Does Your Policy Cover Replacement Cost?

home-insurance-tennesseeIn this hot real estate market in Knoxville, TN and surrounding counties of East Tennessee, we receive numerous calls from new home buyers wanting a proposal on homeowners insurance. These perspective clients are calling mostly because their loan officer has told them they need to acquire homeowners insurance for their new home. I’m always surprised how many of these home buyers don’t fully understand the process. Now, I’m not judging because before I secured my insurance license, I couldn’t spell insurance! Anyway, I digress….

I would bet the best odds in Vegas the first line out of their mouths is, “can I get a proposal on my new home?” These clients are conditioned to the “get a free proposal; we can save you _% on your insurance” mentality. They have been inundated with advertisements pushing cheap, low cost, coverage with no mention of exactly what is covered. These clients are doing as trained, and it really is a shame. Your home is usually one of your biggest assets, it warrants a thorough discussion to make certain all items and features of your home are covered. We have some clients who want to hurry through the process. It is our job as insurance agents to slow you down and to ask numerous questions, so we can discover the risks specific to your household. If the only time questions are being asked is at claim time, trouble is coming. We want to handle as many questions as possible on the front end to avoid trouble and disappointment at claim time.

Reconstruction Cost

One item that always shocks me is the reconstruction cost—better known as replacement cost (RC) on a home—and how it is calculated by some agents. Reconstruction or replacement cost is the cost to replace or rebuild your home. Typically, clients are confused between RC and market value. Many of our clients ask, “why is my homeowners insurance coverage more than what my house is worth?” Many people assume the cost to rebuild their home will be equal to what they paid for it. Insurance companies usually determine building RC on estimated reconstruction costs at today’s material and labor cost. Many factors affect RC…square footage, custom or builders grade, exterior of the home, and basement…just to name a few.

In some areas RC may be lower than the purchase price of the home, and in some areas it will definitely be higher than the purchase price of the home. Unfortunately, I’ve seen numerous situations where RC for homes was estimated at the purchase price of the home, and that is very rarely sufficient coverage. Be certain you get this number correct!

Location, Location, Location

The location of the property also makes a big difference on market value as well. A local example of this would be comparing real estate in different areas of Knoxville. An 1,800 square foot home in South Knoxville would sell for considerably less than an 1,800 square foot home in West Knoxville. However, the RC would be the same. The contractor buying materials for either home to rebuild will be purchasing them from the same type of supply company. Market value is the price a person is willing to pay for a home. It can vary greatly from RC. As I said above, location can definitely affect market value.

Depending on the condition of a home, RC and market value can be thousands of dollars apart. I’m a big fan of home renovation TV shows. These renovations are extreme makeovers, but they are excellent examples of how the replacement cost of a house can greatly change from the original value of a property. If you buy a house and make significant improvements, then it stands to reason your RC will be much greater than your original home cost. Yet even before renovations, the RC for a 1,300 square-foot distressed house is the same as the RC for a 1,300 square-foot desirable home.

Price Per Square Foot

I had a client call yesterday for a proposal. We ran his information through our systems and reached what I thought was an appropriate replacement cost for his home. This number was $356,000 for a 3,100 square foot home. The “proposal” he received from another agent had the replacement cost at $315,000. In my professional opinion, there is NO way a 3,100 square foot home in Knoxville, TN can be rebuilt for $100 a square foot. Who’s going to make up the $41,000 difference at claim time?

Many companies add an additional replacement cost of 25% of your dwelling amount. For example, if you insure your dwelling for $100,000, you would be paid a total of $125,000 (25% more) in case of a total loss. Many agents use this 25% to make up the difference when they underinsure a home. There is one small problem with this strategy. In case of a catastrophe, you will need a correct RC PLUS the 25% to make you whole and rebuild your home.

A great example occurred when the Gatlinburg fires destroyed over 2,800 structures. After the fires, our first client received an estimate to rebuild her cabin at $175 per square foot. The cost prior to the fires was $135 a square foot. Had we initially underestimated her RC, she would not have had enough to rebuild her home. With the additional 25%, she rebuilt her cabin.


Rebuilding a home is always more expensive than the first-time new construction. Multiple factors affect rebuilding costs including site access, site improvements, labor efficiencies, permit and fees, working restrictions because of location, delivery access, materials discounts, utility access, debris removal and current building codes.

Another item to consider is ordinance of law coverage which basically means how many building codes have changed since your home was built. The older your home is, the more important this coverage is. Most policies come with 10% of your dwelling cost and you may need much more. If your home was built in the 1960’s, how many building codes do you think have changed in 48 years? This coverage is not included in your dwelling cost. It is a separate coverage, and you should make sure you know the amount of coverage you have.

National statistics show that over half of the homes in the US are underinsured. The question is, are you willing to take the chance that you will not have enough coverage to rebuild your home? Is the savings of a few dollars, worth the headache and heartache at claim time? In crisis, people are already emotional; adding more stress is not necessary. I know the average client thinks, “it won’t happen to me”, but what if it does? Understanding the difference between RC and market value is a key factor in making sure your coverage is up to the high standards of your home. By making sure your home is insured for its replacement cost, you will be getting the coverage you truly need should you ever suffer a total loss.