How Home Insurance Companies Estimate the Cost of Rebuilding Your Home – Forbes Advisor


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A tornado tears through your neighborhood and demolishes your home. After recovering from the initial shock of the disaster, you decide to rebuild your house. But how much will its reconstruction cost? More importantly, how does your home insurance company estimate the cost? It is essential to know the answers to these questions before disaster strikes.

Here’s why: If your home coverage amount is less than the cost to rebuild, your claim won’t pay out enough money to cover the full replacement cost of your home.

Home coverage is the part of a home insurance policy that pays to repair or replace your home if it is damaged. The amount of housing coverage should be equal to the cost of rebuilding your home, based on local materials and labor costs. If the housing coverage is insufficient, you will be underinsured. For example, if you have $300,000 of housing coverage, but rebuilding costs $320,000, you’ll have to pay the $20,000 difference or cut costs by reducing what’s being replaced.

Typically, the rebuilding cost estimate is done by your home insurance company, as it is a complex calculation. Here we explain how it is done.

Estimate the cost of rebuilding a house

Many insurers use their own sophisticated calculators to estimate the cost of rebuilding a home, says Kelly Rush, director of residential solutions at LexisNexis Risk Solutions, a provider of technology and analytics for insurers and other companies.

To arrive at a final cost estimate, an insurer can supplement the numbers generated by these calculators with data from external sources, as well as software they purchase from external vendors, Rush says.

Trevor Chapman, spokesman for Farmers Insurance, says his company relies on third-party tools to help estimate rebuilding costs. These tools typically weigh factors such as:

  • Type of construction
  • roof type
  • Age
  • Square feet
  • Quality of building materials

Rush says other factors can include the number of bedrooms and bathrooms, local building codes and ordinances, and even the quality of fixtures, flooring and trim.

Chapman says Farmers annually reviews material costs (such as the price of lumber and concrete), labor costs and other home construction expenses to ensure cost estimates accurately reflect inflation. This analysis could lead to an increase in the coverage limits of a homeowner’s dwelling. In the United States, it costs around $300,000 to build a house, although recent labor and supply shortages may result in a much higher cost.

To help its insurance company clients create reconstruction cost estimates, LexisNexis Solutions taps into its industry-wide databases of insurance claims and policies, according to Kelly. This data is then fed into proprietary algorithms that include local material and labor cost figures. The resulting information can be coupled with local claims and political data to refine and finalize cost estimates.

What is the 80% rule for home insurance?

Ideally, your home coverage will match the rebuilding cost estimate, and some insurance companies may require this. But at the very least, you’ll likely need home coverage for at least 80% of the replacement cost. This is called the “80% rule”.

Many owners follow the 80% rule when first purchasing a policy. But the replacement cost may increase if they remodel or renovate. If the housing amount is not adjusted to reflect this, their coverage amount can slip below 80% of the replacement cost.

If your home isn’t insured for 80% of its replacement cost, your insurance company may not cover the full cost of repairing your damage if you file a claim.

For example, suppose the replacement value of your house is $300,000. Eighty percent of that amount equals $240,000, or whatever amount your insurer would want under the 80% rule. But let’s say it’s insured for $180,000, or 60%. Then a fire causes $150,000 in damage. You may think you’re ready because your coverage amount exceeds the damage by $30,000. But you would probably be wrong.

Your insurance company could divide the amount of coverage you purchased ($180,000) by 80% of the replacement cost value ($240,000), or what you should have insured it for: (180 $000/$240,000 = 75%). In this case, you could be reimbursed for 75% of your damages. Seventy-five percent of the $150,000 in damages amount to $112,500.

Let’s also assume that you have a deductible of $1,000. This means your insurance company would pay $111,500, leaving you on the hook for the remaining $38,500: ($150,000 – $111,500 = $38,500).

Where should you get replacement cost estimates?

Policyholders should rely on their home insurance companies for the most accurate estimates of rebuilding costs. On the one hand, says Rush, an insurer’s experience and access to data “is extremely difficult to replicate.”

A cost estimate calculated by an entrepreneur or consumer risks being too broad or too limited, according to Rush.

Review of your home insurance coverage

To make sure you’re not underinsured, Farmers’ Chapman suggests reviewing coverage amounts once a year to make sure they’re still accurate.

Rush from LexisNexis highlights a few reasons why you should review your coverage regularly.

Severe weather events are becoming more frequent

Weather- and climate-related disasters in the United States, such as tornadoes and hurricanes, are increasing in severity and frequency. In 2021, the United States experienced $20 billion in weather and climate disasters. This puts 2021 in second place (behind 2020) for the most major disasters in a given year and in third place (behind 2005 and 2017) for the total cost of major disasters.

Skyrocketing cost of materials

The housing market is still reeling from pandemic-induced supply chain hiccups and labor shortages, which have created a spike in costs and demand. For example, rising lumber prices since the summer of 2021 have added more than $18,600 to the price of a new home, according to the National Association of Home Builders.

When a natural disaster occurs, such as a forest fire, the increased demand for repairs can lead to increased local construction costs. These costs can be exacerbated by supply chain issues and already rising material expenses. That means the coverage you bought yesterday might not be enough to rebuild tomorrow.

Consider extended or guaranteed replacement cost coverage

You can make sure you have enough home insurance to rebuild your home by finding a home insurance company that offers extended or guaranteed replacement coverage.

Extended replacement cost coverage

Extended Replacement Cost Coverage provides an additional percentage of coverage beyond your accommodation limit. For example, suppose your extended replacement cost coverage adds 25% to your home coverage amount. If your home coverage is $300,000, you’ll get up to $375,000 to rebuild your home, if needed. Keep in mind that your insurance company also subtracts your elected deductible amount from a claim payment.

Farmers is a company that provides extended replacement cost coverage. It offers 125% or 150% coverage on top of your home if repair costs exceed the insured amount. American Family, Chubb, Country Financial, Erie, Lemonade and others also offer extended replacement cost coverage.

Guaranteed replacement cost coverage

Guaranteed replacement cost coverage pays for the cost of rebuilding your home no matter how much it costs. Farmers also offers guaranteed replacement cost coverage, as do AIG, Hanover, Nationwide and others.

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