These are unusual real estate market conditions for sure! In my 32+ years in the insurance business, I've not seen anything like it. Now, I'm not saying that opportunities don't exist in the local real estate market. I'm positive there's a group of entrepreneurs who've adapted and are rippin' it up.
From an insurance agent's point of view however, there is often a "disconnect" when we attempt to explain the concept of "insurance to value". In other words, how much insurance coverage should I place on the new home insurance policy?
If you ask an insurance agent, a mortgage broker, and a realtor that question, in most cases you'll get three different answers, especially in the current market conditions. 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 insured for the replacement cost-- this is the cost it would take to re-build the home at today's construction costs. And, keep in mind today can mean next month, in 6 months, in 1-2 years... who knows when the homeowner could suffer a total loss!
Let me give you an example of some numbers I've been seeing lately. Keep in mind I'm not a realtor, just an insurance agent with the job of protecting people and their assets when bad things happen. A home that sold 3 years ago for $350,000 somehow falls into foreclosure (or any of the other similar conditions that I'm not an expert in, like a "short sale"). The home closes escrow currently for $180,000 and the buyer gets a loan for let's say $170,000 to close the deal. Keep in mind this home was insured for replacement cost 3 years ago at $335,000 and had a market value of $350,000. The big question is, "What do we insure it for now?"
So, the new owner calls our office to get a quote on a homeowner policy. As insurance agents, if we are doing our job right, we will use a computerized "replacement cost calculator" to determine what to insure the house for. This tool uses 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. By plugging in the square footage, number of baths, style of home, and the home's other amenities into the data fields, a replacement value is determined.
The final replacement value also considers the extra cost of rebuilding a home after total loss (like a fire). These costs include demolition, debris removal, architectural plans, and even environmental costs. It is typically much more expensive to rebuild a home after a total loss than building a new home on a bare lot.
The replacement value may be more or less than the home's market value. For example, in a depressed home market (like today), this value is usually more than what the home sold for. 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 cannot force insurance above the replacement cost of a home due to this problem.
Keep in mind the replacement cost calculator 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 and often require a more accurate appraisal.
Why do Insurance Companies Insist on Insuring for Replacement Cost?
First and foremost, insurance companies and agents want clients to have adequate insurance in the event of a catastrophe. Clearly, no one wins when a fire destroys a home and there is not enough insurance to fully replace a home and its contents. You may be aware that in recent catastrophic wildfires in California (Southern California and San Diego), the insurance commissioner estimated that up to 40% of the homes were under-insured. This is a "black-eye" to the insurance community.
Insuring to replacement value also insures the insurance companies are collecting enough premium to pay its claims when these catastrophic losses do occur. Insurance companies that go insolvent in catastrophes can be a real problem for both homeowners and state governments who have to bail them out with "guarantee funds".
So, insuring to full replacement value is the practice of all professional insurance agents who understand the "big picture". And in depressed real estate markets like we see today, it sometimes requires a little extra explanation to home buyers so they understand why it is the right thing for all concerned.
If you have any questions about this article, feel free to contact me at:
"I want to thank you folks at CIG Central Valley Insurance for your excellent work with my insurance program. After working with Scott, I now feel I’ve got the kind of protection I need for both my car and home insurance. And with the umbrella policy, I almost feel bullet-proof against a law suit from a serious car accident. Also, your office was a pleasure to work with in getting all this done. Thanks!”