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Guaranteed Replacement, Extended Replacement Replacement Cost Coverage, Actual Cash Value, Building Code Coverage & How Insurance Companies Calculate the Cost to Rebuild Your Home Before I talk about the terms guaranteed replacement, extended replacement, replacement cost coverage, actual cash value and building code coverage that are crucial to your understanding key coverage issues of homeowners insurance, I want to give some background information on how insurance companies calculate the cost to rebuild your home. As a homeowner, ultimately it is your responsibility to determine how much money will you need to rebuild your home exactly the way it is now should you suffer a total loss caused by a fire or other covered peril. Not only do you need to know what it will cost to rebuild exactly as it is now, but more than likely you may be required by your city as a result of current building codes to do additional work to meet the current building codes. Those additional items required to meet the current building codes could add thousands of dollars to your repairs costs. I will give real examples of this later on. Based upon the amount of damage sustanined, you may be even required as a result of the building codes to tear down undamaged parts of your dwelling. If the latter happens, you may not be fully compensated for the value of the undamaged portion that has to be torn down. With all the above in mind, trying to determine how many dollars you will actually need can be very challenging! From my experience in the business, I would say most homeowners are not equipped with the knowledge to accurately determine how much it may cost to rebuild their home and in the process how changes in building codes may effect the amount of coverage needed at the time of loss. From my discussion with many homeowners over the years, I would say many want to rely on someone else to determine the dollar amount needed. This brings up an interesting point for discussion. If policyholders expect agents or the insurance company itself to take the responsibility of determining exactly how much coverage they should have for their dwelling, a time consuming process, will policyholders also accept that in return for this service, additional fees will need to be added to fairly compensate someone for this service? In my agency, I make it clear to my clients or prospective clients, I am not an expert on determining the cost to reconstruct a home and therefore I can not accept this responsibility to be placed upon my shoulders. In fact, I know of no agents, including myself, who are extensively trained to be able to accurately make these calculations. I am pretty accurate, however, in determining how much the premium will be for insuring a home at different amounts of coverage with the various carriers I can place the coverage. In addition, I point out that insurance companies have placed limitations on the total dollars you can recover for the dwelling itself and the costs you could incur due to changes in building codes. Therefore, my clients will know in advance of purchasing their policy from amongst the companies I can apply for coverage, what I expect the premium will be for different levels of coverage. They will know about caps placed on the dwelling limit and costs assocatied with rebuilding to code. Current clients and prospective new clients will soon be able at my website to obtain on-line instant homeowner insurance rates as well. Information pertaining to specific caps on the dwelling and rebuilding to code will be described. Although I will not calculate the rebuiding costs for my clients, my value-added service as an agent comes in the form of getting to know about all the policy variations that exist in the California marketplace, and linking my client to a policy that provides the best protection I can get for them given all the factors involved discussed in the next section of this guide, “Underwriting Guidelines”. The Over-Simplified Method You will need to know the exact amount of square footage of your home. You should break this down between the living area of your home, basement and attic, if any and garage area, if attached. If the garage is attached to the house, it usually costs less per square foot to rebuild than the living area. If an attic or basement is in the house, the cost per square foot will depend on if the area is finished or unfinished. You assume reconstruction costs are at a certain amount per square foot for the living area and a certain amount for the garage, basement and attic areas. You multiply that amount per square foot times the square footage to come up with a total amount. One needs to ask themself in the above method and all the other ones discussed next if the costs per square foot reflect meeting all additonal costs that may due to building code requirements. The Insurance Industry Methods For homes under a certain square footage amount, most insurance companies have “proprietary” formulas to help calculate the cost to rebuild your home. Some insurance companies require you as the homeowner to complete forms, and return them to the company where the information is input into a computer program to calculate the rebuilding costs. In other cases, insurance agents are required to complete worksheets or computer programs either based upon a phone interview or inspection of the home to calculate the replacement cost of the home. Each company is free to use their own sources for making these calculations. It is very likely if