With the current economic downturn dominating the news, it is easy look at your home or business insurance renewal, be happy if it didn’t increase much, and send off a check for payment. Unfortunately, when it comes to property insurance on your home or commercial building, you could be making a mistake that might bring another kind of economic disaster to your doorstep.
Over the past few years, in every part of the country, building costs have risen dramatically. Here in North Idaho, just a few years ago, it was not unusual to use an $80 per square foot estimate for a basic, single family dwelling. Today, many people are surprised that we often recommend $125 per square foot to estimate the replacement cost of the same home. Surprised, that is, until they call their local contractor. So, the 2000 square foot home, with very modest appointments, that could built for $160,000 in 2004, would probably cost $250,000 to build today. And it doesn’t take much to go above that “basic” home cost. Upscale flooring, hardwood kitchen cabinets, top-of-the-line windows — you would be surprised how quickly a home’s replacement cost can reach $200 per square foot and above.
Most insurance companies automatically increase the insured value of your home each year in an effort to keep up with inflation. The problems with depending on that are:
- There is an assumption, often incorrect, that you started with the correct amount in the first place.
- The inflationary figure the insurance company uses is an average, sometimes based on national statistics, that may or may not be reflective of your own local costs.
Most good home insurance policies nowadays have a bit of protection built in for unexpected jumps in building costs. That protection usually offers to pay up to 125% of the insured amount in the event of a total loss. A few policies offer a 150% option. Using the example above, the replacement cost of our 2000 square foot home is now 156% higher than it used to be so even the better home policy would leave you short.
Commercial buildings have not been immune to these increases either. In fact, due to the huge run up in concrete and steel prices, the commercial market has been hit harder in many cases. Recently, I reviewed the value of a nice, 3,000 square foot commercial building one of my clients had purchased in downtown Sandpoint. The insurance company’s estimate of the replacement cost was around $285,000, my client felt $450,000 was more accurate and was flabbergasted when I suggested $200 per square foot, or $600,000. She happened to have a contractor working on the building at that time so she picked up the phone and called him for his opinion. Without being prompted, he did some quick calculations and came back with $200 per square foot! I have to confess, I had a distinct advantage in this case. Only the week prior I had some discussions with our County Assessor about this very subject and had gotten his estimates on some similar commercial buildings which happened to be in the $200-$250 per square foot range. I wish I could take credit for being so darn smart, but I can’t.
The additional problem with commercial buildings is that business insurance policies seldom offer the inflation protection of 125% or 150% that some home owner policies do. If you’re under-insured, you’re just out of luck at the time of the loss. And, in the event of a partial loss, you may still have a problem if the low insured value puts you in a coinsurance penalty. That’s a subject for a entire blog, but just be aware that you can be stung by a partial loss as well as a total loss if you are under-insured.
My advice is to check your insured value right now and review it with your insurance agent. Check his or her figures against what I have found out by talking to contractors and the County Assessor. And remember, don’t compare your “replacement cost” to any kind of “appraised value”. It is apples and oranges. Appraised value is, essentially, the depreciated value of your home or building added to the current value of the land it is sitting on. Replacement cost is the amount you would have to pay a contractor to rebuild your home on your lot today.
I know that no one is looking for a way to increase the cost of their insurance, especially right now. And, certainly, increasing the amount of insurance on your home or commercial building will do just that. But, if you come up $10,000 or more short when it’s time to rebuild your structure, trust me — the few dollars you saved on your insurance premiums will seem pretty meager!
