimate of what it could cost to rebuild the home following a covered loss. Because those figures are calculated differently, they are rarely the same.
What Is Included in Market Value?
Your home’s market value is influenced by factors such as:
• The value of the land
• The location and surrounding neighborhood
• The local housing market
• School districts and nearby services
• The home’s age, condition and appearance
• Supply and demand among buyers
Some of these factors have little to do with the cost of rebuilding the structure. For example, the land beneath your home may contribute significantly to its selling price, but the land itself generally does not need to be replaced after a fire.
What Determines Replacement Cost?
Replacement cost focuses on the estimated expense of reconstructing your home using materials of similar kind and quality. It may account for:
• Current construction materials and labor costs
• The size, style and number of stories in the home
• Roofing, siding and foundation materials
• Kitchens, bathrooms, flooring and interior finishes
• Attached garages, porches and other permanent features
• Debris removal following a loss
• Architectural, engineering and permit expenses
• Updates required by current building codes
Rebuilding one home after a loss can also be more expensive per square foot than constructing several homes as part of a new development. A contractor may need to work within an existing property, remove damaged materials, protect undamaged portions of the structure and coordinate specialized labor on a single project.
Why Replacement Costs Change
Even if you have not made major improvements to your home, its estimated replacement cost can change over time.
The cost of lumber, roofing, electrical components, plumbing materials and skilled labor can rise. Building codes may also change, requiring additional work if a home must be substantially repaired or rebuilt.
This is why many homeowners’ policies include an inflation adjustment that gradually increases the dwelling limit. However, an automatic adjustment does not eliminate the need for periodic reviews. The information used to calculate the replacement cost must still accurately reflect the home.
Home Improvements Can Affect Your Coverage
Certain improvements can materially change the estimated rebuilding cost of a home. You should let your insurance agent know if you have completed projects such as:
• An addition or finished basement
• A remodeled kitchen or bathroom
• A new garage, porch or deck
• Upgraded flooring, cabinets or countertops
• A new roof or major mechanical improvements
• Installation of a wood stove, pellet stove or generator
• Conversion of a seasonal property into a year-round residence
Even improvements that do not substantially change the home’s market value may affect what it would cost to reconstruct.
Is a Higher Dwelling Limit Always Better?
The objective is not simply to insure the home for the highest possible amount. The goal is to arrive at a reasonable replacement-cost estimate based on accurate information about the structure.
An inadequate dwelling limit could leave you without enough coverage after a serious loss. At the same time, increasing the limit without reviewing the underlying home characteristics does not necessarily provide additional benefits. Insurance policies contain terms, conditions and limits that determine how a loss is settled.
The best approach is to make sure the details used in the replacement-cost estimate are correct and to review the coverage periodically.
When Should You Review Your Home Coverage?
It makes sense to review your homeowner’s coverage:
• Before your policy renews
• After a renovation or addition
• After purchasing a home
• When construction costs have changed considerably
• If you are unsure whether the policy accurately describes your home
• If it has been several years since your last detailed review
A good review should look beyond the dwelling limit. It can also include detached structures, personal property, additional living expenses, liability coverage, deductibles and any special items or features that may require additional protection.
We’re Here to Help
At Gladstone Insurance Agency, we can help you review the information used to estimate your home’s replacement cost and explain how that amount differs from its market value.
Every home and insurance policy is different. If you have renovated your home, added new features or simply have questions about your current coverage, contact our office to schedule a policy review.
This article is intended for general informational purposes only. Coverage varies by insurance company and policy. All claims are subject to the terms, conditions, limitations and exclusions of the applicable policy.
