Do you think your house is over insured? Have you asked your agent:

“Why is my house insured for so much? It isn’t worth that!”

It might be the most asked question in ALL of insurance (except for health insurance, which has its very own continent as far as insurance questions are concerned).

I have a client who buys a house for $140,000. They call for an insurance policy. The insurance value on the house comes in at $225,000. The confusion ensues.

Why is there such a discrepancy between what the insurance company thinks your house is worth, compared to what the real estate market thinks? To answer this question, it’s first necessary to explain what an insurance company’s responsibility is.

Insurance must make you whole

Your insurance carrier works by the law of indemnity. Indemnity means to restore you to the same financial position you enjoyed prior to the insurance loss. In other words, to make you whole again.

To adhere to this law, the insurance company cannot in good faith, insure you for what you paid for the house, or for what you personally would like it to be insured for. Instead, they must provide enough coverage to re-build you a home of the same size in the event of a fire or other loss. So, if you have a 1,600 sq. foot house, they would not be able to make you whole by only building an 1,100 sq. foot house in return.  In today’s market, building costs are around $150/sq. foot. This includes labor, materials, and meeting legal requirements with your municipality. The exact number per foot will fluctuate depending on whether you rebuild as a colonial, ranch, or craftsman. Use the $150 as a guide and it should help you land close to where you need to be.

Are there exceptions?

There is a slight variation to all of this that you do have some control over. For instance, say you bought an old Victorian or Greek Revival in town; those can come with vintage features that are not so simple to reproduce. Have you noticed there aren’t too many contractors out there advertising lath and plaster work? As such, the cost to re-build a home like this can send the price per square foot skyward. If you bought the house because you couldn’t live without these aspects, then you’ll want to go with the full replacement cost you are given by the carrier. However, if you are not as concerned with plaster walls and ceilings, then you could opt for something called Functional Replacement Cost.  Choosing this method tells the insurance company that you are okay with having the costly vintage parts of the house replaced with modern building materials, like drywall. Doing so will generally take the premiums down to a more typical amount for the size of home in question.

So, remember, it’s not what you paid or what someone else will pay. It’s your insurance company saying, we want to make you whole…so you don’t have to share a room with your kids.

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