Hello homeowners! Today at Looker Wolfe & Gephart Insurance, we’re addressing a common concern: why you need to insure your home for 100% of its replacement cost, even if you’re tempted to opt for less coverage to save on premiums. Let’s explore this topic through a typical scenario – but 1st – it is key that you understand the difference between replacement cost and market value.
| Replacement Cost | Market Value / Appraised Value / Zillow Value |
| the amount of money it would take to rebuild or repair your home with materials and construction methods of similar quality, without deducting for depreciation. This coverage ensures that if your home is damaged or destroyed, you can restore it to its pre-loss condition, providing you with funds to replace what was lost at current market prices for labor and materials. | refers to the price your home could fetch on the open market if you were to sell it. This value considers factors like location, size, condition, upgrades, and current real estate market trends. However, market value isn’t directly used for insurance purposes since it includes the value of the land, which remains after property damage or destruction. |
Why Insurance to Value (ITV) is Critical
Insurance to Value (ITV) is a key concept in property insurance. It means your insurance coverage should match the full cost to replace or rebuild your home, not just its market or purchase value.
Underwriting Requirements
- Regulation and Protection: Insurance companies, follow underwriting rules that require homes to be insured for at least 80% to 100% of their replacement cost. This isn’t just about the rules; it’s about ensuring you’re adequately protected in case of a significant loss.
- Consumer Protection: These standards are in place to protect you and your mortgage lender from being underinsured, which could lead to financial hardship after a disaster.
Understanding the Impact of Partial Coverage
Let’s illustrate with an example:
Scenario:
- Home Value: Imagine your home’s replacement cost is $300,000.
- Coverage Purchased: You decide to insure your home for only $200,000, assuming this will save you on premiums – and your policy has an 80% co-insurance requirement.
Partial Loss Event:
- Damage: A fire damages part of your home, costing $100,000 to repair.
- Without Replacement Cost Coverage:
- If your policy pays out on an Actual Cash Value (ACV) basis (which accounts for depreciation), let’s say the depreciated value of the damaged parts is $80,000.
- With Co-Insurance Penalty:
- Since your coverage ($200,000) is less than 80% of the replacement cost ($240,000), you might face a co-insurance penalty. Here’s how it works:
- Step 1: Calculate the Required Coverage – $300,000 * 80% = $240,000.
- Step 2: Your Coverage Percentage – $200,000 / $240,000 = 83.33%.
- Step 3: Penalty Calculation – $80,000 * 83.33% = $66,664.
- Since your coverage ($200,000) is less than 80% of the replacement cost ($240,000), you might face a co-insurance penalty. Here’s how it works:
Outcome: Instead of receiving $100,000 to repair your home, you’d receive approximately $66,664. This means you’re out-of-pocket for roughly $33,336 to cover the repair costs! If you thought you saved a few hundred bucks on your premium; you will have just learned a hard lesson in insurance 101.
Why Full Coverage Matters
- Financial Protection: By insuring for 100% of replacement cost, you avoid the co-insurance penalty and ensure that in the event of a total or significant loss, you can rebuild without needing to dip into personal savings or loans.
- Inflation and Increased Costs: Building materials and labor costs can rise. Full coverage today might not be enough tomorrow if prices inflate.
- Pace: Rebuilding or repairing your home can be done at your pace, without the rush to find additional funds.
Conclusion
While paying for full replacement cost insurance might seem like an unnecessary expense when times are good, it’s a safeguard for when disaster strikes. At LWG Insurance, we’re committed to helping you understand and secure the right coverage. Remember, the small extra you might pay in premiums can prevent significant financial stress later.
Do you have questions about your home insurance? Contact us for a personalized consultation to ensure your home is covered correctly. We can work via email, phone, or swing by the office!