Have you ever wondered why your home or business is insured for an amount other than its re-sale value? The amount of insurance you carry on the building itself is often different from its estimated retail value. It even fluctuates slightly with the economy. So why is the house that you bought last year for $350,000 insured for $425,000?
The insurance contract at its core is an agreement that the client will pay a premium so that the insurance company will indemnify them (make whole again) in the event of a disaster. This contract is always predicated on the worst case scenario. Although fires, hurricanes, electrical storms, broken water pipes and vandalism typically affect only a portion of a home, the insurance is designed to cover both smaller incidents as well as complete destruction.
In calculating what it would cost to rebuild a home or business, there are many factors. All of the factors contemplate the complete destruction of the building – again, planning for the worst case scenario. Insurance companies utilize specialized software that is specifically designed to determine all of the costs involved in rebuilding. These programs are called Replacement Cost Estimators or Rebuilding Cost Estimators. These programs contain hundreds of variables that are used in calculating an accurate rebuilding cost. Some of them include:
- Location and zip code – it may take longer to ship rebuilding supplies to a more remote location, which therefore may cost more
- Current cost of building supplies – building supply costs fluctuate with the economy, including the fluctuations in fuel costs. Costs for contractors in your area, including their costs for subcontractors and insurance are considered. These figures are typically updated quarterly in the Replacement Cost software
- Debris removal – this can be made harder or easier depending on the location of the structure and its proximity to other buildings (i.e. this can be tough when houses are very close together)
- House features – the rebuilding cost estimators take into account the style of the home – meaning a rambling 1880 Victorian mansion with fancy trim, wide wood moldings and a wrap-around porch requires different building materials than a 2010 ranch house built with 100 other similar homes in a sub-division.
- Original building supplies – Indemnification means that the insurance will pay to use building supplies that are either exact or similar to the original construction materials used. This is the concept of Replacement Cost. Did you have a vinyl sided house? You will get a vinyl sided house. Did you have old wooden windows? They don’t exist anymore so you will get new vinyl windows of similar dimensions. Did you have a linoleum kitchen floor? You’re not going to get an upgrade – you’re going to get a linoleum kitchen floor.
The idea is to restore your home or building to its exact conditions (or as close as possible) before the disaster occurred. No better. No worse.
An inner city 1950’s row house may only sell for $100,000. However, in order to rebuild that row house from the ground up, it could easily cost over $200,000. It’s attached to other row houses on either side. Debris removal will be challenging. Attempting to use original building materials (think brownstones) will also be more expensive if they are not readily available.
A home built in a large development was probably built simultaneously with 100 other homes. The builders did everything in bulk. They bought building supplies in bulk, hired subcontractors to do the electrical work and plumbing work in bulk. They poured concrete for all the homes in a short time frame, thereby reducing costs. There’s a reason that builders do this – it’s cheaper. It’s cheaper per house to build a development than to build a single home. It may cost $80,000 to build each home in the development, they sell them for $150,000, but to rebuild just one house could cost $180,000.
Therefore, it is extremely important to insure your home or business to its true rebuilding cost. If your home or business is completely destroyed, it won’t really matter what you could have sold it for. What will matter is the cost to rebuild it. You want it rebuilt exactly the way it was. So does the insurance company. We hope that you never need your insurance policy. But if the worst happens, we also want there to be enough money set aside to rebuild your home or business and restore your life.