Understanding Residential Reconstruction Cost

Most Insurance companies today perform an home inspection after a new homeowner policy is issued. I am consistently asked Why is the insurance coverage amount greater than the current market value? Below is some insight into WHY....

Although we are always mindful of housing values, construction activity and other related trends, insurance companies adjust their coverage limits based on the costs to rebuild after a loss. Experience has shown that rebuilding figures often are significantly higher than the costs associated with building a new home.

Rebuilding versus new construction. Newly built homes usually do not include features added after occupancy, such as interior decorating, window treatments, expensive electronic systems and home theaters. The promise is to rebuild a policyholder's home to the same specifications of the original at the time of the loss. Doing so can lead to higher costs due to high-end custom features and the use of materials that are difficult to replace.

Unreported renovations. Homeowners spent $276 billion on home renovations in 2008; 30% of that amount ($83 billion) is attributed to high-net-worth households. Two-thirds of these home improvements, from expensive electronic systems to ornate window treatments are not reported to insurance companies but would be covered under a replacement cost contract.

Building in bulk. Developers buy a large parcel of land, subdivide it into building lots and turn a profit on both the land and the home. A contractor rebuilding a single home must make all his profits from a single source. Additionally, when building several homes, materials are bought in bulk at substantial savings.

Increases in labor and material costs. Labor rates in the construction industry increased by 4.5% in 2008, while materials used in residential construction increased by 4.9%. Costs increase even more when rush orders and additional labor are necessary to rebuild a home in a short time frame.

Resale value versus replacement cost. The average resale value for homes in the U.S. dropped about 11% in 2008. However, the cost to replace a damaged home went up. According to Xactware, a supplier of software used to process 80% of U.S. property claims (used by the six largest insurance carriers), the cost to repair a property after a loss increased 5.8% in 2008.

Sources:1 Joint Center for Housing Studies, Harvard University, 2009 2 U.S. Bureau of Labor Statistics3 4Q 2008 House Price Index, Federal Housing Finance Agency, February 20094 2008 Property Report, Xactware, February 2009