The most important reason for getting homeowners insurance is to make sure you can replace your home if you have a total loss. You don’t want to come up short if you need to rebuild your whole home, so it’s critical that you understand how the replacement cost estimate (RCE) works.
Your dwelling coverage limits should cover your home’s full replacement cost. This is the amount that it would take to rebuild your home from the ground up using materials of a similar quality. Many people choose to insure the structure of their home for its entire replacement cost, as opposed to its actual cash value, because it’s the option most likely to make them whole after a total loss.
Insurance companies use the information you put on your application, proprietary formulas, and third-party data to calculate your home’s replacement cost estimate. However, inflation can cause the cost of rebuilding your home to fluctuate, so insurers make adjustments to your replacement cost estimate to make sure you have the appropriate amount of coverage.
Worth noting: your home’s replacement cost estimate and market value are different. The market value is what someone will pay for your home, not what it costs to build it. So depending on market conditions, the replacement cost could be more or less than your home’s market value.
Insurance carriers use many factors to estimate the rebuild cost of your home. The more details you provide on your application, the more accurate your replacement cost estimate will be.
The replacement cost estimate focuses namely on the size of your home and the quality of the materials and appliances, such as:
But there are other costs that factor into a replacement cost estimate, like paying for:
Once all the details are plugged into your provider’s system, the software uses the building and materials costs in your area to calculate an estimate. The data is updated regularly to keep up with the current costs of construction.
While the materials and structure of your home are only going to change if you do a major renovation, construction costs vary based on market conditions. And as construction costs go up, so does your replacement cost estimate.
Data analytics company Verisk shows reconstruction costs are on a sharp upward trend this year. Lumber prices in particular are up 54 percent, thanks to increased building activity and limited supplies in many areas.
Take Louisiana, for example. Last year, Louisiana was hit with numerous hurricanes that created a high demand for reconstruction. This coupled with rising materials costs in the area gives Louisiana an inflation factor of approximately 11 percent, which means replacement cost estimates will go up by 11 percent, too.
If your replacement cost estimate increases – and considering the direction construction costs are going, it probably will – then you should be ready for a bump in your homeowners insurance premium. Basically, your insurance provider will recommend increasing your limits so you’re ready for a disaster. As your dwelling coverage increases, so does your premium.
Increases to your premium usually take place at renewal, a process that begins about one month before your expiration date. During renewal, you can see how your previous dwelling coverage compares with the new replacement cost estimate.
You may want to revisit your policy’s replacement cost estimate if you’ve remodeled or renovated any part of your home. Just taking something like plywood cabinets and replacing them with custom cabinets can increase your replacement cost. Without updating your policy to reflect that change, you may not have the adequate coverage to replace your upgrades.
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