Your home’s insurance amount is based on its replacement cost, or the amount needed to rebuild it as it exists (same features, quality and location). This value is not the same as market value, which reflects your home’s purchase price if sold. A home’s market value is influenced by things such as neighborhood desirability (quality of school systems, tax rates, community services, etc.) and land value.
Because a home’s market value and replacement cost can differ significantly, it is important that you insure your home for its replacement cost. For example, a home that costs $176,000 to rebuild in Illinois might sell for $310,000; while a home that costs $176,000 to rebuild in Pennsylvania might sell for $150,000 at that location. However, the cost to construct the home in either location is $176,000. Therefore, the home should be insured for $176,000, regardless of its location and the amount for which it may be sold.
Your insurance company is interested in the home’s replacement cost because at the time of a loss, it will pay to rebuild or repair your home, not purchase a home already on the market. Therefore, the insurance company must have an accurate assessment on file of the probable cost to rebuild your home. The amount your home is insured for is based on this assessment.
Insurance companies typically use a formula to determine the replacement cost. This formula takes into consideration the physical features of your home (such as square footage, building materials, etc.) and the cost of construction labor in your area.
Also, the cost to rebuild your home may be more than the cost to build it originally. This could be due to several factors, such as availability of materials originally used, changed building codes that may require updates, more costly materials, or even availability of skilled craftsmen to duplicate unique features.
To ensure adequate protection, base your home’s insurance amount on its replacement cost to determine the accurate replacement cost. Remember to notify your agent if you make additions or changes to your home.