Replacement cost

One of the great mysteries of the property insurance world is replacement cost. During my agent days, I was frequently asked to insure property and determine a replacement value of someones house. Talk about conflicts, here's what I'm up against: I've got a homeowner who doesn't want to pay anything for house insurance, a mortgage professional who dictates to me how much coverage he needs and an insurance underwriter who has her own idea of what it should be insured for. Try keeping all three happy at the same time. For my own peace of mind, I always imagined delivering a check, in person, after a total loss and asked myself: would these people be happy with the results? I always aimed for satisfied, not mad (too little) or ecstatic (too much).

To imagine the difference in property valuations, let's look at two different but similar sized houses. One is a Duffy home (I'm just picking a random builder) built in 2001 and the other is a 2 1/2 story federalist style brick home built in 1860 in a historic district of town. Both have a market value that is roughly the same, but the construction techniques are very different.

The Duffy home has 2800 SF and a combo of vinyl and stone facing on the exterior. Common asphalt roof, poured concrete basement, framed with 2X4, 2X6, engineered floor trusses and manufactured roof framing. Steel exterior doors and wood/vinyl windows. Interior is plywood sub-floors with carpet,ceramic tile,vinyl sheet tiling, and engineered wood flooring, walls are drywall. Interior doors are hollow core 6 panel with basic oak baseboard and door trim. Kitchen has standard appliances, granite tile counter tops and semi-custom cabinets. It also includes a Pre-fabricated gas fireplace with manufactured mantel and surround. Modern furnace & HVAC. A very nice home in a upscale neighborhood, market value around $400,000. Good quality all around, but nothing unusual in the construction materials. Almost everything in the house can be purchased or ordered at Lowe's and any competent handyman or construction crew can repair the house.

The 1860 house at 2200 SF has original antique brick exterior with a slate roof. The basement walls are field stone and mortar; at some point the original basement floor has been replaced with poured concrete. The framing is full dimensional lumber with original hardwood floors. Original solid wood exterior doors, original wood windows some leaded decorative windows. Solid wood interior doors, antique oak trim, including hardwood stairs, handrails, chair rails, crown molding (man you'd think the stuff grew on trees). Original brick fireplaces (four of them) and original gas lights (refitted for electric). Modern kitchen and cabinetry, upgraded plumbing, electric & HVAC. A historic home in a upscale historic neighborhood, market value also $400,000. All materials in home need to be repaired since replacement is difficult. To find existing or matching trim, material needs to be salvaged or recreated from antique material. Handymen are usually not up to the job, craftsmen with a specialty in older construction are needed and they don't work cheap.

So what would replacement cost be on both houses? On the newer house, a percentage of the retail value comes from the price of land in a trendy of the neighborhood. Using an industry calculator, the replacement cost for the house would range from $290k to $360K depending on features inside the house. This would suggest the land value of the lot is around $75K.

Using the same calculator on the older house, replacement cost would range from $650K to $750K. The price of the house is dictated more by the market demand for this type of house and less by the value of the land and reconstruction costs. Yet at a real estate closing table, both parties want to see the same replacement cost on their insurance policy. In fact, even after a extensive explanation of historic house replacement, the owner of the 1860s house insisted on a lower replacement cost to keep his homeowners premium down.

Now before we discuss how these two figures are calculated, here are some definitions of property replacement techniques:

•Like kind and quality: replace damaged property using the existing construction techniques and similar materials.

•Modified replacement Cost: Modifies loss settlement to repair or replace home with “commonly used and available materials”
•Extended replacement cost: Will pay to repair or replace home up to 125 percent of insured value.
•Guaranteed replacement cost: Will pay to repair or replace home no matter what it costs.
•Replacement cost of Personal Property: replace old damaged personal property with new property at current cost without depreciation using current products
Replacement: Rebuilding old from scratch.

Reconstruction: Rebuilding damaged property.

Actual Cash Value: Insuring for the market price of a property. Not enough to rebuild but enough to buy the house next door.



Issues that control the cost of replacement or reconstruction of houses and the major differences between older (say pre-1940) and newer homes.

Replacement Cost.
Valuations based on the cost to replace with similar quality and utility. New replacement cost valuation methods fully consider the additional costs involved in rebuilding a home, particularly older homes, for both partial and total losses.
–For older homes, Full dimensional lumber, original wood flooring, lath and plaster walls and ceilings, heavy rafters and sheathing, stone foundations, extensive use of solid wood trim and doors, crown moldings, etc.
–Impacts of requiring updating to building codes, environmental issues, such as lead paint and asbestos which have to be remediated (particularly older homes).
–Demolition and debris removal costs.
–Higher average labor costs in a rebuilding project.

Reconstruction Cost
Includes more accurate valuation estimates for rebuilding an exact replica of the home, including original materials. Replacement cost contracts require this unless the insured is willing to accept commonly used materials (or if the insured doesn't know he has modified replacement cost on his policy). It also recognizes the higher costs in most situations to rebuild a home – even a newer home.
»Time is of the essence in helping the displaced property owner.
»Wages paid to subcontractors on a single job often are higher.
»Materials costs can be higher due to loss of volume discount and normal demand and availability factors.
»More special orders may be required.



Cost for each type of construction vary widely based on cost of materials and cost of labor in different areas of the country. To improve accuracy, insurers use location adjustment programs that are based on the full Zip code, not just the first three digits.

