Overview

The recent downturn in the value of residential real estate has impacted homeowners insurance. In many parts of the country, the cost to re-build a home has exceeded the cost to buy a similar home in the same neighborhood.

For many, this is counter-intuitive. Homeowners don’t understand why a property should be insured for more than its current value. The fact is there is no relationship. Each value has a different use, is calculated using different measures, and will change at different rates. Below are several questions and answers that provide more detail.

Question:
What is the difference between the market value and the replacement cost estimate of a home?

Answer:
Every home will have a market value and replacement cost estimate, however each value is totally independent and applied to different uses.

The market value is current price at which a property can be purchased or sold.
The replacement cost estimate is expected cost to rebuild a structure with like kind and quality materials on its original site.

Both market value and replacement cost estimates fluctuate, but changes are influenced by different factors and may not occur at the same time, speed, or amount.

Question:
What aspects of the property are included in determining the market value and replacement cost estimate of a home?

Answer:

The market value includes the land on which a house stands and all related structures, such as landscaping, fencing, detached garages or sheds, swimming pools, gazebos, etc.
The replacement cost estimate does not include the value of the land or detached structures on the property.

Question:
What is the underlying basis of the market value and replacement cost estimate of a home?

Answer:

The underlying basis of determining the market value of a home is supply and demand of real estate in the local area.
The underlying basis of the replacement cost estimate is localized material, labor, and equipment costs used in property reconstruction. Market value of the home is not a factor. The replacement cost estimate does include overhead and profit charged by a builder, architect fees, and other associated reconstruction costs.

Question:
What factors can influence changes in the market value and replacement cost estimate of a home?

Answer:

Changes in market value are influenced by many factors including:
- Marcoeconomic conditions that impact demand for housing
- Localized changes in housing supply
Changes in replacement cost estimates are influenced by many factors that impact property reconstruction costs. These include:
- Supply and demand of building materials
- Local labor practices
- New building methods and materials
- Catastrophic events
  - Often result in a sudden surge in demand for reconstruction activity
  - May impact supply or production of building materials
- Commodity prices
  - Higher gas prices result in higher transportation results, which will impact reconstruction costs

These web pages are a resource dedicated to helping agents and insurers provide homeowners more information about the replacement cost estimate and how it is different than market value.