One of the most common sources of confusion among homeowners insurance clients is discovering that their dwelling coverage doesn't align with what their home would sell for, or what an online real estate tool says it's worth.
Adam Bakonis (pictured), Mercury Insurance's director of property product management, said the disconnect is structural rather than a sign something is wrong.
"Market value reflects what a buyer may be willing to pay for a home and the land it sits on. Replacement cost focuses on what it could take to rebuild the physical structure after a covered loss. Those numbers aren't expected to move together," Bakonis said.
Market value is what a buyer might pay for a home under current real estate conditions, shaped by factors including location, school districts, lot size, local housing supply and demand, interest rates and proximity to jobs and amenities. None of those factors affect what it costs to physically rebuild the home after a covered loss.
Replacement cost, which is what homeowners insurance is designed to cover, estimates the cost of rebuilding the structure using materials of similar kind and quality at current prices, without including the land, since the land itself isn't destroyed in a fire or storm.
In competitive housing markets, market value often runs well above replacement cost. In other markets, rebuilding can cost more than the home would sell for. Neither scenario signals a problem with the policy.
Bakonis said the confusion typically arises when clients put two unrelated numbers side by side.
"Homeowners sometimes see their dwelling coverage and compare it with an online real estate estimate or a recent appraisal. That can create confusion because they're comparing two numbers designed to answer completely different questions. One estimates what the property may sell for. The other helps estimate what it may cost to put the home back together," he said.
Rebuilding a single home after a major loss is different from building dozens of homes as part of a new residential development. A contractor may need to demolish damaged sections, remove debris, work within an existing lot and meet current building code requirements, even if the home was originally built under older standards. Code compliance alone can add meaningful cost when a home built decades ago must be reconstructed to today's requirements.
After a widespread disaster, when many homes in the same area need work at the same time, demand for contractors, skilled labor, lumber, roofing and concrete can all push rebuilding costs higher still.
Two coverage options address these scenarios specifically. Additional Replacement Cost coverage provides extra protection when rebuilding expenses exceed the standard dwelling limit, which can happen in high-labor-cost markets or after a disaster drives up contractor prices. Ordinance or Law coverage addresses the cost of rebuilding to current code requirements. Neither is automatically included in a standard policy, but both are worth discussing with clients whose homes could be exposed to either situation.
"Coverage options such as Additional Replacement Cost and Ordinance or Law can help homeowners prepare for rebuilding expenses that may go beyond their standard dwelling coverage," Bakonis said.
Clients sometimes notice their dwelling coverage amount has shifted from one policy period to the next without any work having been done on the home.
Construction labor rates and material costs move over time, independently of real estate values, and insurers periodically adjust estimated replacement costs to reflect those changes. But automatic adjustments cannot account for everything, which is precisely why significant renovations or additions must be reported.
If a client remodels a kitchen, adds square footage, finishes a previously unfinished space or makes any other substantial improvement, the agent needs to know.
"Your insurer can't account for changes it doesn't know about. A quick conversation can help make sure the information being used to estimate your rebuilding cost better reflects the home you actually have today," Bakonis said.
Clients don't need to become construction-cost experts, but they should periodically confirm that their insurer has accurate information about the home's square footage, construction type and major features, and should report any significant renovations as soon as they're complete.
If the dwelling coverage amount seems unclear or insufficient, the right conversation is with the agent, not an online real estate tool.
Most importantly, clients should understand that the price a home might sell for is not the right number to insure it for. As Bakonis put it: "Your home is both a piece of real estate and a physical structure, but insurance and the real estate market look at it through different lenses. Understanding that distinction can make your homeowners policy much easier to understand and help you have a more productive conversation with your agent about your coverage."
