Although your homeowner's insurance is being written today, the coverage you’re purchasing is for tomorrow and beyond. When we determine replacement cost for insurance purposes, we’re looking at the cost of rebuilding your home with new materials at that current labor cost at that point in time, which is in the future.
How is Replacement Cost Determined?
When we go to insure a home, we’re looking at the structures only. To be fair to all parties, we use an evaluation software called E2Value, which is used by insurance companies across the nation. This software takes the size, shape, and main characteristics of the home, or building, and assigns a cost to rebuild it using “future” values (of materials, labor, etc.).
Comparing Assessed Value, Purchase Price, and Replacement Cost
Comparing different values on the same structure is like comparing apples, oranges, and bananas. The apple is the assessed value, the orange is the purchase price, and the banana is the replacement cost. All three are values of the same property at different points in time.
Assessed Value: For the apple, your assessment is determined by the local government and is updated on a periodic basis (approximately every 5 years). Most people would like a low assessment for reduced taxes.
Purchase Price: For the orange, your purchase price is negotiated between the buyer and seller. It factors in a current property appraisal and real estate market.
Replacement Cost: For the banana, your insurance replacement cost, or rebuilding cost, is used when there has been damage to the property by a covered event, such as a fire. If the building is destroyed, then it would need to be completely rebuilt at the construction costs at that point in time. Again, you have to remember we’re looking into the future. Your replacement cost is what it would take to completely rebuild the home in the future.
Hopefully, this comparison helps you to understand why these three property values of a home are all different, and why the insurance replacement cost value for your home can be more than the purchase price.
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