Are you properly covered? Featured

8:00pm EDT October 26, 2008

In today’s declining housing market, the discrepancy between home value and cost to insure a home is widening, says

Michelle Mendes, vice president for Aon Private Risk Management for Aon Risk Services, Inc.

“It can be confusing to the homeowner if the house has a market value of $400,000 and they are told they need $800,000 in insurance to replace the home,” says Mendes.

The reason is that the cost to replace a home exactly the way it was, if it burned to the ground or got swept away in a storm, is almost always more than the house is worth on the open market, according to Mendes, particularly if the house is old or has customized features.

Smart Business spoke with Mendes about why homeowners should not assume that the amount of coverage on their home is enough to replace it if disaster should strike.

What is the confusion surrounding home market value and replacement costs?

The amount of insurance coverage needed is rarely close to the price you paid for your home. While the market value of a house can vary widely depending on the neighborhood location, area of the country and other factors, what usually does not vary much is the amount it will cost to replace that home — board by board — if a fire should burn it to the ground or if it gets swept away by a flood, hurricane, tornado or any other natural disaster.

In areas where home prices are spiraling downward, such as in the southeast and mid-western parts of the U.S., that gap between cost to replace and market value is ever widening. On the East Coast, where homes are holding value the best, the market value of the home is closer to the cost to replace.

Are most homeowners, then, underinsured?

Yes, most homeowners are severely under-insured; the latest estimate is that 64 percent of U.S. homes are undervalued and underinsured. The problem is that people don’t understand the cost of replacement of their homes, which is usually shockingly high.

Why aren’t more homeowners savvy to this fact and insured to the right level?

Most insurance companies leave it up to the individual and his or her agent to determine how much insurance the individual wants. But there are many unseen elements of homes that may not factor in. Take, for example, many of the ‘green’ updates homeowners are adding, such as geothermal. That ought to factor into the valuation of the home when determining the right amount of insurance to cover that home.

Then there are homes, for example, with period-style detailing, such as customized moldings and woodwork. If the house’s market value is $1 million, you can bet, in this market, that the cost to replace it will be much higher than that. Homeowners need to realize that if they plan to put the home back to its original condition after a disaster, they will have to insure it for replacement value, not market value.

What are some steps homeowners can take to ensure that they are adequately covered?

Be sure to choose an agent/broker with personal insurance knowledge that also represents more than one insurance company. They should be able to help you understand the valuation of a replacement cost. Quite a few companies will appraise your home for you.

Decide if you want unlimited replacement cost or a capped amount for your home. This will dictate which companies you are quoted and therefore which contract is chosen to insure your home. Would you settle for a minimal rebuild rather than an ‘exact’ rebuild (i.e.,in an older home this may mean sheetrock walls instead of plaster walls, etc.). There are even insurance contracts that utilize ‘functional’ replacement costs. This is the most minimal replacement available. Hard wood floors would likely be replaced with linoleum in this case.

Are you choosing homeowners insurance to fulfill the mortgagee’s requirement or to protect one of your most valuable assets? If you are more concerned with asset protection you will find yourself working with both an agent and an insurance company who will assist you in the valuation process. Some companies will do prospective appraisals so you can know prior to placing coverage what they feel the replacement costs would be. In either situation, a knowledgeable insurance consultant is one of your best tools.

Do you have any advice about home insurance considering the current economic situation we find ourselves in?

Despite decreasing market values, your home’s replacement cost is increasing. The cost of construction, building materials and fuel all play a part in the annual replacement cost increases that all policies experience. If your home is an integral or large part of your portfolio, as it is for many of us, you should consider providing it with superior protection. Seek good counsel and choose the insurance product that best fulfills your needs.

MICHELLE MENDES is vice president of Aon Private Risk Management for Aon Risk Services, Inc. ( Reach her at (216) 623-4151 or