you talk to several insurance companies or agents, none of the calculations will be identical and in fact can differ by thousands of dollars. For homes over a specific square footage or dollar value, usually over several thousand square feet or over $500,000 in replacement values, or older or unique homes, the worksheets described above will not work. In these cases the insurance company may actually send out their own estimator to make the calculation, but only after you have purchased your policy from that company. From the years of experience I have in this business, here are my observations on the use of insurance company supplied estimator programs: 1. Insurance Agents typically do not receive in-depth training on how to use these home replacement cost estimator programs. My experience has been that insurance companies typically deliver these forms to their agents, require them to be used and sent along with an application, but provide no training on how to use them! 2. No special insurance licenses or classes are required to use these programs. 3. Homeowners typically do not know a lot of the answers to specific questions asked of them about details of their home by these programs. 4. Homeowners or agents might “abuse” the process to get a low insurance value in order to keep their premium as low as possible. In the days when companies offered guaranteed replacement cost policies, agents could tell policyholders, don’t worry, my company offers guaranteed replacement cost coverage, so even if the dwelling value on your policy is less than what it turns out will be the cost to rebuild your home, we guarantee to replace your home no matter what it costs! For consumers being offered these guaranteed replacement type policies they had no incentive to buy more coverage since they were given these promises. In 1996, a book was written titled “Insuring to Value”. It was authored by Diane Richardson, The National Underwriter Company & The Editors of Marshall & Swift. I strongly recommend it to everyone who is interested in gaining a better understanding of the problems of accurately determining the cost to rebuild a home. Probably the majority of homes in California, and nationwide for that matter, would be of such size and value that the typical home estimator program by any insurance company could be used to calculate its replacement cost. If these programs were so accurate, why has a major organization such as Marshall & Swift found in studies that at least 70% of residences are underinsured by an average of 35%? My simple answer to why some many homes are considered underinsured is as follows. Insurance Companies that several years ago offered guaranteed replacement cost clauses were more concerned with market share and writing lots of business than in insuring homes accurately. Homeowners up until the last few years thought they had no reason to buy higher levels of insurance when they were given these guaranteed replacement cost policies. I have another interesting explanation I want to put forth for the underinsurance problem. I hear very often in discussions with homeowners about what it will cost to rebuild their home that one should look at the current costs for new home construction. If new homes are costing a certain amount per square foot, the reasoning is that if my home is similar that is what the cost per square foot should be. However, it turns out in discussions I have had with one insurance company that the above set of costs per square foot don’t really apply with a home that has suffered, for example a fire loss. In some materials sent to me by the insurance company, it was pointed out that it typically costs 30% to 40% more per square foot to reconstruct a home that has been damaged. So if a new home costs $100 per square foot to build, an existing home that has been damaged is looking at costs between $130 to $140 per square foot. Here are two reasons for the increased costs of reconstructing a damaged house. First, due to new environmental laws, it is more expensive to remove the debris from the house. In the past, the damaged materials could be all scooped together and hauled away to a dumpsite. Today, the damaged materials must be separated according to types of material and disposed of based upon issues involving the toxicity of the material. Second, it appears contractors who build new homes are usually not the same contractors involved in reconstruction. There are fewer contractors involved in reconstruction and because of lack of competitors, the costs charged to deal with all the issues involved in an insurance claim, drive up the cost per square foot. Therefore, if historically, insurance companies have based the cost for which you must insure your home on new construction costs and not "reconstruction costs", this might explain why many homes might be underinsured. Residential Consultants My insurance agency insures a lot of larger, unique and more expensive homes whereby the use of a home estimator program simply won’t work. Some of the insurance companies I work with actually will send either their own in-house residential consultant to make the replacement cost analysis of the home or contract out this analysis to a firm that specializes in providing this type of service. The “residential consultant” will come out to your home, take detailed notes about the home, take measurements and pictures. This information is usually input in a computer program, typically provided by an organization such as Marshall & Swift, and the results are sent to the agent. Based upon the