“Why does the limit of coverage on my home keep increasing when the market value is going down?” is a frequently asked question. The information below is intended to provide answers to how market value, replacement cost, actual cash value, and reconstruction costs differ and how they impact the coverage limit on your home.
A common misconception is that homeowners insurance is directly related to the market value of a house. Market value is what the buyer will pay for the property and includes the cost of land. A fair selling price can be determined by using comparables, market trends, seasonality, and other available data. Market supply and buyer demand then determines the final price. The market value could be more or less than the insurance coverage on your home.
Replacement cost is what it would cost to reconstruct your home based on current construction costs, special features, size, age of the home, etc. It is the actual cost of replacing the home—without deduction for depreciation—using current standards and building codes that include fees associated with architects, contractors, builders profit, etc. It does not include land value.
Components that affect replacement cost include:
It is impossible to predict today what the exact cost will be to replace a home in the future, so it is important to have enough coverage to account for unseen circumstances. That is why Federated provides an additional buffer of 25% over and above the coverage limit on homes we insure to protect against unanticipated rising construction costs.
The actual cash value basis is the cost to replace the damaged property with materials of comparable quality, less depreciation. Depreciation is a reduction in value to reflect physical wear and tear, age, and obsolescence. As an example, property such as a roof may have a life expectancy of 30 years. Damage that occurred after 15 years would have a 50% deduction for depreciation.
These factors all play a part in why insurable value and market value are two different amounts.
This article is intended to provide general information purposes only and should not be construed as coverage, legal, tax, or financial advice with respect to specific facts or circumstances. You should always consult your personal attorney and insurance advisors for advice unique to you and your business. © 2009 Federated Mutual Insurance Company. All rights reserved.