“Why does my homeowners insurance keep going up?” It’s one of the most common questions that insurance agents get, especially during times like these when market values are down from where they have been recently. Often, that question is followed by an understandable statement, “My house isn’t worth anywhere near that.” Herein lies the confusion, and hence the answer. First though, in honor of the current election year, watch me talk and talk and talk without ever really answering the question. Instead I am going to focus on the real issue: Why is your home insured for so darn much to begin with?
Homeowners Insurance: Replacement Cost vs. Actual Cash Value
Many people mistakenly think that homeowners insurance operates like most auto insurance and will only pay a maximum of the value of the property insured. The most common example of that is auto insurance which, typically, will only pay up to what the car is worth at the time of the accident. That type of insurance is known as “actual cash value”. Most homeowners insurance policies, however, are insured on a “replacement cost” basis meaning that they will pay what it costs to replace the home without regard to the value of the property at the time of the loss. Essentially, a homeowners insurance policy is promising to rebuild your home, not just pay what you lost. This then leads us to the next important factor, costs to rebuild a home.
It Costs More to Rebuild a Home than to Build a New Home
Imagine how upset you would be if your home burned and your homeowners insurance only paid a fraction of what it cost to rebuild. That is exactly what would happen if the home was insured for actual cash value. Needless to say, you’d be pretty livid and for good reason. People expect that their home will be rebuilt to pre-loss condition. This is how it differs from auto insurance. If your car is totaled and it is worth $10,000 at the time of the accident, you can presumably go out and buy a similar car with similar mileage for that $10,000. However, with a home, you can’t just go out and buy a used home and plop it right down where your old home stood (except for a mobile home which is a different topic altogether). So with homeowners insurance, the only way to restore you to pre-loss condition is to rebuild the home on the existing site. When rebuilding a home, many things have to be done that are unnecessary when building a new home. Demolition of the damaged portions of the home, removal of some undamaged portions to enable the rebuilding of the damaged portion (like tearing out the remaining portion of the roof, removal of all of the debris and contents, etc.). All of that and more add significantly to the cost of rebuilding a home.
Economies of Scale: Building One Home vs. Many Homes
Another factor which can cause a rebuild to cost more than a new build is economies of scale. Simply put: Often when a builder is building a home, he is actually building multiple similar homes, either in a housing tract or at multiple sites around town. As a result, the builder may see significant cost savings in materials and subcontracted labor. No such cost savings are present when doing a single rebuild.
Inflation Guard: Keeping Your Homeowners Insurance Adequate
By now, you may have figured out that I haven’t answered the title question: “Why does my homeowners insurance keep going up?” Well, unlike our ‘beloved’ politicians, I will actually answer that question now. Inflation guard. Boom. That’s it! Yes, two words to answer the question that I have now spent 616 words so far (and counting!) answering. See, every year your insurance company increases the limit of insurance on your home too keep up with inflation. If they didn’t, their longtime policyholders would become underinsured because inflation would outpace the coverage on their home. Then, after being insured with the same company for 20 years, you would find out that it cost more than double to rebuild your home than when you started the policy. And you would be mad, really mad. We’re talking llama-spittin’ mad. So, every year they increase the coverage by about 4% to keep pace.
Hopefully, this has given you a little insight as to why your homeowners insurance is the way it is. Not to mention a llama-infused chuckle.
(Note: How much do I love you, dear reader? I bought this picture of a llama, just for you.)