Replacement cost Valuation vs Market Valuation
Most people do not understand how the insurance companies place a value on your home for insurance purposes. Many consumers assume their insurance policy covers their home for the value it would be sold for. With most insurance policies that is Incorrect! Let’s look at the difference between a replacement cost policy & a market value policy.
REPLACEMENT COST – When your policy includes replacement cost on your home, they are insuring it for the value it would cost to rebuild it. They are going to “replace” your home with a new one that was like the home you lost. Your area & market value are not considered when insuring a home with replacement cost. There are different types of replacement cost policies. A very few companies will offer Guaranteed replacement cost coverage. Erie Insurance is one of the companies that offer a guaranteed replacement cost policy. Most companies will offer a limited or capped replacement cost policy. Unlike a guaranteed replacement policy that will have no limit or cap in the event of a total loss to your home, the other policies will place a cap or maximum limit they would pay in the same type of event. Some companies will place the maximum cap by the limit shown on the declaration pages. Other companies will offer an “extended” replacement cost, that will limit your coverage to a certain percentage of the insured dwelling value. With extended replacement cost policies, the most common limits are 125% or 150% of the insured dwelling value. No matter what replacement cost limit you have, the insurance company is always going to insure the home for what they feel it would cost to rebuild from the ground up.
And what most people don’t understand is the replacement cost of a home is generally more than if you were building a new home on an empty lot. There maybe additional construction constraints to “re-building” in a certain area. You may have additional work from engineers to verify if any of the remaining structure can be used. There are additional factors that make Re-building a home, after a total loss, more costly than building a new home.
MARKET VALUATION – Very few companies will offer this type of policy. Instead of using replacement cost, they will use the market value of the property for the property insurance limit. This may be useful to a customer when their home is in a neighborhood with lower market values. For example, a home with a replacement cost of $500,000 might only sell for $200,000. This would be a scenario when you may want to look into a Market value policy. But there is usually some kind of trade off. The insurance company may not insure the home for replacement cost in any scenario, if you have a market value policy. They may choose to settle claims using Actual Cash Value, also known as ACV. With an ACV policy the company determines the replacement cost, then they use depreciation to settle the claim. The depreciation includes things like age and condition.
The confusion for many people is that they believe the value of what they can sell their home for (Market value) is what the insurance company uses for the “insured value” that you see on the policy. That is not the case. Whenever you have a replacement cost provision on your policy, the insurance company will want to insured it for the true replacement value of the building. It wouldn’t matter if that building is in the priciest neighborhood, or a lower end neighborhood. The replacement value is always determined by how much it would cost to re-build it. It will factor in specific characteristics of the home, including build quality, materials & workmanship. But it will not factor in area, or what the home would sell for.
Make sure to check your insurance policy so you know what you are paying for !!