The intent of any cost valuation program is to maintain a high level of accuracy, recognizing that costs are subject to change. To do this, the programs:
- collect data quarterly from over 2,600 areas in the U.S.
- collect union and wage rates for more than 75 trades
- contain over 30,000 line items of construction, including productivity rates and crew sizes to install each of them.
- take into account regulations, debris removal stipulations and license fees for all municipalities.
- study reconstruction/replacement cost data from past claims to more closely reflect the cost insurers pay when a loss occurs.
- consider local cost concerns such as building code requirements, hillside foundation costs, architect fees, and variables for older structures.
- conduct extensive quality control analyses to validate real cost activity from claim settlements, both partial and total.

Accurately generating replacement cost is a important step to take when closing on a house or reviewing homeowners coverage. It is particularly important to the owners of pre-1940 houses and restoration buffs all over the US. Take time to review your policy or ask your agent pointed questions about your coverage.

Definitions of Rental Property Coverage

May 14th 2007 Called Kym the adjuster to touch base and find out where we were in the claims settlement. No word yet, she's waiting on input from the GC to get her numbers together. I ask if she's received copies of the leases (hint hint I want my loss of rent coverage) she has received them; she says the company will pay out based on how long they estimate the renovation will take and an advance is possible if needed. We'll see how that goes. I'm hoping this doesn't require the services of an attorney.

Since there's nothing going on on my claim I'll cover the basics of Dwelling coverage on rental property (property that's not owner occupied). This applies to residential property with 1 - 4 units and no commercial exposure (no apartments on top of stores or houses used for a public access business). This does not apply to commercial coverage.

A standard policy has four parts:

1. Declarations - Insurance company name, name of insured, address of property, amount of coverage, premium, and policy period.
2. Insuring Agreement - Contains consideration clause, effective time & location, policy limits, ACV limitations, company options, direct vs indirect losses, insurable interests and perils covered.
3. Conditions - Conditions that apply to insurer and insured; an example would be insured requirements to notify insurer of loss.
4. Exclusions - What's not covered. Flood, war, nuclear, earthquakes and wear & tear (including insect & animal damage) are general exclusions that apply to all policies.

The policy is broken into the base policy (called a standard fire policy or SFP) and a Dwelling Form endorsement (Def. an endorsement is an addition to a Property & Casualty policy that adds more coverage; called a rider if it's Life & Health related). The SFP covers basics like fire & lightning. Additional loss coverage depends on which endorsement you buy:

1. DP-1 endorsement - Basic Form or DP-1 - Pays ACV (replacement cost minus depreciation) coverage (replacement cost may be available for extra $$) Named coverages are: Wind, Hail, Aircraft, Riot & Civil commotion, Vehicle, Volcano, Explosion & Smoke. DP-1 policies are generally only sold on vacant property (under renovation or for sale) SO another important endorsement is vandalism and malicious mischief (VMM). May not cover trees and scrubs.
2. DP-2 endorsement - Broad form, Includes all coverages on DP-1 plus replacement cost on structure, burglary damage, falling objects, weight of snow & ice, water leakage, freezing pipes, power surge and glass. VMM is included without an endorsement. Usually includes trees and scrubs.
3. DP-3 endorsement - All risks -includes all coverages in DP-2 and generally covers anything not excluded. Theft only applies to build in items.

To determine what your coverage is, read your policy (it's a thumping good read..for an insurance geek) or look at your declarations page. If it's still not clear, discuss with your insurance agent or call customer service at your insurance company. Be sure to press for details, since your agent may not know what he's selling.

The policy will pay up to a certain amount of money for the above mentioned losses based on your declarations page:

Deductible - Usually $500 to $1000, amount property owner is to pay before losses are paid.

Coverage A: Dwelling- the building itself including all structures and fixtures attached to the property. May be replacement cost or ACV. Usually contains an inflation provision so coverage (and premium) go up a certain percentage every year on the policy anniversary date. Determining proper replacement cost is a discussion for another day.

Coverage B - Other structures - Outbuildings or unattached items (like fences). Usually 10% of Coverage A. Pays in addition to Coverage A, so on a total loss, if you have $100,000 of Coverage A you would receive up to an additional $10,000 under coverage B.

Coverage C - Personal property - Again a percentage of Coverage A: This tends to vary by insurance company. This is limited to the owners personal property at a rental house, not the tenants things.

Coverage D - Loss of Rents. Usually 10% of Coverage A. Covers fair market rent for up to a year or whatever period the insurer thinks is needed to repair property.

Liability Coverage Sometimes called Coverage E - Usually between $100,000 to $500,000 of coverage. Coverage for owners to pay $$ for negligent acts that caused bodily injury or property damage related to owning the property.

Med Pay - Sometimes called Coverage F -Provides small amounts of medical coverage so injured parties don't need to sue for liability coverage to get minor injuries paid for.

Other coverage included (read your policy to see if they're included):

Board up and securing property after loss.

Debris removal - certain limits may apply, such as removal of fallen trees.

Fire department service charges -typically around $500 is covered.

Coverages for code compliance - extra $$ paid to bring older properties up to current code. For example the asbestos shingles on my rental.

Later I'll discuss how properties are valued and how insurance companies pay claims.

Ernesto TIG