Why my home is insured for more than its worth

Why is my home insured for more than it's worth?.............. This is the #1 question we get.
Most of us have a home market value that is much less than the cost to re-build the home thanks in part to declining real estate values and foreclosures. Insurance carriers do not consider market value when establishing the insurance valuation at all. Why you ask? Well, insurance companies have to make sure that, in case of a total loss, there is enough coverage to rebuild the home exactly as it was prior to the loss. Most responsible insurance carriers have a replacement cost calculator that allow their agents to adequately value and insure homes but in many cases, clients feel this amount is too high based on their purchase price or their taxable value. So why is REPLACEMENT COST more expensive than purchase prices or taxable values? Here are 3 reasons that immediately come to mind;

1. The insurance company must clean up the site and remove any debris from the destroyed home.
2. The insurance company will rebuild only one home so any economies of scale in building multiple homes are completely gone.
3. The insurance company must also account for any increase in labor and materials cost. After a big catastrophe, materials and labor are in high demand and, as we all learned in business 101, if demand goes up you can expect costs to go up.

But what if you don’t care and want less coverage? Some insurance carriers will allow you to insure your home on an actual cash value basis, otherwise known as depreciated insurance coverage. Many insurance companies today will not sell you a policy that has a value less than the cost to replace your dwelling. However, if you shop around enough, you may find one that will. Buying a $100,000 value policy on a $200,000 house can be a short trip to financial disaster. After a loss (partial loss that is) your insurance company will appraise the “replacement value” of your home on the date of loss and will then apply the co-insurance penalty. The penalty is the coverage I had, divided by what I should have had, then multiplied by the loss. The % of replacement cost value you insured your home for will be multiplied by the newly appraised Replacement Cost value of your policy. Then you can subtract your deductible to find out the value of your claim and what you will receive. So, if you insure your $200,000 home for $100,000, and let’s say you have a $100,000 loss, simply multiply $100k by 50% and you will receive $50k, less your deductible. That is a recipe to financial disaster.

In summary, the current market value, purchase price or tax assessment HAVE NOTHING TO DO with, nor has any relationship to REPLACEMENT COST. The only number that insurance companies will use for insurance purposes is the Replacement Cost Value.