Insurable Value vs. Market Value - There is a Difference

“Why does the limit of coverage on my home keep increasing when the market value is going down?” is a frequently asked question. The information below is intended to provide answers to how market value, replacement cost, actual cash value, and reconstruction costs differ and how they impact the coverage limit on your home.

Market Value

A common misconception is that homeowners insurance is directly related to the market value of a house. Market value is what the buyer will pay for the property and includes the cost of land. A fair selling price can be determined by using comparables, market trends, seasonality, and other available data. Market supply and buyer demand then determines the final price. The market value could be more or less than the insurance coverage on your home.

Replacement Cost

Replacement cost is what it would cost to reconstruct your home based on current construction costs, special features, size, age of the home, etc. It is the actual cost of replacing the home—without deduction for depreciation—using current standards and building codes that include fees associated with architects, contractors, builders profit, etc. It does not include land value.

Components that affect replacement cost include:

  • Availability of skilled labor
  • Changing construction codes/standards
  • Debris removal
  • Demand surge – If a tornado damages several homes throughout a particular area, this would cause the demand for labor and materials to be high and increase prices
  • Demolition
  • Fuel/energy costs
  • Material costs

It is impossible to predict today what the exact cost will be to replace a home in the future, so it is important to have enough coverage to account for unseen circumstances. That is why Federated provides an additional buffer of 25% over and above the coverage limit on homes we insure to protect against unanticipated rising construction costs.

Actual Cash Value

The actual cash value basis is the cost to replace the damaged property with materials of comparable quality, less depreciation. Depreciation is a reduction in value to reflect physical wear and tear, age, and obsolescence. As an example, property such as a roof may have a life expectancy of 30 years. Damage that occurred after 15 years would have a 50% deduction for depreciation.

Reconstruction vs. New Construction

Many people think that rebuilding costs are less than new construction. Actually, rebuilding can cost about 20 to 30% more.

Here are some of the reasons why reconstruction (cost of rebuilding) costs are higher than new construction.

  • Access to Worksite – New construction usually allows easy access to the site. Existing houses have limited access due to fences, flowers beds, shrubs, trees, etc.
  • Bottom-to-Top vs. Top-to-Bottom – New construction begins at the foundation and builds upward. Repairing a house that is not totally destroyed usually means removing the roof and rebuilding from the top down that takes more time and money.
  • Building Code Changes – Newer and more demanding building codes may need to be met when rebuilding a home.
  • Construction Costs Rise After Disasters – Costs of building materials and labor nearly always rise in response to a sudden surge in demand.
  • Debris Removal & Demolition – New home construction normally begins on open ground with minor site preparation. Parts of the damaged structure may require demolition and removal and the site may have to be extensively cleaned.
  • Economy of Scale – When a contractor has many homes under construction at once, materials can be purchased in larger quantities at discounted prices.
  • Labor – When a new home builder has several houses under construction, work can be scheduled for the most efficient use of workers.
  • Protection for Parts of Home and Undamaged Contents – All parts of the property not destroyed must be protected from further damage or looting, which adds more cost.
  • Special Features & Unusual Materials – Unique or customized features and materials of older and remodeled homes can be very expensive to duplicate.

These factors all play a part in why insurable value and market value are two different amounts.

This article is intended to provide general information purposes only and should not be construed as coverage, legal, tax, or financial advice with respect to specific facts or circumstances. You should always consult your personal attorney and insurance advisors for advice unique to you and your business. © 2009 Federated Mutual Insurance Company. All rights reserved.

Published Date:August 30, 2018

Categories: Risk Management - General