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Homeowners Insurance Replacement Costs
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Many people assume that if a fire or storm destroys their home, their homeowners insurance will make them whole again. But unless you have replacement cost coverage, your home insurance may not cover your home’s replacement in the event of a loss. Replacement cost is the most common type of homeowners insurance, but you’ll have to make sure your policy accurately reflects your home’s full replacement value to get the full benefit.
“One common mistake that many insured people make is to confuse ‘market value’ with ‘replacement costs.’” As risk manager Gary Raphael, with ACE Private Risk Services, wrote for Advisor One, the drop in housing values during the Great Recession confused people into thinking that as their property values dropped, they could reduce their premiums by dropping some coverage they thought they no longer needed.
What they didn’t realize, Raphael said, was that the cost of raw materials and fuel continued to rise, even as the property values plummeted. While the construction industry was devastated by layoffs, and new construction all but ceased during the depths of the global economic crisis, the economy was booming in China. All of which, on top of an Asian building boom, drove up the costs of steel, copper, oil and lumber worldwide.
Although the gap between the two prices today has narrowed somewhat, many families do not have enough homeowners coverage to pay for the replacement cost of rebuilding their homes. As a result, some families facing the loss of their homes are not being reimbursed enough to rebuild. Instead, they are forced to move to a much smaller house in what might be a worse neighborhood.
What is replacement cost value?
Replacement cost refers to the actual amount it would cost you to replace your home and the things in it. Replacement cost value is one of two types of coverage you might have in a homeowners insurance policy. The other type is actual cash value, which refers to your home’s value and its contents after accounting for depreciation.
The benefit of replacement cost coverage is that in the event of a total loss, such as in the case of a fire, you can replace everything new. With actual cost coverage, your insurer pays for the current value of your home and belongings, rather than what it would cost to buy new ones. This can result in a substantial out-of-pocket expense.
[ Read next: How to File a Home Insurance Claim ]
What is my house’s replacement cost value?
To make sure you have enough insurance to cover your home’s replacement cost value, you first have to determine what its value is. There are a few steps you can take to figure this out.
- Take inventory of everything in your home and estimate what it would cost to replace each possession with new items. If possible, include a photo or receipt to accompany valuables.
- Hire an appraiser to help you determine the cost of rebuilding your home. A general rule of thumb is to take your home’s square footage and multiply it by your local building costs per square foot.
- Use a replacement cost calculator. Some insurance carriers and appraisers have calculators to help you determine the replacement cost value of your home and possessions.
How does replacement cost get paid?
How your homeowners insurance company pays you depends on what type of insurance you have: actual cash value or replacement cost.
The actual cash value pays out based on the depreciated value of an item. Suppose you bought a fridge for $1,500, and it died after just a few years. To calculate your payout, the insurer would use the item’s replacement value, expected lifespan and current life to determine its actual cash value. This number is likely far less than it’ll actually cost you to replace the fridge.
But if you have replacement cost insurance, you can expect to get the full amount needed to replace it. If the same fridge still costs $1,500, that’s how much you’d likely get. Your carrier might send you the actual cash value upfront, and then the rest of the money once you replace the fridge and send a receipt.
How to submit a replacement cost claim?
If you’ve suffered a loss and need to submit a replacement cost claim, here are the steps you’ll need to follow:
- Contact your insurance company as soon as possible. Ideally, you’d contact your carrier or agent right away. They can tell you what you’ll need for your claim, how long you have to file, what your deductible is and how long the process will take.
- Depending on the situation, you may need to make temporary repairs to prevent further damage. Don’t make any permanent repairs just yet and be sure to save any receipts.
- Gather the necessary information. When you file your claim, an adjuster will visit your home to assess the damage. When they arrive, be sure to have a full inventory of any damaged or destroyed items, and gather bids from local contractors.
- Keep as much paperwork and information as you can in case there’s a disagreement with the insurance company about the sustained damage and value of your home.
- Replace your items and keep the receipts. With replacement cost insurance, the carrier will likely pay you the actual cash value upfront. Then, once you actually replace your items, they’ll pay you out for the remainder of the cost.
Guaranteed vs. extended replacement cost
Guaranteed replacement cost coverage means that if your home and possessions are destroyed, your insurance company will cover the full amount it costs to replace them. This type of coverage assumes a certain building cost.
Extended replacement costs coverage means your insurer will pay you out for slightly more — usually about 20% — than the cost to replace your home. The benefit of extended replacement cost is that if building costs go up, you’ll still be able to replace your home and possessions fully.
Today, some of the people most vulnerable to the underinsurance trend are first-time homebuyers who may not have much experience determining coverage limits. To stay on top of these price fluctuations, the Insurance Information Institute (III) has come up with an insurance checklist of things first-time buyers can do to ensure they aren’t left out to dry in the next catastrophe.
While it’s great advice for novices, it’s also a good idea to revisit this list each year to ensure your coverage keeps up with the times. Here’s a modified version that can be reviewed annually:
- Break it down into sections. Loretta Worters, spokeswoman for III, was quoted in a Fox Business story last month, advising homeowners to calculate their rebuilding costs by excluding the value of the land and just including the square footage, type of exterior wall construction, the style of the home, number of rooms and bathrooms, roof materials, kitchens amenities and any other home extras, including sheds and garages.
- Check for signs of age. Look for cracks in the plaster, plumbing leaks, integrity of wooden floors and ceiling molding, and any possible dangers with electrical wiring. Determine whether any necessary repairs should result in an increase in insurance limits.
- Look for leaks and moss growth on roof. Always one of the more costly parts of the house to repair/replace, so keep an eye on signs of age. You should also check with your insurer if you can get insurance discounts for adding fire or hail-resistant materials.
- Add up previous year’s maintenance costs. Were they more or less than normal? Do you expect other major costs in the coming year?
- Itemize your personal possessions. Did you make any valuable purchases in the last year? Make sure they are enumerated and recorded on your policy so you don’t have to create a list retroactively after a catastrophe.
As we have seen, insurance coverage levels are not something you can just set and forget. Your policy is a living document that needs a little TLC every now and then. If you review this checklist each year and play a more active role in keeping tabs on your coverage limits, you can avoid heartache in the future – and perhaps discover a few extra discounts you didn’t know you had.