What’s a tempting way for a client with a home insured for $2 million to potentially lose $600,000? He or she can cut the amount of coverage for their home by 30%, thinking that it doesn’t need as much insurance because home prices have fallen by a similar amount since mid-2007. But this attempt at reducing premium payments—so tempting with the weak economy and housing market— is based on a dangerous misconception.
The amount of coverage needed to adequately insure a home does not necessarily track its market value. In fact, recent data shows that while market values continue to decline, insured values are holding steady or going up. If the client’s home were destroyed by fire, most homeowners insurance policies would not provide enough insurance to rebuild it. The family would have to settle for a smaller home or cover the insurance gap out of their own pocket.
This problem is not theoretical. ACE’s survey of 600 independent insurance agents found that inadequate insurance for the home was one of the most likely and serious problems of being underinsured. Another study by Marshall & Swift/Boeckh, a leading worldwide provider of building cost data and estimating technology, found that 64% of American homes were underinsured.
Home market values and insured values do not correlate because they depend on a vastly different set of factors. The market value of a home can be influenced by mortgage rates, the number of homes for sale versus the number of potential buyers, the quality of the school system and other community services, the ease of commuting to major work centers, and more.
By contrast, the insured value of a home depends entirely on the potential cost of rebuilding the home if it were destroyed. Therefore, changes to the insured value of a home must reflect changes in the cost of construction materials and labor. Evolving building codes, debris removal regulations and other factors can also affect the cost of rebuilding. Surprisingly, these factors are driving rebuilding costs up.