Wednesday, January 2, 2008

Thoughts on Insurance Part 2: Market Value Vs. Replacement Cost

First off, please read the disclaimer at the bottom of this page and know that I am not an insurance agent and that every state has different rules and regulations.
I used to work in the personal (auto and home) industry, and a recent post by Mrs. Micah made me decide to share some things I learned. Please note that I do not benefit in any way by sharing this opinion with you and that it is only an opinion!

Market Value Vs. Replacement Cost
These two options are part of your home or renters insurance. They both have to do with how your insurance company will pay for a loss to your home or possessions (aka personal property).

The market value of your home is how much you could sell it for at any given moment. The replacement cost of your home is how much it would cost to build your house from scratch at today's costs.
Let's say you own a home and it burns to the ground. If you have market value coverage on your home, your insurance company will pay you what it determines the house could sell for, minus the value of your land (assuming you had it covered for at least that amount). Now take the same scenario and assume that you have replacement coverage. In that case, your insurance company will pay the costs for a house to be built on your property that is of similar size and quality to the house that burned down, up to the amount of coverage you have (though a lot of policies in Wisconsin, and maybe elsewhere, will pay 110% of what your insurance coverage is).

With the cost of building materials on the rise, the cost to rebuild a house is often more expensive than the market value of that home. This is especially true if you own a quality-built house or a very old house, such as an old Victorian.

My husband and I have replacement cost coverage. We gave our insurance agent all of the information about our house (size, quality, wood floors, fireplace, etc.), which he put into a calculator he has. He then let us know how much it would probably cost to rebuild our house. That is how much we insured our house for. With our insurance company, the amount automatically goes up a little each year to account for inflation in the cost of building materials. Plus, we have that extra 10% in case the agent's calculation would up a being a little low.

Personal Property

This is the big one. Whereas your home's market value and replacement cost are often pretty close to each other, it is not the same with your possessions (personal property).

The best way to explain how these coverages differ when it comes to your possessions is to use an example. Let's say that your couch is destroyed in a fire at your apartment complex. You paid $500 for your couch 10 years ago. You tell your insurance claims adjuster about your 10-year-old couch and he checks your policy. If he says you have market value coverage, he might calculate an original $500 cost minus $400 of depreciation equals a check for $100 to go find another 10-year-old couch. Good luck with that! If, on the other hand, he says that you have replacement cost coverage, he might calculate that a $500 couch 10 years ago would cost about $900 to replace new today. He would then cut you a check for $900 to buy yourself a brand new couch of similar size and quality.

You might say to yourself, "Big deal, I don't mind checking Craigslist for a used couch." That's great, but what if everything in your apartment/house was destroyed? Do you really want the hassle of trying to find used couches, tv's, computers, clothing, toys, kitchenware, etc? I'm guessing that, if you lost everything, you would want to be able to go to your local store and pick out your replacements quickly so you could restart your life.

The issue of market value vs. replacement coverage might not be easy if the difference in costs was large, but it is usually a very small additional premium for a lot better coverage.


Mrs. Micah said...

We weren't really offered the option of picking replacement vs. market value for our renter's insurance. Instead, it was based on the type of stuff we own. Most of our furniture is economy and purchased at thrift stores (well, I think most was probably a gift).

As I understand it, we'll get coverage for up to $26,000 to replace items in the apartment. And that should cover what we've got, I think. The biggest expenses would be our laptops.

Becky said...

That's interesting. When I worked in insurance, we never asked people what type of stuff they owned. We knew replacement cost was the better coverage, so we encouraged it. Like I said, though, every state has different regulations and ways of running things. Hmmm!