Does lower home value translate to lower home insurance costs?

The real estate market has been particularly brutal to homeowners, with median single-family home prices dropping from $218,000 in 2007 to $178,000 in 2010, according to the National Association of Realtors. While some cost-conscious homeowners may think that a drop in home value means they can save money by cutting back on insurance coverage, doing so could be a big mistake, experts say.

It’s not hard to find someone dealing with some type of pain related to home ownership. In fact, a Standard & Poor’s study in December found that home prices in six metropolitan areas, including Atlanta and Miami, had hit new lows.

Yet “homeowners are surprised when their insurance premiums are not keeping pace with the home values,” says Jeremy Bowler, senior director of the insurance practice for market research firm J.D. Power and Associates. In 2010, J.D. Power found that customer satisfaction among homeowner's insurance policyholders had sunk to a five-year low. Part of the reason for the dissatisfaction: Many policyholders believe their premiums should go down along with the market value of their homes, Bowler says.

But in reality, home insurance policies have nothing to do with the potential selling price of your home.

home insurance property value

“We see a large proportion (of policyholders) who think, ‘My house would sell for $150,000, so that’s what the carrier would pay me,’” Bowler says.

Instead, if your home is by a fire or other natural disaster, you'll want your insurer to pay for the costs of rebuilding your home and replacing the contents, says Dick Luedke, a spokesman for State Farm.

Since there’s no correlation between a home’s market value and its replacement costs, a homeowner could see the worth of his home dwindle but find that replacement costs have gone up. Likewise, the opposite could be true, with a homeowner seeing an increase in equity, yet a decrease in replacement costs. To be properly insured, a homeowner should have coverage equaling at least 100 percent of current replacement costs, Luedke says.

The keys to replacement

A number of factors determine those replacement costs. “When you’re looking at constructing a home, you’ve got to consider the cost of building materials, labor, and overhead and profit,” says Norrine Brydon, a vice president at Marshall & Swift/Boeckh (MSB), a provider of building-cost data.

It’s typically more expensive to rebuild a home after a total loss than it is to construct a new home for a number of reasons. New construction is built from the foundation to the top, whereas the replacement of a home typically involves removing the roof and rebuilding from the top down, which is more time-consuming and costly, according to MSB. With new construction, several homes typically go up at the same time, allowing builders to purchase materials in bulk -- which costs less than buying materials for the rebuilding of one home. Also, demolition costs frequently are involved with rebuilding a home after loss.

Those who live in older homes also may have to deal with the additional costs of complying with building code changes that have been mandated since their homes were built, such as upgraded wiring.

Although home values have been in decline, replacement costs have been steadily rising. In 2009, the cost of building materials briefly dipped, but now that cost is back up to pre-recession levels, according to Brydon. And despite the fact that unemployment has been so high in the past few years, actual labor costs for building a house have continued to rise.

So, let's say you own a 2,000-square-foot home and have to replace it. Using the U.S. average price of construction per square foot -- $83.89 in 2009, according to the National Association of Home Builders -- rebuilding that home would cost an average of $167,780.

Ensuring sufficient coverage

Your homeowner's insurance agent or broker can help you determine replacement costs. Other ways to make sure you are adequately covered include:

• Checking with a local builders' association or a reputable builder to investigate trends in replacement costs.

• Asking a contractor how renovations and home additions will affect home replacement costs.

Some common changes that can lead to increased replacement costs include upgrading or remodeling a kitchen or bathroom, finishing a basement, putting in custom molding or adding rooms.

Whenever homeowners make major home improvements, they should alert their insurance provider to determine the effect on the replacement value and decide whether they need to boost their insurance coverage.

“If customers don’t call their insurer and describe what they’ve done to the house and discuss how that might increase the replacement costs, they may essentially be taking on some of the insurance risk themselves,” J.D. Power's Bowler says.

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