Homeowner’s Insurance Costs: It’s Not How Much Your House Is Worth but How Much It Costs to Rebuild
Loretta Worters, Insurance Information Institute

What is your house worth today? Real estate website Zillow indicates through its Home Value Index that home prices nationwide are down this spring by 8.2 percent. S&P/Case-Shiller Home Price Indices also indicate that if you bought your home after 2003, it’s probably worth less now than it was then.

So if the market value of your house is down, your homeowner’s insurance should be lower as well, right? And a lower homeowner’s premium fits with cutting back to offset rapidly rising gas and food prices, right? Wrong and wrong.

Why? The main benefit of homeowner’s insurance is that it pays the cost of repairing or rebuilding your home. That cost includes not only labor and materials to rebuild but also demolition and the removal and disposal of materials that can’t be reused. It is not linked to the market value of the home and the land upon which it sits.

To understand better how home insurance works, look at building costs. The cost of construction includes labor and materials and general contractor and subcontractor overhead and fees. These costs fluctuate at different times and in different parts of the country. For example, if your home is damaged at the same time as others nearby from a single storm, local prices for rebuilding materials and labor may “surge,” reflecting the fact that demand for them has suddenly increased. So insurance for the typical cost of lumber and carpenters might be insufficient to rebuild a home that was damaged in a big storm.

Besides covering the cost to repair or rebuild a home, homeowner’s insurance has three other significant benefits, two of which are often linked to the amount of insurance on the house: coverage on the home’s contents and other personal property and coverage for the cost of living somewhere else while the home is being restored. So cutting back on insurance to rebuild the house cuts back on these benefits, too.

If you want to spend your homeowner’s insurance dollars wisely, insure your home for the full cost of rebuilding it today, but take the highest deductible you can handle. Consider a deductible of at least $500. If you can raise the deductible to as much as $1,000, you may save up to 25 percent on many home insurance policies. (Deposit $10 per month of the savings into a bank account that you can use to pay for damages under the deductible amount.) Since the average person files a homeowner’s insurance claim only every eight to ten years, most homeowners will save money over time.

Also, buy guaranteed replacement cost coverage on your home. This pays whatever it costs to rebuild your home as it was before the disaster—even if it exceeds the policy limit. This protects you against a “surge” of rebuilding prices. Replacement cost coverage generally won’t cover the cost of upgrading the house to comply with current building codes, but you can buy additional insurance (called Ordinance or Law) to help pay for these costs.

Some insurance companies offer an extended, rather than a guaranteed, replacement cost policy. An extended policy pays a certain percentage over the limit to rebuild your home. Generally, it is 20 to 25 percent more than the limit of the policy. For example, if you took out a policy for $100,000, you could get up to an extra $20,000 to $25,000 of coverage. Even though a guaranteed or extended replacement cost policy may be a bit expensive, it offers the best financial protection against disasters for your home.

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Loretta Worters is a vice president with the Insurance Information Institute. As a national spokesperson for the property/casualty insurance industry, she is frequently quoted in leading publications, including the Wall Street Journal, the New York Times, USA Today, Bloomberg Businessweek, Forbes, and Fortune and appears regularly on ABC, CNBC, CNN, and Fox. Ms. Worters serves as the industry’s chief crisis communications officer, developing and implementing disaster communications plans and working with national media during such catastrophes as Hurricane Katrina, the California wildfires, 9/11, Hurricane Andrew, and the Northridge Earthquake. Follow her on Twitter.