How to determine what to insure your home for.

Replacement Cost vs. Market Value:
Insuring a Home Properly

Ask an insurance agent, a mortgage broker, and a realtor "How much
insurance should I have on my new home" and I will guarantee you will get
three different answers. The mortgage broker might say the loan amount, the
realtor might say the market value, and the insurance agent, if he or she is
doing their job correctly, will say the replacement cost of the home. So
who's correct?

In short, it has to be the replacement value for proper insurance protection. Homeowners
want enough coverage to rebuild their home if a catastrophe happens. Let's
take a look at how an insurance company comes up with this number.
Insurance companies use a computerized "replacement cost worksheet"
using historical data of building costs in a given area. This data is
compiled by independent companies who do actual surveys of building costs
and provide it to insurance companies and others in the construction
business.

One of the best known companies providing this information is
Marshall & Swift. By plugging in the square footage, year built, number of baths, style
of the home, and the home's other amenities into the worksheet a replacement
value is determined. The worksheet also considers the extra cost of
rebuilding a home like demolition cost, debris removal, architectural plans,
and even environmental costs. The replacement value may be more or less
than the home's market value.

In a depressed home market, this value could
be more than what a home sold for. The replacement value could also be more
than the sales price in a distress sale. In a hot real estate market, the
value could be, and usually is, less than what the home sold for. The
replacement value will also be less than the market value when a sale
involves a large amount of acreage. This causes a dilemma in that the
mortgage company or bank wants the insurance to be equal or greater than the
loan amount and the buyer doesn't want to insure more than the replacement
cost.

Many states have enacted laws stating lenders can not force insurance
above the replacement cost of a home due to this problem. Keep in mind that
the replacement cost worksheet works well in determining the correct amount
of insurance for the average home in the average community. High valued
homes with a lot of customization present a different set of challenges.

Why do Insurance Companies Insist on Insuring at Replacement Cost?
First and foremost, insurance companies and their agents want
clients to have adequate insurance in the event of a catastrophe. No one
wins when a fire destroys a home and there is not enough insurance to
rebuild what a family has worked long and hard to accumulate. Insuring to
replacement cost also ensures that the insurance company is collecting
enough premium to set aside the reserves that are needed to pay it's clients
claims when they do happen.
I hope this sheds a little light on the difference between the
market value and that mysterious number insurers use called "Replacement
Value"