Buying a home (especially if it’s your first) is exciting, stressful and more often than not, confusing.
Once you’ve made your selection and your offer has been accepted, your next call should be to your Ohio homeowners insurance agent to get your policy started.
But, imagine your surprise when you’re informed that the $$$ you paid to buy the house is NOT the same $$$ that the insurance company is going to use to insure it. Huh? Why is that? And how does THAT work?
For the majority of Ohio homeowner insurance policies, insurance companies use REPLACEMENT COST for the amount of dwelling coverage.
What you pay for the house is called the market value.
What’s the difference between market value and replacement cost?
Market value is the price at which a house will sell within a reasonable period of time. As you can imagine, it is a subjective figure, based on supply and demand and overall real estate market conditions.
Replacement cost is objective- based on cold, hard facts. It’s the cost to repair or rebuild the house exactly as is, based on a home’s characteristics. Examples include:
• Year built
• Style of house
• Square footage
• Foundation type
• Number and type of bathrooms
• What the walls are made of
• What’s on the floors
• Any attached structures, such as a garage or deck
OK, so market value seems easy enough to figure out. But how do you calculate the replacement cost?
It’s often a combination of visiting the property, or if that’s not possible, then we gain information from the property tax card and the real estate listing.
We plug the information we collect into special software and the software calculates the replacement cost.
So why should I insure my house at replacement cost?
Well, I suppose because the insurance company said so isn’t really a very good answer…..But honestly, that IS the answer.
However, there’s also another answer that demonstrates why insurance companies like to use replacement cost for the dwelling coverage (and why you should too).
Imagine for a minute that insurance companies used the market value to establish the dwelling amount when the new policy is written. BUT, that amount was subject to change based on market conditions (much like real estate prices).
So, at time of new policy, your dwelling coverage is $250,000. But 6 months from now, the real estate market has worsened and your house is now worth $175,000, so the dwelling coverage adjusts to $175,000 as well.
And then, the claim happens. And you have $225,000 damage. But your dwelling coverage is now at $175,000. Do you see a problem with this claim? And would you be happy with the outcome?
Using an objective number like replacement cost removes the potential for wild fluctuations, such as what you have with the real estate market. And makes it way more likely that you’ll be pleased with the claim settlement.
So, now that we’ve established replacement cost as the go-to dwelling amount for an Ohio homeowners insurance policy, let’s move on to a possible claims outcome should you still decide to underinsure your house (if you can).
What happens if I don’t have enough insurance on my house?
Then there's a good chance you'll be upset when a claim is paid.
So not only do homeowners insurance policies not use market value and use replacement cost for the dwelling coverage, BUT you’re also required to insure a certain percentage of the replacement cost. This is called the insurance-to-value clause.
Example: Your home has a replacement cost of $250,000. The policy says you are allowed to insure at 80% ($200,000) and not have a penalty at claim time.
Whoa, what do you mean a penalty?
Yes, it’s called a co-insurance penalty and has resulted in many unhappy people when a claim occurs. Here’s how it works…..
Using the house from the above example, we know that $200,000 is the minimum the homeowners policy will allow. However, you’re hellbent on insuring at $150,000 because “that’s what the house is worth!”
The claim happens. It’s $100,000 worth of damage. From here it’s a simple math problem on the part of the insurance company to determine how much will be paid on the claim.
---------------------- X Loss = Payment
Here’s how it works out using the numbers above:
$150,000 (what you insured for)
------------ X $100,000 = $75,000 payment
$200,000 (the 80% minimum required)
And where does the remaining $25,000 come from? That’s called self-insurance, meaning you get to pay it out of your pocket. And yes, this can and will happen.
We hope this post helps you understand the difference between replacement cost and market value, why replacement cost is so important and the penalties for not having enough insurance on your house. A qualified insurance agent can also help explain these concepts and make sure you have the correct policy and correct amount so you don't have a problem at claim time. Want to discuss your Ohio homeowners insurance with qualified agents? Call us or fill out our contact form. You can also request a homeowners quote quickly and easily. We're here to help!
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