Market Value vs Replacement Value...Insuring a Home Properly

Ask an insurance broker, a mortgage broker, and a realtor the question “How much insurance should I have on my new home” and I guarantee you will get three different answers.  The mortgage broker might say the loan amount, the realtor might say the market value, and the insurance broker, if he or she is doing their job correctly will say the replacement cost of the home.  So who is correct?

In short, it has to be the replacement value.
Homeowners need enough coverage to rebuild their home if a catastrophe happens.  Let’s take a look at how an insurance broker comes up with the number. Insurance companies use a computerized “replacement cost worksheet”  using historical data of building costs in a given area.  This data is provided to insurance companies and others in the construction business by independent companies.

Your broker will put the square footage, number of baths, style of home and other amenities information into the worksheet to determine a replacement value.  This  replacement cost also considers the extra costs at time of replacement such as demolition costs, debris removal, and architectural costs to name a few. The replacement value may be more or less than the home’s market value.

The value of the replacement value most times is determined by the market.  In a depressed market the value could be more than the home’s price while in a hot real estate market it may be less.   It will also be less if the sale involves other variables such as: large amounts of land, waterfront property, newly developed subdivisions and locations i.e. city vs. rural. 

 So, why do insurance companies insist on insuring at Replacement Cost?
First and foremost, insurance companies want clients to have adequate insurance in the event of a catastrophe.  No one wins when a fire destroys a home and there is not enough insurance to rebuild what a family has worked long and hard to accumulate.  Insuring to replacement cost also ensures that the insurance company is collecting enough premium to set aside the reserves that are needed to pay it’s clients claims when they do happen.

 I hope this sheds a little light on the difference between market value and that mysterious number insurers call “Replacement Value.”