What is replacement cost? Why don’t I insure my home for its market value?

July 28, 2020

Have you ever wondered why your homeowner's insurance doesn’t reflect what your home is actually worth?

Paying for your homeowner’s insurance can be frustrating if you are required to insure your home for some seemingly arbitrary number that far exceeds the current market value of your house. It makes you feel like you’re overpaying.

So… what gives?

Coverage ‘A’ on the standard homeowner’s policy is the basis for many of the other coverage amounts you will find on your policy. Also called the “Dwelling” limit, this value is calculated by estimating the full cost to replace your home from scratch. In the insurance world, we call this your “Replacement Cost”. We typically make our dwelling limit and replacement cost match, and it is the amount that you insure your home for.

The reason your home may be insured for more than its market value has to do with a number of variables, but ultimately it boils down to how much insurance companies think it would cost to rebuild your home from scratch. The costs of construction materials, labor, and build quality, can all have a significant impact on replacement cost estimates for your home. Insurance companies must factor in these variables when valuing your dwelling, or else they risk not being able to fully cover you in the event of a loss. In contrast, when you are buying or selling a home, there are many different factors at play, such as: location, depreciation, school system, housing market, etc.

Even with all of the available tools, the replacement cost calculation is still only an estimate, and, well, you know about the best laid plans. That is why insurers offer the optional coverage, “Increased Replacement Cost,” which allows you to insure your home above and beyond the replacement cost estimate. Most seen as a 25% increase on your dwelling limit, the increased replacement cost coverage ensures that you will be made whole in the event of a loss, even when the costs exceed your dwelling limit. We include this optional coverage in our “Great Coverage” quotes because it is an extra level of protection that can prove invaluable if your replacement cost estimate turns out to be inadequate to actually replace your home in the event of a total loss.

If you’re concerned that you're paying too much for your home insurance, trust your intuition, because you probably are paying too much. But it’s most likely not because of your dwelling limit. It’s because shopping for insurance across all of the different carriers is needlessly difficult and overly complicated, but that is where we come in.

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