Understanding Home Insurance and Replacement Cost

The last several months we have seen multiple people who currently have less than enough coverage to rebuild their home, or they have received a comparison quote from a different agency with an undervalued dwelling limit. I am referring to the Estimated Replacement Cost of your home, or the calculated amount it will take to rebuild the home from the ground up.

You may say "I only paid $150,000 for my house so I don’t need $300,000 of homeowners insurance coverage." Fair enough, but to qualify for replacement cost coverage the home needs to be insured for the amount it takes to replace it exactly as it is today and not market value.

You may think if you insure the home for the lower amount and something happens then you could just go buy another home. What if several homes are destroyed or an entire town? What if there isn’t another home to buy or you have to move out of the community?

Another issue that is more likely to impact you if your home is under-insured is the coinsurance clause in your insurance policy. The simple explanation for this clause is that your home must be insured to a certain percentage, typically at least 80%, of your homes calculated replacement cost (not market value). If you turn in a claim such as roof damage and your home is underinsured, there will likely be a coinsurance penalty.

For example, you have a home with an estimated replacement cost of $300,000 but it is insured for $150,000. You turn in a hail claim on your roof for $18,000 and you have a $1,500 deductible. The coinsurance provision would make this hypothetical claim look like the following:

 

$18,000 claim - $1,500 deductible = $16,500

Required amount of coverage on the dwelling ($300,000x80%) = $240,000

Actual dwelling coverage = $150,000

Coinsurance percentage (150,000/240,000) = 63% x $16,500 = $10,395 total claim payment

 

You successfully saved some premium over the year but ended up costing yourself an additional $6,105 out of pocket to complete the repairs to your home.

To avoid this costly mistake, make sure you work with your agent to find out how they came up with their recommended coverage amount. Talk to local contractors and find out what the going rate per square foot is for new home construction and update your existing agent on any changes or updates made to your home.