current coverage on the home and the results of the appraisal, the dwelling limit may stay the same or could be adjusted up or down. Insurance Appraisals vs. Real Estate Appraisals In contrast to how homes are appraised for insurance purposes, I want to mention another type of appraisal made on one’s home, the real estate appraisal. A real estate appraisal is used primarily in determining the market value of a home for lending purposes and not the cost to rebuild one’s home. In order to become a real estate appraiser, one must be licensed. Requirements for the basic Residential License involve a minimum of 90 hours of appraisal related education and a minimum of 2,000 hours of acceptable appraisal experience. Based upon the size of the home, a typical appraisal for real estate loan purposes may cost several hundred dollars, and the homeowner pays the cost. The real estate appraiser usually takes several hours to complete just one appraisal. To try to accurately determine the reconstruction cost of your home in the real world is a time consuming process. Typically the commission received by an insurance agency on the average size homeowners policy is not significant. There is no financial incentive, therefore, for insurance agents to spend a lot of time on this process. In addition, many people I talk to feel pressed for time. They want me to calculate within minutes what it might cost to rebuild their home. In the real world, such calculations simply can't be done in a few minutes. Nevertheless, it amazes me that at some websites you will find for homeowners insurance you can get almost instant calculations on how much insurance you may need based upon a few questions asked. As a result, it is my opinion this process will lead to an inaccurate calculation and very likely inadequate insurance protection. It is my opinion if homeowners have the expectation that their insurance agents or insurance company has the responsibility to accurately calculate the cost to rebuild your home, 1)fees would have be to added to the premium you pay for the policy to fairly compensate the agents for the time involved; and 2)agents would have to receive adequate training, perhaps even a special license, before they should be allowed to provide this service. Guaranteed Replacement Cost Coverage, Extended Replacement Cost Coverage and Replacement Cost Coverage With the above discussion on how reconstruction costs are made, now I want to talk about the above terminology. Up until a few years ago in California, some of the largest writers of home insurance, such as State Farm, Allstate and Farmers all offered “Guaranteed Replacement Cost Coverage”. Therefore, if the methods being used to calculate the replacement cost of your home were inherently defective, most homeowners thought they had the assurance that if the calculation was wrong, they had a guaranteed replacement cost policy. In simple terms, this meant that not matter what the insurance amount was on the home, if it costs more to rebuild and no matter how much more, the company “guaranteed” to rebuild your home no matter how much it would cost. This “guarantee” was not really much of a guarantee, however. Most companies that offered “guaranteed replacement” cost coverage also had included in their policy an exclusion for any additional costs to rebuild the home to meet the current building codes. Court cases held up that exclusion. The guarantee really only meant the company guaranteed to rebuild the home the way it was, and if there were any additional costs to bring it up to current codes, the homeowners had to pay those costs. After the Oakland Firestorm in 1991, many homeowners who had the guaranteed replacement cost clause, found this out and were outraged. For a variety of reasons, the insurance companies that thought they didn’t have to pay for code upgrades for homes that had “guaranteed replacement cost” coverage that were total losses in the Oakland Firestorm ended up paying for them. I had a chance to participate in meetings involving legislation introduced after the Oakland Firestorm to address the confusion around “guaranteed replacement” cost coverage. The bottom line is that unless a guaranteed replacement cost homeowners policy includes full building code coverage, the homeowner does not have a policy that truly guarantees to rebuild their home to meet the current building codes no matter what it costs. Despite the above, the insurance industry was able to convince the California Legislature that in the California Residential Property Disclosure that the terminology "“Guaranteed Replacement Cost” Coverage could still be used as long as a company had no cap on the dwelling limit. The disclosure notice must clearly show if it was a guaranteed replacement cost policy with full building code coverage or limited or no building code coverage. For example, I know of one company that only provides a $25,000 fixed amount for building code upgrades yet still has unlimited dwelling coverage and calls their policy guaranteed replacement. Their disclosure notice clearly shows the policy has limited or no building code coverage. As a consumer, you must understand that with such a policy you may still be out thousands of dollars if after a covered loss, the additional costs brought on by current building codes cost more than $25,000. In California today, I know of no insurance company actively advertising the fact that they offer guaranteed replacement cost coverage with full building code coverage included. Some carriers may still be offering this type of