Dwelling value vs. market value: What are you insuring?
With home values steadily rising in Colorado in recent years, we have gotten many questions about why the dwelling limit listed on the homeowners insurance is lower than the market value of the home. Many homeowners are concerned that their home is underinsured since they could sell it for more than what the dwelling is insured for. With spring coming up and the real estate market starting to pick up again, it might be a good time to explain what home buyers are actually insuring.
An insurance company is never going to sell your home, just rebuild it. Therefore, your insurance carrier must insure the home for the amount of money it would cost to rebuild your home, not what the real estate market estimates it is worth. Market values and contracting costs can differ greatly. At this point in time, contracting costs tend to be lower than market values, mostly due to the highly inflated cost of land in Colorado. For example, your home may appraise for $500,000, but that includes the cost of the land, so it is very possible that it would actually only cost $400,000 to rebuild the home in the event of a total loss.
Most carriers use a similar system to determine the estimated cost to rebuild a home in the event of a total loss. When filling out the Replacement Cost Estimator (RCE), we can get very specific with the details in the home to get the most accurate figure possible. Some of the things considered are the above ground square footage, the foundation (basement, slab, etc.), the portion of the basement that is finished, the number of bathrooms, and the finishes in the home, like flooring, counters and cabinets. For homes with higher end finishes, we can go even further and input the light fixtures, window types, ceiling fans, crown or base molding, and special features like theatre rooms, build in speakers, wet bars, and wine cellars.
Regardless of the features in your home, we can use the RCE to determine the most accurate estimated cost to rebuild your home to ensure you are not under or over insuring your home. That being said, the RCE is only an estimate and since market costs of labor and materials are constantly changing, the actual cost to rebuild your home may change even over an annual policy term.
In order to account for inflation and increasing construction costs during a policy term, we try to include Extended Dwelling Coverage on every homeowners policy that offers that coverage. Extended Dwelling Coverage provides an additional percentage of your dwelling limit, usually either 25% or 50%, which can extend if there is a loss. That means if your dwelling limit is $100,000 and you have 25% of Extended Dwelling Coverage, if there is a significant loss to your home and the actual cost to rebuild exceeds your $100,000 dwelling limit, you would have an additional $25,000 available to cover the increased costs.
One stipulation most insurance carries have is that your dwelling limit needs to accurately reflect the features of your home in order for the Extended Dwelling Coverage to extend. You cannot underinsure your home and then count on the additional percentage of coverage to fill that gap, which is why it is important to notify your agent if you make any significant changes to the home, like finishing the basement or upgrading the kitchen or bathroom.
Since insurance coverage is based on the replacement cost of your dwelling, not what it will sell for, insuring your home for more than what it would cost to rebuild it will not result in a higher claim payout if there is a total loss. That means if you insure your home based on what you could sell it for, you may be paying higher premiums for no reason.
What about new construction?
On the other side of the coin, often times the dwelling limit on a home that was just built is going to be higher than the price just paid to build the home. That may seem counter-intuitive, but there are several factors that can make the estimated cost to rebuild the home greater than the original cost to build the home.
First is that when a new home is being built, more often than not it is built with a group of homes or as a new subdivision. When that is the case, it costs less to build each home than it would to build just one home by itself. For example, once the contractors have poured the foundation for one home, they can move on to the next one and pour that foundation while the first one is hardening. If only one home is being build, the contractors generally have to wait for the foundation to harden before they can start on the next step.
While they are waiting for that to happen, those contractors are generally still getting paid, because otherwise they would likely go out and find new work and the builder would have to find new contractors. Since companies are not able to multi-task as easily when only one home is being built, it tends to cost more in labor hours.
Another factor is that when multiple homes are being built, the contractors are often able to purchase the required materials in bulk, which gives them a discounted rate. When only one home is being built, they are only purchasing the piping, flooring, wiring, toilets, sinks, bathtubs, and so on for one house rather than many houses, so the cost for materials can be higher.
Debris removal is another piece of the dwelling value puzzle that people often overlook. Most policies include coverage to remove the charred remains of your home after a fire, and the cost of debris removal can be significant. Local ordinance may also require the undamaged portion of your home be removed if it sustains significant damage. Each town ordinance requires demolition when a certain percentage of damage is reached, usually 60% or more. In cases like this, your dwelling value is not only covering the rebuilding of your home, it is also covering the demolition of the undamaged portion of your home as well as the cost of hauling that debris out so that your new home can be constructed. Debris removal or demolition is generally not a cost incurred when a home is first being built because, in theory, the house is being built on vacant ground.
As you can see, there is more to insuring your home than you would think. Most carriers use inflation guard to keep dwelling values in line with rising contracting costs, which causes the dwelling limit to increase accordingly at each renewal. While inflation guard is important to ensure you are not still insuring your home for what it would have cost to rebuild it 10 years ago, it is not an exact science. It is best to reassess your dwelling value with your agent every 3 to 5 years to ensure your home’s replacement cost keeps in line with rebuilding costs.
Let us review your current coverage and provide you a new homeowners insurance quote. We'll compare over 20 companies so you can make the right choice.