What Replacement Costs are Included in Homeowner’s Insurance Coverage?

Many home owners are unaware that the replacement costs included in their insurance coverage may not be sufficient. The dollar limit of your homeowner’s insurance policy represents what the insurance company will replace: your home and your valuables in case of a disaster. In order to be sure that you are fully protected you must have an understanding of what it cost to replace your home and possessions today.

For example, if you purchased a $100,000 home in 1997 your homeowner’s insurance coverage would have been written to replace the home at that time if it had been destroyed. To replace the same home ten years later would cost much more than $100,000. But if your policy dollar limit is still at the level that was set in 1997 and your home was destroyed in 2008 your insurance policy will only pay $100,000 leaving you with a serious financial loss.

There is a big difference between “actual cash value” and “replacement value.” In your homeowner’s insurance policy the extent of your coverage is outlined in the “loss settlement” clause which identifies which property will be valued at replacement cost and which will be valued at actual cash value. Before you buy homeowner’s insurance make sure you fully understand the difference in your policy by discussing this clause with your insurance agent.

A replacement cost homeowner’s insurance policy will provide you with more protection than a policy based on actual cash value. The easiest way to understand the difference between these two policies is to imagine that you purchased a television set for $300 five years ago and it has been stolen from your home. To replace this television set today would cost $500 but if you were to sell this television set the actual cash value might only be $100.

If you choose a “guaranteed replacement cost” homeowner’s insurance policy the coverage you receive will pay for the full cost of repairing or replacing your home if it’s damaged or destroyed. When you purchase “extended replacement cost” coverage, the insurance company will pay you a certain amount above the policy limits, usually 120-125%. Both of these policies were designed to protect the homeowner after a major disaster has struck. In the aftermath of a tornado, earthquake or flood the cost to replace your home including building contractors and materials can exceed the normal costs during the period of reconstruction.