In today’s declining housing market, the
discrepancy between home value and
cost to insure a home is widening, says
Michelle Mendes, vice president for Aon
Private Risk Management for Aon Risk
Services, Inc.
“It can be confusing to the homeowner if
the house has a market value of $400,000
and they are told they need $800,000 in
insurance to replace the home,” says
Mendes.
The reason is that the cost to replace a
home exactly the way it was, if it burned to
the ground or got swept away in a storm, is
almost always more than the house is
worth on the open market, according to
Mendes, particularly if the house is old or
has customized features.
Smart Business spoke with Mendes about
why homeowners should not assume that
the amount of coverage on their home is
enough to replace it if disaster should strike.
What is the confusion surrounding home
market value and replacement costs?
The amount of insurance coverage needed is rarely close to the price you paid for
your home. While the market value of a
house can vary widely depending on the
neighborhood location, area of the country
and other factors, what usually does not
vary much is the amount it will cost to
replace that home — board by board — if a
fire should burn it to the ground or if it gets
swept away by a flood, hurricane, tornado
or any other natural disaster.
In areas where home prices are spiraling
downward, such as in the southeast and
mid-western parts of the U.S., that gap
between cost to replace and market value is
ever widening. On the East Coast, where
homes are holding value the best, the market value of the home is closer to the cost to
replace.
Are most homeowners, then, underinsured?
Yes, most homeowners are severely under-insured; the latest estimate is that 64 percent
of U.S. homes are undervalued and underinsured. The problem is that people don’t
understand the cost of replacement of their
homes, which is usually shockingly high.
Why aren’t more homeowners savvy to this
fact and insured to the right level?
Most insurance companies leave it up to
the individual and his or her agent to determine how much insurance the individual
wants. But there are many unseen elements
of homes that may not factor in. Take, for
example, many of the ‘green’ updates
homeowners are adding, such as geothermal. That ought to factor into the valuation
of the home when determining the right
amount of insurance to cover that home.
Then there are homes, for example, with
period-style detailing, such as customized
moldings and woodwork. If the house’s
market value is $1 million, you can bet, in
this market, that the cost to replace it will
be much higher than that. Homeowners
need to realize that if they plan to put the
home back to its original condition after a
disaster, they will have to insure it for
replacement value, not market value.
What are some steps homeowners can take
to ensure that they are adequately covered?
Be sure to choose an agent/broker with
personal insurance knowledge that also represents more than one insurance company. They should be able to help you
understand the valuation of a replacement
cost. Quite a few companies will appraise
your home for you.
Decide if you want unlimited replacement
cost or a capped amount for your home.
This will dictate which companies you are
quoted and therefore which contract is chosen to insure your home. Would you settle
for a minimal rebuild rather than an ‘exact’
rebuild (i.e.,in an older home this may mean
sheetrock walls instead of plaster walls,
etc.). There are even insurance contracts
that utilize ‘functional’ replacement costs.
This is the most minimal replacement available. Hard wood floors would likely be
replaced with linoleum in this case.
Are you choosing homeowners insurance
to fulfill the mortgagee’s requirement or to
protect one of your most valuable assets? If
you are more concerned with asset protection you will find yourself working with
both an agent and an insurance company
who will assist you in the valuation process.
Some companies will do prospective
appraisals so you can know prior to placing
coverage what they feel the replacement
costs would be. In either situation, a knowledgeable insurance consultant is one of
your best tools.
Do you have any advice about home insurance considering the current economic situation we find ourselves in?
Despite decreasing market values, your
home’s replacement cost is increasing. The
cost of construction, building materials and
fuel all play a part in the annual replacement cost increases that all policies experience. If your home is an integral or large
part of your portfolio, as it is for many of us,
you should consider providing it with superior protection. Seek good counsel and
choose the insurance product that best fulfills your needs.
MICHELLE MENDES is vice president of Aon Private Risk Management for Aon Risk Services, Inc. (www.aon.com). Reach her at
(216) 623-4151 or [email protected].
