A study done by CBS Money Watch several years ago stated that 59% of homeowners are underinsured and, on average, only have 78% of the insurance amount needed to replace or rebuild their homes. Scary, huh? In general, people tend to be under insured. I get a ton of questions concerning home insurance valuations from my partners. Some of these questions come from clients and REALTORS who are looking to skim down on cost. Some of the questions come from mortgage professionals looking to keep their clients qualified. In the space I have here, I’ll cover the top two questions I get on the valuation of homeowner’s insurance. Because, believe it or not, we don’t just pick random numbers.
1-) Why is the coverage amount listed on the home different from the amount of the loan? Shouldn’t they be the same?
Great question! In a nutshell….no. Here is the reason: The loan amount for the home, typically the amount that is being paid to purchase the home (assuming we aren’t doing renovations, etc.), is based on a ton of factors that are not taken into consideration for insurance. For example, the cost of the home will factor in details such as the neighborhood that the home is in, the school district, the value of the land it is built on, the property’s proximity to waterfront views, and tons of other factors. From a real estate perspective, the value (and conversely the amount paid) for the home takes into consideration all of these factors. A buyer may be willing to pay more for a property based on one or several of these features. However, from an insurance perspective……those points really don’t matter.
To clarify, insurance coverage will certainly be concerned with features of the home such as its proximity to the water (for risks such as hurricane, wind or water exposure), etc. However, the purpose of insurance on a home is to provide the coverage to rebuild a property, make repairs, protect the owner from liability exposures. Insurance does not take into consideration the trendy neighborhood, the school district or the cost of the land the property is built on. If you think about it….that makes sense, right? Insurance certainly wouldn’t be rebuilding or covering the replacement cost of those features, so the features that impact the price (and thus the required loan amount) are separate from the insurance valuation of the property. Therefore, the amount that is being paid for the house really has very little to do with the insurance valuation amount to rebuild the home.
Which leads us to the next question…..
2-) How do we come up with the coverage valuation for the home?
This is a super common question that I get and the answer is pretty simple. Remember how I mentioned above that insurance is not concerned with the cost of the land or the school district of the property? Well, insurance is interested in the features of the home. We want to know the square footage, the finishings used in the rooms, the number and size of decks or porches and the new custom upgrades that were done in the kitchen. We want to know about the new garage that was built and the game room you furnished. Why? Because all those features are things that we are replacing for you on your insurance and are features that we look at when calculating your replacement cost. The easiest way to think of this principle is that insurance (with the exception of some of the features of liability protection) is interested in tangible, concrete, repairs and rebuilds.
The foundational purpose of homeowner’s insurance is to restore a homeowner to the condition they were in prior to the loss and to provide liability protection. This restoration takes into account the cost to repair or replace what you currently have, plus the cost of labor, taking into consideration the cost of inflation and materials. These repairs and coverages are subject to the deductibles that you selected on your policy. In coming up with the replacement coverage amount, we use a calculation system that takes into consideration the details of the home (materials used, square footage, additions, upgrades, number of bedrooms and bathrooms, etc.) and calculates an up-to-date estimate of what it would cost to replace those features in the home to include labor, materials and inflation. This is the number that we use as the valuation coverage amount for the home. It is really a very simple equation factoring [feature to be replaced/repaired] + [ cost of material to replace/repair] + [labor to repair/replace] + [allowance for inflation]= cost.
INSIDER FYI: There are two valuations of coverages on your property insurance: Actual Cash Value (ACV) and Replacement Cost (RC). ACV is the actual cash value of the item that was lost or damaged at present day value. This means that the value of the item will depreciate with time and will very likely not provide a coverage payout that will allow you to replace the item at present day. RC on the other hand, covers your property on a replacement basis as closely as possible to the item that was lost, at the cost that it takes to replace the item at the time of loss. In terms of the coverages for your home, RC is always the superior coverage option.
Kelley Carter, CPIA
The Choice Insurance Agency’s mission is to help you get from where you are to where you want to be financially by planning, achieving your plan and protecting your plan from unexpected events. In the process, our goal is to deliver insurance services in a manner that exceeds your expectations. See what The Choice Insurance Agency can do for you today. Give us a call at 757-416-5100 to speak with one of the licensed, professional members of our team or request a contact here. The Choice Insurance Agency. We’re on YOUR side. 757-416-5100 .