Are you one of those people who think you don’t need to worry about your home insurance? Maybe you’ve owned your home for ten, twenty, or even thirty years and nothing has gone wrong.
Guess what? Things change. And something really important is changing that increases not just the risk that your home could be seriously damaged, but that you won’t have enough insurance to rebuild if the worst were to happen. Please take a few minutes to read about what you can do to help yourself before you have a problem.
We have already written about the importance of replacement value in general:
The Most Important Number In Your Insurance Policy
Bad Things That May Happen If Your Home Isn’t Insured For The Right Replacement Value
This article will go into more depth about what is currently changing and why it is more important than ever to get your replacement value correct.
Save Me Time!
- The increase in catastrophic losses increases the odds of people losing their home.
- The increase in inflation and the shortage of supplies and labor means it will cost more to repair or rebuild a home after a disaster.
- If your home’s replacement value is outdated – and there’s a good chance it is – the insurance payout will be inadequate and you will not be able to afford to rebuild.
- Fortunately, there are ways to prepare for this risk if you update your insurance coverage. The good news is they are even attractively priced right now.
The Rest of the Story
Whether it be the recent wildfires in Colorado, devastating tornadoes in Kentucky, or the flooding after Hurricane Ida, more people are finding themselves surprised by the magnitude of damage to their home from extreme weather.
Worse, many are realizing that their insurance coverage is inadequate to rebuild. This risk has grown meaningfully due to what insurers call “demand surge”.
Demand surge means that after a big disaster like a hurricane there is often a shortage of contractors, lumber, and other supplies so the price of construction goes up so much that you may pay 50% more to rebuild than you would in normal times.
While normally only mega disasters like earthquakes and major hurricanes led to demand surge, the growing inflation across the economy, and especially in housing, means demand surge is becoming much more common.
Smaller disasters are now leaving people unable to rebuild because their insurance is inadequate. Before we address how you can protect yourself from this risk, let’s briefly review how this can happen.
How Replacement Coverage Works
Your policy premium is based on the amount you insure your home for. We previously called this amount the most important number in your insurance policy…because it is. Before you ask your agent what your premium is, ask them how much your home is insured for and why that’s the right amount.
If you insure your home for $500,000 and you were to lose your home, the insurance company would pay up to $500,000 for you to rebuild. There are some important exceptions to this we will get to in a moment.
What you need to remember is you don’t want to insure your home for the amount you paid for it or for what it would cost to rebuild it yesterday.
You should insure it for what it would cost to rebuild it tomorrow, realizing that there is a chance you will face demand surge or other pressures that will drive the cost up.
Because if the rebuilding cost has increased to $600,000, you will not be able to rebuild your home…unless you can come up with an extra $100,000…or have the benefits of one of the coverages below.
It is also important to check that your policy is up to date. If you last updated your policy ten years ago, you might only have $400,000 of coverage instead of the $500,000 you expected. Many homeowners unfortunately never even check their insured amount after they first buy their policy.
Don’t Want to Worry…Here’s Your Solution
If you read the above and threw up your hands saying “I have no idea what the right amount of insurance is for my home. I can’t predict inflation or any of those other things”.
Good news. There are two choices you have that can alleviate your downside. They are called extended replacement coverage and guaranteed replacement coverage. These options cost a little more in premium, but greatly reduce your risk.
Quite simply, what they do is put the risk back to the insurance company. We will explain the mechanics in a moment, but the first thing to understand is that in periods of low inflation, these coverages are good deals for the insurance company. You probably don’t need the extra coverage and they get to charge you more.
However, in times like we are facing now where the risk of inflation is higher, these coverages have gone from expensive to a potential bargain.
Extended Replacement
Extended replacement is cheaper than guaranteed replacement. It typically gives you 25% extra coverage. So, in our example from earlier, your $500,000 insured value actually provides $625,000 if your home were destroyed.
In some cases, this still won’t be enough, especially if your insurance is out of date to begin with, but most of the time it will make a big difference.
The extra cost will vary by insurance company and where you live but 5% of your premium is a reasonable estimate, so likely less than $100.This is certainly cheaper than if you raised your policy’s insured value to $625,000.
So for under $100, you can protect yourself from a worst case loss of over $100,000. Obviously, the odds of a full loss are very low, but protecting yourself against a full loss is also the reason you have insurance.
If your current insurance doesn’t fully protect you from disaster, then it’s not really insurance anymore, is it? And if you are one of those people whose risk has increased due to the current environmental and financial risks, it is likely $100 well spent.
Guaranteed Replacement
If you really want to be able to sleep soundly at night, the best option for you is called guaranteed replacement coverage. This is what it sounds like…no matter how much it costs to rebuild, it will be covered.
This obviously costs more than extended replacement, probably 10-15% of your premium, but means the insurance company assumes all the risk. If you are affected by a large catastrophe where the $500,000 home costs a million dollars to rebuild, you have nothing to worry about.
In the current environment, guaranteed replacement can be a very attractive option, but it is more expensive.
If you live in an area where there is a greater risk of a weather event that can affect your whole community like a tornado or wildfire, you may want to consider guaranteed replacement despite the extra cost as it is the only option that fully protects you. The reason being that events which affect large communities tend to raise rebuilding costs the most.
Note, pricing for guaranteed replacement is based on long term estimates of the likelihood of customers needing it. With the risk of being materially undercovered rising, that means guaranteed replacement may be underpriced by insurers today, at least in certain parts of the country.
While insurers will over time raise the cost of guaranteed coverage, you can add it now before they do and ensure you have full protection no matter what happens to your home.
What To Do Next?
Now that you better understand what your options are, there are a few things you need to do to decide what is best for you.
First, verify that your current insured value is appropriate. Before you can add extended or guaranteed replacement, you need to make sure you have enough basic coverage.
This likely requires a conversation with your agent to make sure they have up to date information on any chages to your property in recent years, such as renovations. You can also check on construction costs in your area for new homes to give you a sense of what it might cost to rebuild to compare with what your agent recommends.
The next step is asking your agent to quote you the extra cost for either extended or guaranteed coverage. Every insurer prices these policies differently, so you may find, in some cases, extended appears like the better deal while, for other insurers, guaranteed will be more appealing.
Then, obviously you need to evaluate your individual risk of demand surge in your area to decide what your risk is with your current amount of coverage. Not everyone needs extra coverage, so you may decide the extra cost isn’t worth it, but it’s important to be aware of the changing environment and know how it could affect you rather than just hope for the best.
And if you are interested in increasing your coverage, now is the ideal time to do so before insurers react to rising losses and raise their pricing.
If you have further questions about choosing the right replacement coverage, you can contact us and we are happy to help.
