Replacement cost increases? In this market?

There is a battle being waged everyday in the offices of independent agencies across the country over what is commonly known as "inflation protection".  The idea is that a personal homeowners policy will increase the replacement value of a home year-over-year to keep up with perpetually rising costs.

Then came 2007, 2008, 2009 and now 2010, when if you've picked up a newspaper, turned on a TV or listened to the radio you would have heard something about the housing market and it's not so sunny outlook. We'll lay out the reasoning behind both arguments and discuss how that effects homeowners insurance quotes, premiums and rates.

The case for decreasing or flat reconstruction costs.

If you've looked around you'll notice more homes for sale, fewer new homes are being built and the current mortgage mess that has made moving from home to home an act taken our of necessity and not a hobby. What that tells me (and many clients) is that there is decreasing demand, which should have the effect of lowering prices.  Here's a common comment we receive, "If no one is building anything and builders are struggling to find work they'll take on a project now for less than they would have 3 years ago."

The other argument is that a client's home has almost certainly dropped in value on the market. Whereas once his home was worth a million dollars, now it's worth 30 - 50% less. That creates an uncomfortable conversation about how rebuilding the house would cost more than the house is actually worth on the market. The answer is usually not satisfying and promises are made to work with the insurance company to find an equitable answer.

The case for increasing reconstruction costs.

Insurance companies, for the most part, continue to have increases year-over-year on the rebuild cost of homes. Let's take a closer look at the stated reasons for this stance.

Carriers admit that the housing market and the overall economy are having an effect on the market and everyday life in general. However, they site various Construction Cost Indices that track the actual cost of materials and labor in the U.S.  One such report shows an increase of 4.9% from Dec. 2007 to Dec. 2008.  The reasons:

• Fluctuating energy costs (mostly higher)
• Rise in the cost of skilled labor
• Reduced competition as builders go out of business
• Increased demand for raw materials from overseas (read: China)
• Material increases
• Mill work up 2.1%
• Appliances up 4%
• Hardware up 12.5%
• Asphalt roofing up 58%
• Drywall up 7.5%
• Paint up 16.7%

The cost of material isn't really up for debate as things cost what they cost and it's easily tracked.  The numbers from 2008 to 2009 and 2010 are actually right on par. The most recent report says overall construction costs are up 2.9% year-over-year.

In playing devil's advocate insurance agents are often put into a position to "admit" that a soft insurance marketplace is forcing carriers to "make their numbers" by other means, like increasing the rebuild cost of a home, which leads to higher premiums.

What doesn't help some carriers is that when left unattended, the replacement cost of a home can be increased too much. One such case in Florida I've seen had a home reappraised in 2009 after an initial appraisal in 2004.  The cost to rebuild was basically the same over that five year period.  The problem was that the "inflation protection" on the policy had increased the replacement cost on the policy over 200%.  That was not a fun conversation to have with the client, who correctly wanted to know why he was over-insuring his home for four years.

In conclusion, an agent can, and should, fight for a client if something is over insured. Insurance companies do make mistakes and two carriers can look at the same house and come up with two totally different figures. It's up to the agent to help navigate those waters.

If you have more questions on this topic please give me a call.