Every once in a while, I’m asked by a mortgage loan officer or processor if the home insurance policy a client has selected includes guaranteed replacement cost coverage. In most instances, the answer is no, however, there are a few carriers that still offer this. I thought we’d take a look at that as we conclude this series on home insurance coverage and forms.
A home insurance policy with guaranteed replacement cost coverage simply means the insurance company guarantees to replace the home in the event of a total loss regardless of the cost it takes to do that. For example, if the home is insured for $200,000 and the cost to replace it is $300,000, $400,000 or more, the insurance company will rebuild the home the way it was constructed before the total loss.
Most home insurance policies were written as guaranteed replacement cost up to the late 1990s. Around 2000, many companies began to move away from offering guaranteed replacement cost coverage on their home insurance policies due to the cost they incurred from severe losses. Part of the problem was many homes were not properly insured to begin due to agents who underinsured the home knowing the guaranteed replacement cost would provide a backstop in a major loss.
To cover their exposure, home insurance companies made three changes to their home policies once they stopped offering guaranteed replacement cost coverage. These three changes are policy limits, inflation adjustment, and extended replacement cost coverage.
Policy Limits: Most home insurance policies cover a home up to a specific limit and no more. In this case, whatever the amount the home is insured for is the maximum amount, or limit, that will be paid in the event of a total loss. If the home is insured for $200,000 and it cost more to rebuild it, then the additional cost will be paid for by the homeowner. This is why it’s so important to have a home properly insured from the beginning.
Inflation Adjustment: The majority of home policies written today are written with inflation adjustment coverage. This means the amount of coverage on the home adjusts or increases each year based on the rate of inflation. If the US economy experiences a moderate rate of inflation of say, 3% to 5% a year, then it’s safe to assume the amount of coverage on the home will increase 3% to 5% a year to keep up with inflation.
The purpose of this is to prevent a home from becoming under insured. If the coverage amount on your home hasn’t changed in the past 3 to 5 years, you definitely need to talk with your agent to see if you’re policy adjusts the amount of coverage based on the rate of inflation. This may be available as an option if it’s not already included.
Extended Replacement Cost: One of the options offered on most current home policies is extended replacement cost. This provides an additional percentage of coverage on the dwelling limit. The most common percentages are 25% and 50%, although some companies offer 100% extended replacement cost. The purpose of this additional coverage is to help provide a little padding if there is a total or near total loss.
For example, if the home is insured for $200,000 and has optional 25% extended replacement cost added to the policy, the total amount of coverage is $250,000. The cost to add extended replacement cost coverage to your policy is about $50 a year for the 25% option and approximately $100 a year for the 50% option, though this varies by carrier.
MetLife still provides guaranteed replacement cost coverage as an option on their home insurance policy. If your home policy isn’t a guaranteed replacement cost policy, but have an appropriate replacement cost limit on a policy that adjusts for inflation and has extended replacement cost, then you should be adequately covered. If you’d like me to review your coverage, let me know.
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