coverage. Good luck trying to locate any of them. Extended Replacement Cost Coverage The majority of California homeowners are insured with State Farm, Farmers and Allstate. All three of these companies no longer offer guaranteed replacement cost coverage. What these and many companies have done is come out with what is now basically called “Extended Replacement” Cost Coverage. The company may actually use different wording. However, what extended replacement cost coverage basically means is as follows. The company on their endorsement offering this coverage basically has set a “cap” of how much they will pay over and above your dwelling policy limit. For example, if the home is insured for $100,000, they may only pay an additional 25% above this amount. Therefore, the maximum payment on the house would be $125,000. I have seen percentages as low as 20% and as high as 100%. Based upon who you have your home insured with, and if you have this endorsement on the policy as it may not be automatically included, the maximum payment you can receive now after a partial loss is capped by this percentage. If you don’t know what percentage you currently have, as it is usually not clearly shown on your renewal paperwork, you should contact your agent to find out what you indeed have. To make matters worse, even with the extended replacement cost endorsement, to my knowledge most companies do not include full building code coverage. For example, I know of one carrier that offers an additional 50% on their extended replacement cost endorsement. So if the home is insured for $100,000, the maximum payment will be $150,000. However, that company only offers up to 10% of this amount as additional coverage to apply towards additional costs to rebuild your home to meet the current building codes. So the maximum additional payment for code upgrades may only be $15,000. Some companies offer full building code coverage with the extended replacement cost coverage. I work with two carriers that will 1) pay up to 100% more than your policy limit after a covered fire loss and 2) include in this amount costs associated with rebuilding your home to current building codes. Here are the current insurance problems homeowners in California face today with the above issues. First, insurance companies methods for calculating the cost to reconstruct your home are already defective so must homeowners are probably now underinsured for a serious fire loss. Second, with the extended replacement cost restrictions, even with an extra 20% or higher amount, a homeowner may still not have enough to reconstruct their home. Third, with limitations on building code upgrade coverage, thousands of dollars of additional costs a homeowner may incur to rebuild their home to meet current building codes may not be fully covered. Perhaps now you can understand why I have said earlier “show me the policy”. To simply get a quote online and not know if the quote includes: 1)true guaranteed replacement cost coverage; 2)guaranteed replacement cost coverage with limited or no building code coverage; 3)the percentage of extended replacement cost coverage, if it is included in the quote and how much building code coverage is included with extended replacement cost coverage, leaves many homeowners potentially very underinsured. The time to find out potentially how underinsured you are should be before you suffer a loss so you can take some proactive steps to find better coverage. That is where working with any agency like David Shaffer Insurance Services can benefit you. The terminology "extended replacement" cost coverage may not actually be the wording use in your current policy to describe the endorsement that provides this type of coverage. One company may call it "Modified Replacement Cost Coverage", another may include this type of endorsement in an endorsement that covers several changes in coverage that has the name "Excel Plus". If you are uncomfortable having a homeowners policy that only provides an "extension" of an additional 125% to 150%, you can shop around to find companies that may offer you an extension from 150% to 200% or Guaranteed Replacement Cost Coverage. If you can't find the above, although it may not be a perfect solution, you can increase your dwelling coverage and offset the higher premium by choosing a higher deductible. In addition, if you only have a small amount of additional building code coverage, find out if you can buy more from your current carrier. For example, I know of what company that automatically includes 10% of your dwelling limit as additional coverage to meet current building codes. The same company has an extended replacement cost endorsement of 175%. The company offers the option to increase the 10% code limit from 10% to the full policy limit when extended to 175%. Remodeling and Its Impact on Guaranteed Replacement or Extended Replacement Cost Coverage If you have remodeled your home in the last few years and spent as little as $5,000 in the process and have not informed your agent or insurance company, and you have either Guaranteed or Extended Replacement Cost Coverage, you may have voided this coverage! Furtheremore, you may not even be covered for any of the remodeling work you have done if you have not notified your agent and/or insurance company and had your coverage increased, if required, to reflect this work. Typically the endorsement providing the additional dwelling coverage will include wording on what impact remodeling or rennovating your home will have on this endorsement. If this applies to you, contact