Could your home be underinsured? Don't wait until disaster strikes to find out

Daniel Workman

As thousands of California wildfire victims can attest, cash-value home insurance pays only a limited portion of expenses required to rebuild a severely damaged or completely destroyed residence. After the Southern California wildfires of 2007, nearly 1 million people were forced to evacuate, according to California's Department of Insurance. Many found out too late that they were under-insured.

That's because cash-value coverage is tied to how much it would cost to replace your home at the time of loss, minus depreciation charges. If an insurance company assesses 30 percent depreciation for the wear and tear on a $200,000 house, then a cash-value home insurance policy will pay a maximum of $140,000 $200,000 minus $60,000).

Replacement-cost home insurance offers more financial protection because insurers don't deduct depreciation for that type of coverage. However, you still have to carefully determine the amount of replacement-cost coverage to buy so that you don't run into under-insurance problems.

Estimate basic home rebuilding costs

A quick way to estimate rebuilding costs, according to consumer rights group United Policyholders, is to multiply new building construction cost per square foot for the community you live in by your home's total square footage.

Ask your local builders' association for the latest construction cost per square foot. When you calculate the total square footage in your home, be sure to include dimensions for the entire structure. If you focus on living space only, you end up insuring a smaller dwelling.

Let's look at a sample calculation. According to the National Association of Home Builders, the U.S. average price per square foot was $83.89 in 2009. Applying that average to a single-family house with 2,500 square feet, basic rebuilding costs equal $209,725 $83.89 times 2,500).

Another way to estimate your home insurance needs is to hire a professional replacement-cost appraiser. Clearly specify that you want a replacement-cost estimate for your home, as opposed to the market-value appraisal of your property that most real estate appraisers provide.

Identify hidden home replacement costs

Don't forget about renovations, special architectural details or unique building materials that would add to replacement costs when your home is rebuilt. The U.S. Department of Labor reported that homeowners spent $226.4 billion on residential property improvements and repairs in 2007, up 13 percent from $201 billion in 2004.

Home improvements include such upgrades as:

  • Aluminum roofing.
  • Arched windows.
  • New carpeting or hardwood flooring.
  • Renovated kitchens and bathrooms including cabinets).

Check to see whether your insurance company allows increased coverage for home improvements. Some insurers give you 90 days to notify them of any remodeling projects or additions that increase your home's value by $5,000 or more, according to United Policyholders. Certain improvements, like a new security system, actually may lower home insurance premiums.

Prices for building materials like cement, gypsum, lumber and structural steel go up when demand rises. For example, lumber costs climbed 6 percent in 2005 after devastating storms the previous year, according to the Insurance Information Institute. Consider upgrading your policy with an inflation-protection feature that automatically adjusts for local construction cost increases.

Building code laws may have changed since your home was built. If your community now has building code laws that require changes to your home's structural design or the use of more expensive construction materials when rebuilding, you'll want to add ordinance or law coverage to your home insurance policy. This feature pays a specific amount toward those charges, according to the Insurance Information Institute.

Schedule annual coverage reviews

A growing list of rebuilding expenses can be intimidating. Be proactive by performing a yearly home insurance checkup that verifies that your current coverage is keeping up with total rebuilding expenses.

Keep in mind that most insurers allow you to buy an extended replacement-cost endorsement that covers an extra 25 percent to 100 percent of expenses above your basic policy limits.

Here's one final tip. Because most home insurance policies include contents coverage typically set at 50 percent to 75 percent of your dwelling's insured amount, according to the Insurance Information Institute), your annual review should ensure that you have adequate replacement-cost insurance to cover personal possessions if your home is destroyed.

See how much you could save today on your home insurance. Get your free home insurance quotes today!