If you are a homeowner or own a building for your business, you may have asked yourself this question. My house/building is only worth X, why in the world is my coverage so high?
This is one of the most frequent question I get asked by both homeowners and business property owners. It often leads to frustration and the thought that insurance company is simply trying to get more money.
The problem is that most people confuse market value or appraisal value and replacement cost. The two are very different indeed and this is very important when understanding your dwelling/building insurance amount.
Let’s take a 1500 square-feet, frame, 2-story home. The market value or appraisal value could be $125,000. Of course this depends on the area, market conditions, etc. Most people then think that they should insure this home for $125,000. Makes sense right? Wrong.
Since almost all homeowner’s policies pay at replacement cost, the market value or appraisal value had no bearing on how much the home should be insured for. Replacement cost depends on how much the insurance company thinks it would cost to rebuild.
In the example I gave above, the insurance company may feel that the home should be insured at $180,000 ($120/square foot). Unless you understand that the insurance company is using replacement cost vs. market value or appraisal you may feel that they are insuring your home for too much.
Insurance companies use replacement cost estimators to try to determine how much would be needed to replace the home or building in the event of a loss. Although these estimators are not always perfect, they do give guidance on what amount is needed to property insurance your home or commercial building.
The bottom line is that once you understand this fundamental difference you can better understand the reasoning on how and why the replacement cost on your home or commercial property is often times much higher than what the market or appraisal value would suggest.
The Insurance Coach 