your agent or company immediately before a loss occurs and find out how the work you have done needs to be included in your policy so as not to void the guaranteed or extended replacement cost endorsement. If you are planning to rennovate or remodel your home, you need to report this to the agent or insurance company before you being the work and see what you need to do to be properly insured for the planned changes and to make sure you don't void this additional coverage. Replacement Cost Coverage If the homeowners policy has neither guaranteed replacement or some sort of extended replacement cost coverage endorsement, more than likely the maximum payment one can receive is the limit shown on the policy declarations page. A replacement cost policy may or may not have any building code coverage. Actual Cash Value It is very unusual to find an actual homeowners policy that only offers actual cash value coverage. I don't know of any that exist, but some may. Basically the maximum you can collect is the policy limit shown for the dwelling coverage and after a partial loss, some items such as a roof, may be subject to depreciation. Final Comments First, if peace of mind is what you want when you buy a homeowners insurance policy, many who read the above should realize their current insurance coverage is inadequate. My website will shortly allow on-line quotes that will allow you to instantly get estimates for policies that may offer substantially broader coverage than you now have. Second, finding better coverage may prove difficult if not impossible for some. Insurance companies have criteria commonly called “Underwriting Guidelines” that one must meet in order to qualify for a policy. Based upon a homes location and many other issues discussed in the next section, some homeowners may have to accept they many not be able to ever obtain adequate coverage. Finally, to qualify for a company’s guaranteed or extended replacement cost endorsement, typically you must allow the insurance company to insure your home for 100% of its replacement value. Despite the potential defects in the programs used to make the calculations of what it might cost to insure your home, it would not surprise me if the database used by the insurance company is based upon new home construction. This implies homes that are being built to meet current building codes. If you have agreed to insure your home for 100% of the cost to rebuild your home as calculated by your insurance company, and if your insurance company’s database includes new homes being built to code, I find it a sad commentary that although many of these companies base your insurance value on a home that meets current building codes, when you have a claim they won’t pay for the full costs you might incur to rebuild your home to code! Therefore, if the company you now have does not offer full building code coverage, you should look for a company that provides this coverage. (If you have earthquake coverage, I know of no company that offers more than $10,000 for costs you will incur after your home is damaged by an earthquake to rebuild your home to meet current building codes). See if you can answer the following quetions without looking at your policy? 1)Does your policy include the guaranteed dwelling replacement cost coverage endorsement? 2)If not, does your policy include an extended replacement cost coverage endorsement? 3)If yes to either 1 or 2 above, how much additional coverage does your policy provide to pay for costs to bring your house up to current building codes? 4)If yes to 2 above, what is the percentage included in the extended replacement cost coverage endorsement? 120%?, 125%?, 135%?, 150%?, 175%?, 200%? 5)If yes to 1 or 2 above, will the policy limits for other structures, contents or additional living expenses be increased in relation to the increase in the dwelling limit? THE IMPORTANCE OF ADEQUATE BUILDING CODE COVERAGE Many companies in California do not offer building code coverage limits equal to the policy limits for the dwelling coverage. One company, for example the California State Automobile Association, offers a fixed amount of $25,000. Other companies offer a percentage of the dwelling limit. I have seen in the policy of one major writer of homeowners insurance a limit of 10%. So if your home is insured for $300,000, the policyholder only has an additional $30,000 to apply to code upgrades. To my knowledge, it is virtually impossible to know until a claim occurs exactly how the building codes in your city will impact the additional costs a homeowner will incur. Below are real examples I received from an insurance company on claims involving code work. Location: Atherton, CA Date of Loss: 1996 Type of Loss: Fire The home was insured for $406,000. After a total loss, the actual cost to rebuild the home was $822,156. The actual dollar amount to bring the home up to current building codes was $200,000. Location: Stinson Beach, CA Date of Loss: 1999 Type of Loss: Fire The home was insured for $631,000. After a total loss, the actual cost to rebuild the home was $1,294,600. The actual dollar amount to bring the home up to current building codes was $300,000. Location: San Francisco, CA Date of Loss: 1995 Type of Loss: Fire The home was insured for $532,000. After a total loss, the actual cost to rebuild the home was $1,013,270. The actual dollar amount to bring the home up to current building codes was $727,190. David Shaffer Insurance Services © 2000 |
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David Shaffer Insurance Services
