| A question we continually get from both our current | | | | time. The difference of $170,000 and the sales price of |
| clients and any potential clients is what is the | | | | $200,000 is the builder's profit. |
| difference between replacement cost and actual cost | | | | * I sell this home 5 years later to you at a price of |
| or fair market value. The question usually comes in the | | | | $230,000 for a profit of $30,000. Not bad! |
| form of "why are we insuring my $200,000 home for | | | | So, what do we insure this home for: $170,000, |
| $340,000" but can also come in when discussing other | | | | $200,000, or $230,000? Could you rebuild this home for |
| forms of property including jewelry, commercial | | | | any of these amounts? The answer is no, and actually |
| property, or equipment such as tools or backhoes. | | | | these numbers wouldn't get us close to rebuilding this |
| When buying a home, we as home buyers typically | | | | home at all! |
| look at the sales cost of the home (also referred to as | | | | First of all, let's assume we have a total loss due to a |
| fair market value) when determining which home to | | | | fire. We have debris to clean up (your old house) to |
| buy and what we can afford. This price will rise and | | | | the tune of $12,000-$30,000 dollars, whereas our |
| fall with both the supply of homes and the demand | | | | builder just had an empty lot to build on. We have to |
| from the market. | | | | hire engineers and architects to look at the existing |
| Currently, home values are down so we're able to buy | | | | foundation or structures to make sure it's suitable to |
| more home than we were saying five years ago. To | | | | build on and redesign the construction plans. We also |
| insurance companies, this number is irrelevant. The | | | | have to hire a contractor to build the house with |
| amount the insurance company is concerned with is | | | | today's prices for materials and labor. Furthermore, we |
| what is the maximum amount needed to rebuild and | | | | have to build the home as of today's building codes |
| restore our client to before loss condition if the home | | | | which can significantly raise the cost of construction |
| were to be destroyed by fire or another named | | | | (building codes get much more stringent as time goes |
| covered peril. | | | | on driving up costs). Plus, this is a one off job now for |
| Let's put some numbers down as an example: | | | | the builder. He's lost all the economies of scale he had |
| * I build a new home at the cost of $200,000 (fair | | | | when he could order 15 bathtubs at the same time |
| market value at the time of building). | | | | from his suppliers. |
| * The price to build the home for the builder is $170,000 | | | | All of these added expenses can add 30-50% to the |
| due to economies of scale, since they are building 10-15 | | | | building (or rebuilding) of your home. We sum up all of |
| homes at any given time. Materials, labor, etc., is fairly | | | | these costs with the term "replacement cost", or the |
| cheap and reasonable for the builder because they're | | | | cost you would need to rebuild the home to the |
| not building just one house, they're building several at a | | | | allowable standard that it was before the loss. |