Insuring your house: understanding replacement cost
House Insurance Replacement Cost Vancouver
One of the areas of house insurance which leads to some confusion for homeowners is insuring to “replacement cost”, which is the industry standard to which all homes must be insured.
Let’s start off by explaining what insurance replacement cost for a house is not:
- A house’s replacement cost is NOT the assessed value.
- A house’s replacement cost is NOT the market-related value.
Replacement cost is the cost in TODAY’s market to reconstruct a building as it was immediately preceding an insured loss. Beyond the costs of rebuilding, expenses such as debris removal would also be covered. As you can imagine, in the event of a major loss caused by a fire, costs would greater to clear the property and rebuild.
How is replacement value calculated?
When insuring your house, your broker will ask you for detailed information about the building: e.g. Sq footage of house? Is there a basement? Number of bathrooms? Type of flooring? etc.
This information is then inputted by the insurance broker into a software program (approved by all insurance companies) which produces the replacement cost of the house upon which the broker MUST quote house insurance.
Insurance brokers who insure properties on values lower than replacement cost are potentially jeopardizing their clients and their assets by incorrectly insuring properties. Homeowners may be delighted to pay lower premiums, but certainly not at the risk of under-insuring their houses.
House insurance and your mortgage
Many people – incorrectly – believe that if they have a mortgage that they should only have to insure the property to the value at which it is mortgaged, which is often substantially lower than the replacement cost. They ask: “Isn’t the bank only concerned about getting their money back if something happens to the house?”
If insurance companies were to allow homeowners to choose the $ amount of insurance for their properties, then it is possible that the amount would not be sufficient to rebuild. The insurance companies would then be responsible to the mortgaging banks for substantial extra expenses.
Here is an example which better illustrates this point:
Let’s say a homeowner has a mortgage of $100,000 and chooses to insure the house for $100,000. However, after a total loss the cost to rebuild the house is actually $150,000.
The insurance company only pays up to $100,000, which would mean that one-third of the house is not rebuilt.
The homeowner may then decide that the bank has enough money to cover the mortgage, and walks away from the property, leaving it in the hands of the bank to resolve.
As the property is not saleable in its state, the bank now needs to spend an additional $50,000 to complete rebuilding the house, along with the additional cost of maintaining and eventually selling the home, perhaps an additional $15,000 cost. The bank ends up collecting only $35,000 on the $100,000 loan.
Insuring your house to full replacement costs provides these advantages in the event of a major insured loss:
- The house gets rebuilt exactly as it was prior to the loss;
- The value of the property remains the same or even slightly increases (because the home would be brand new once it is re-built);
- It eliminates the possibility of having issues with the mortgaging bank; and
- The homeowner is fully protected.
For all of these reasons, the insurance industry standard for insuring homes is “replacement cost”.
Do you have any questions about replacement cost and house insurance?
Would you like to speak to one of our professional insurance brokers about insuring your house? (All quotes are free and no-obligation.)
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Disclaimer: This article is designed to provide information for personal use only. Please consult your professional insurance broker for further information. Habitat Insurance Agencies Ltd is not responsible for any legal disputes of this matter.