Do you have enough insurance coverage to cover the cost of replacement to rebuild your home and replace all of your belongings if disaster strikes? This is because inflation and natural catastrophes can dramatically increase the cost of home construction, meaning you might need more coverage than you think.
When you’re buying a homeowners insurance policy, you can choose between actual cash value or replacement cost for your personal property coverage.
Personal property coverage insures your possessions, including furniture, electronics, clothes, appliances, and other items in your home, up to the policy’s limit. Choosing between actual cash value or replacement cost coverage influences how much your insurer will reimburse if you file a claim and how much you pay for homeowners insurance.
What is replacement cost insurance coverage?
Replacement cost insurance refers to having enough coverage to rebuild the home and replace lost items. Homeowners can buy a replacement cost policy that covers their dwelling and personal property (like electronics, furniture, and clothing). It can also offer both dwelling and personal property coverage.
Most homeowners insurance policies provide some coverage for the loss of personal belongings. This coverage is typically for 50% to 70% of the amount of insurance on the dwelling. So, if a house is insured for $300,000, insurance will pay out $150,000 to $210,000 for personal property.
For some people, that’s plenty of coverage. For anyone whose personal property is valued at more than their standard homeowners’ policy provides, it makes sense to buy a replacement cost insurance policy that covers personal possessions. Personal property replacement cost coverage does not apply only to homeowners.
Renters insurance replacement cost provides the same level of security for those who lease their homes.
How does replacement cost insurance work?
When you file a claim, your insurer may not pay out the full replacement cost of your home or belongings right away. Instead, you may get an actual cash value payment first. Then you’ll receive the balance of the payout once you’ve replaced the item and submitted your receipt to your insurer as proof.
Dwelling, other structures, and personal property coverage are generally subject to a deductible. A deductible is the amount of your claim an insurer expects you to cover yourself, so it will be subtracted from your payout.
Here’s an example: A tree falls on your home, damaging your 5-year-old roof. You file a claim to replace it. The insurance company estimates that your existing roof is worth about $8,000 and that it’ll cost $12,000 to buy a new one. The deductible on your policy is $1,000.
The insurer mails you an initial check for $7,000 — the actual cash value of your roof ($8,000) minus your $1,000 deductible. Once you’ve replaced the roof, you send the receipt from the contractor to your insurance company, which mails you a check for the remaining $4,000.
Replacement cost vs. actual cash value
An actual cash value insurance policy pays what your items are worth minus depreciation, or the loss of value over time. For example, if your sofa is lost in a covered fire, your insurer will pay only what the sofa was worth when it was destroyed, not the amount it would cost to replace it with a new one.
Choosing actual cash value coverage will usually save you money on your insurance premiums. However, it could cost you more in the long run if many belongings are damaged at once and your insurance payout isn’t enough to replace them. Most insurers offer the option to upgrade to replacement cost coverage for your belongings.
While actual cash value coverage is most common in your policy’s personal property section, it may also apply to your roof. That means if a hailstorm damages your roof halfway through its expected lifespan, your insurance company might pay only half the amount you’d need to replace it.
Check your home insurance declarations page or call your agent to find out whether you have replacement cost or actual cash value coverage.
Replacement cost value vs. market value
RCV and market value are not the same, especially when it comes to home insurance. Market value is the amount an appraiser deems a home or property is worth or the amount that someone is willing to pay for that home or property, including the land. It is based on what the current market is willing to pay.
Homeowners’ insurance companies do not use market value when calculating costs for dwelling or personal property coverage. With RCV coverage, the cost to rebuild the home’s structure or replace personal property at today’s prices is accounted for in the dwelling coverage and is paid for following a covered loss.
This will likely be lower than the market value, as it does not consider land value.
Guaranteed vs. extended replacement cost coverage
When you first purchase your home policy, your agent calculates the current replacement value of your home. However, there are situations where the replacement cost of your home can change drastically throughout the year.
Inflation impacts the cost of materials and labor throughout the year and as the economy fluctuates.
In situations with widespread loss, the sudden high demand for materials and labor, along with transportation difficulties, can also drastically inflate the replacement cost of your home. To account for this, many companies offer replacement cost endorsements for your dwelling that may help you avoid expensive out-of-pocket expenses.
