What is the difference between Reconstruction and Replacement Cost
Coverage? - It is important to understand that the reconstruction cost
(replacement value) is the amount that the insurance company estimates
it will cost to completely rebuild the property from the 'ground up'
with like-kind materials at the current labor rate and materials cost
for the geographic area in which the property is located. This amount
also includes often disregarded or forgotten 'soft costs' such as
architectural fees, permitting fees, and the cost of demolishing and/or
removing the damaged structure prior to rebuilding. From a strictly
insurance-based perspective, the reconstruction cost of a home has
absolutely no relation whatsoever to the property's purchase price, the
mortgage loan amount, appraisal value, or market value. In other words,
the reconstruction cost is a completely independent value with no
correlation at all to any other property-related value. For example, you
may have purchased a property that appraised at a market value of
$230,000, but because of the seller's personal situation you were able
to negotiate terms and purchase it for $180,000. After providing a 20%
down payment of $36,000, your mortgage loan balance is only $154,000.
Although there are several different values associated with this
property, none of them have anything at all to do with what it may
actually cost to completely rebuild it after a loss.
How Are
Reconstruction Costs Determined? - Another common area of misinformation
for property owners is regarding how a property's reconstruction cost
is actually determined by the insurance carrier. As opposed to common
belief, this is not simply a 'blind guess' as to the cost of replacing
the property. This formula is a little complex and it may vary somewhat
from company to company depending upon the data points used, but the
process (which is simplified below) is generally the same. Most
companies in the United States pay an enormous amount of money each year
in order to have full access to the Marshall & Swift/Boeck (MSB)
construction database. This is an experienced and well-respected
third-party company that maintains accurate construction costs
(materials and labor) for every single zip code in every county in the
United States. This database is updated every 90 days and it is usually
very accurate. When requesting a new quote for property insurance, you
agent may ask you many questions regarding the property's physical
features, such as the square footage, number of stories, construction
type, roof material, exterior walls material, what floor coverings are
used, etc. The purpose of these questions is to understand exactly how
your property is built so that this information can be input into the
carrier's reconstruction cost software. Once this data has been obtained
and input into the system, the software works with the MSB database to
compare labor and material costs for the area and determine a fairly
accurate amount of what it is expected to cost to rebuild the property
at current labor and material rates. The reason that two different
companies may have two completely different reconstruction costs even
when using the same data has to do with how the company calculates its
own internal cost estimate, not with the MSB database. For instance,
company 'A' may develop a reconstruction cost of $100,000, but within
their internal calculations, they may add an additional 20% for labor
costs, 5% for 'soft costs', and 22% for materials while company 'B' uses
only the hard costs provided by Marshall & Swift/Boeck. The purpose
of this is to err on the side of caution and attempt to include an
additional margin in order to offset any unforeseen fluctuations in
actual costs after a loss. Each company's reconstruction cost formula is
proprietary and agents have no idea exactly how each company calculates
the end cost or what margins are included. All agents have access to is
the final estimated cost of replacement.
Can Two Properties Built
Exactly Alike Have Different Reconstruction Costs? Absolutely! Labor
and material costs can vary a great deal from one geographic area to
another. For example, here in Texas a home in El Paso may have a
reconstruction or replacement cost of $150,000; however, that same house
with the exact same size and physical features, may have a
reconstruction or replacement cost of $210,000 in Houston. The reason
for this, as has already been mentioned, is due to the local building
codes, labor rates, materials costs, and other such issues.
Why
Are Reconstruction Costs for New Properties More Than the Builder's
Sales Price? - One common point of disagreement between an insured
property owner and his or her insurance company is that of the
reconstruction cost of a property being a great deal more than the
actual purchase price of a new home that was only recently built. From
the customer's perspective, he or she may have only paid $200,000 for
the property, which includes the builder's construction cost as well as
the equity, land and everything else involved, but the insurance company
determines that the replacement cost is actually $225,000. The customer
often can't understand why the reconstruction cost for the insurance
company is so much more than for the builder and he or she often argues
that the property is being over insured. This is a logical point of
view; however, it is simply not the case. When a tract builder
constructs a new home, their cost of construction is far less than that
of a custom builder. The reason for this is simple. When a tract builder
constructs a new home, he or she is usually building a great many more
at the same time and in the same subdivision or geographic area. This
means that the builder is often purchasing millions, if not tens of
millions of dollars, of supplies and materials in bulk. This allows the
builder to obtain huge volume discounts on pricing which greatly reduces
his or her construction overhead. In addition, the builder may use the
same labor crews for framing, concrete work, and all other phases of
construction. Because the builder is supplying a steady flow of
repeatable work to his subcontractors and these subcontractors are
working for extended periods of time in the same areas, the labor rate
is also greatly reduced. This is not the case with regard to custom
builders. Rebuilding a property is always more expensive than first-time
new construction. If your two-year home that you purchased from the
original builder for $200,000 is destroyed in a fire, the contractor or
builder that you hire to rebuild the home will not have the same deep
discounts on his labor and material costs. In addition, he will have the
added expense of obtaining new blueprints, architectural and permitting
fees, debris removal, etc. which the original builder either did not
have or which was also greatly reduced. This means that your $200,000
home may cost $250,000 to rebuild.
Why Do Older Properties Often
Cost More To Rebuild - It is also important to understand that older
properties may cost even more to rebuild. In addition to all of the
other aspects already described, older properties may have unique
architectural features that are difficult to replicate with today's
codes and materials and some of this work may require craftsman
specializing in such things as tin ceilings, ornate molding, and similar
work; all of which increases the construction cost.
Are
Reconstruction Costs Automatically Updated When My Insurance Policy
Renews? Yes and no, it depends upon the company issuing the policy. Most
standard companies automatically re-process the reconstruction cost
when a policy renews using the information previously provided. This is
why property owners may see both their premiums and reconstruction costs
increase on an annual basis. However, if there have been any
improvements or alterations made to the property, such as room
additions, elevation changes, interior remodels, or other such changes,
the reconstruction or replacement cost listed on the policy will be
inaccurate as it does not include these new modifications unless the
insurance company is notified and this new data is included. This is why
you should always contact your agent any time you make changes to your
home or property that may affect what it ultimately costs to rebuild.