- Guaranteed replacement: This coverage helps pay for rebuilding the structure of your home after a covered peril, even if the current cost is higher than the coverage limits listed on your declarations page. For instance, if your dwelling coverage only covers up to $250,000, but the cost to rebuild your destroyed home is $300,000, guaranteed replacement cost could cover the rebuild even though it exceeds the coverage limits.
- Extended replacement: This coverage considers a certain percentage, often 25 to 30 percent, over the dwelling coverage limits specified in the policy. For example, if your coverage limit was up to $200,000, but the cost of rebuilding your home is $250,000, an extended replacement cost endorsement that covers up to 25 percent more than the policy limits would cover the cost to rebuild.
These endorsements are typically more expensive than standard dwelling coverage. However, if you want more complete financial protection over the long term, they may be options worth considering. Speaking with your insurance agent may help you determine if these types of coverage are right for you.
Factors that affect replacement cost coverage
As straightforward as replacement cost sounds, there are a number of factors that go into determining how much a homeowner needs. Here are a few examples:
- What it costs to replace a home (without the land). Let’s say a homeowner pays $600,000 for a home because it’s near the beach. If that home burns to the ground and needs to be replaced, it may only cost $450,000 to rebuild because $150,000 of what the homeowner initially paid was due to the value of the lot on which it was built. In this case, replacement cost coverage would be for $450,000 rather than $600,000.
- The existing qualities of a home. Imagine a home is full of unique features like intricate molding, a slate roof, antique door handles, or a custom-built storm room. Even if that person spent $400,000 to buy the home, it may require more to rebuild due to the expense of making it “like new.”
- Where the home is located. The price of rebuilding a home varies by region.
How to calculate replacement cost for your home
As mentioned, the market value of a home may not represent the true cost of rebuilding. After all, the land on which a home sits will not need to be replaced if the home is destroyed, but unusual features (like extraordinary woodwork or stained glass windows) need to be factored in. Homeowners have three options for coming up with an accurate replacement cost:
- Break down each and every feature of the home and seek valuations. For example, find out how much it would cost to replace the model of hot water heater currently in the home, then do the same for every other feature that would need to be replaced if the home was destroyed. This is, by far, the most labor intensive way of calculating replacement cost.
- Count on your insurance agent. An experienced agent has access to a sophisticated home value calculator. This replacement cost estimator takes location, age of the home, and any special features into account as it calculates how much coverage is required.
- Hire an independent appraiser. Hiring an appraiser from your area offers a couple of advantages. The appraiser is familiar with the construction codes that govern how your home needs to be rebuilt, understands the value of property in your area, and has a clear sense of how much it will cost to track down and install unique features.
How insurance companies determine replacement cost
Insurance companies evaluate your home’s characteristics, such as building materials, age, square footage and labor costs in your area to calculate your home’s dwelling coverage amount. A percentage of your dwelling amount determines your personal property coverage amount.
Once those figures are determined, your policy would cover either RCV or ACV for damaged or destroyed items that fall within these coverage categories.
Therefore, your insurance company does not determine replacement cost, per se. You and your insurance company will determine the coverage amounts where replacement cost can apply, along with dwelling, other structures and personal property coverage. In many cases, replacement cost coverage will apply to your dwelling and other structures coverage.
However, personal property coverage varies by insurer. It may be best to review how replacement cost coverage applies (or does not apply) to your coverage to avoid surprises should a claim occur.
Knowing your home’s replacement cost
While replacement cost insurance offers more financial protection than actual cash value coverage, you could still end up underinsured if you don’t set your coverage limits high enough.
Insurers use replacement cost calculators to determine how much dwelling coverage you’ll need to rebuild your home. The estimate will incorporate various information about your home, like its square footage, construction materials and the year it was built.
You can also determine your home’s replacement cost on your own. One method involves multiplying your home’s square footage by the current cost of construction per square foot in your area, Alan Himmel, a public insurance adjuster in Florida, said by email. “You can get an idea of per square foot building costs by calling the builders association in your area, an insurance agent, or even … contractors.”
The average cost to build a house is about $150 per square foot, according to HomeAdvisor.
You can also hire a contractor to provide a construction estimate or have an independent insurance agency pull multiple homeowners insurance quotes to get a sense of what each insurer estimates it will cost to rebuild your home.
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