Understanding Insurance: Higher Value, Why?

When it comes to insurance, the cost of replacing or repairing a damaged item or property is often higher than its actual value. This is because the insurance value is based on the cost of rebuilding or replacing the item, which includes labour and materials, rather than the market value, which is the estimated price the item would sell for. In the case of homes, the insurance value may also include the cost of preparing the land, which can be significant. For vehicles, the insurance value may be based on the actual cash value (ACV), which takes into account depreciation, wear and tear, and other factors. Additionally, insurance policies may need to be updated to keep up with inflation, which can further increase the insurance value over time.

Inflation and insurance value

Inflation is a general increase in the price of goods and services over a period of time. In other words, you can buy less today than you could yesterday with the same amount of money. Inflation can have a direct impact on insurance values. For example, in the context of home insurance, a payout from your policy might not be sufficient to cover the cost of materials for repairs or rebuilding after a claim. This is because the cost of rebuilding a house is often more than the resale value.

The insurance value of a house is what it costs to rebuild the house, including the costs of labour and materials, whereas the market value is what the real estate market would pay for the house. The gap between the insurance value and the market value has narrowed in recent years, but a gap still exists. This is because the cost of rebuilding a house is subject to the effects of inflation, such as the rising costs of labour and materials, which increase the cost over time.

In the context of car insurance, inflation can also affect the value of your car. The insurance company bases its offer on the actual cash value (ACV) of the car, which is the amount that the company determines someone would reasonably pay for the car, assuming the accident had not happened. However, if you total your car shortly after buying it, the insurance payment may be less than what you owe on the vehicle. This is because the ACV will be significantly lower than what you paid for it, as a new car takes its biggest valuation hit when its new owner drives it off the lot.

Periods of high inflation can result in insurance companies experiencing higher claims payouts and operating costs, leading to more expensive premiums for the consumer. As a result, some customers may have to drop their coverage or switch policies to save on costs. Inflation can also diminish the buying power of money, which means that premium payments no longer go as far as they once did, and insurers are forced to raise rates to keep up with increasing costs.

Rebuilding costs

The insurance value of a property is the cost to rebuild the house from scratch. This is different from the market value, which is the estimated price for which a property is likely to sell. The insurance value is generally based on the amount required for purchasing building materials and hiring contractors to build a replacement.

The cost of rebuilding a house can be estimated by multiplying the square footage of the property by the current replacement cost of similar properties in the area. Another way is to hire a licensed appraiser to get a more precise estimate. Some factors that influence the rebuilding cost include the current construction costs, the age of the property, its size, and any special features.

The cost to rebuild a house is often higher than its resale value. This is because it costs a lot to find the labour and materials, secure, prepare, and build the house from scratch. The gap between the insurance value and the market value has narrowed in recent years, but it still exists.

In some cases, the insurance value of a property may be lower than its market value. This can occur if the property is located in an area where land is cheap or the housing market has declined. Additionally, if a property has unique features, high-end materials, or expensive architectural details, the cost of rebuilding may exceed the market value.

Market value vs. insurance value

Market value and insurance value are two very different concepts, and understanding the difference is key to getting the right insurance coverage.

The market value of a property is the estimated price for which it is likely to sell on the real estate market. This amount is influenced by factors such as the property's location, the value of the land, and the demand for housing in the area. Market value is important when purchasing or selling a property, as it affects the real estate transaction.

On the other hand, insurance value, or insurable value, is the cost of rebuilding or replacing a property. This value does not include the cost of acquiring the land, but it does include the cost of purchasing building materials and hiring contractors to rebuild the structure. The insurance value of a property tends to change over time, as the cost of construction materials and labour can fluctuate.

In some cases, the insurance value of a property may be higher than its market value, especially if the home is constructed with rare or expensive materials or is located in an area where land values are low. Additionally, the insurance value may be higher if the property has special features or high-end finishes, as these can increase the cost of rebuilding.

It is important to note that insurance value is not the same as the replacement cost of a property. The replacement cost refers to the amount it would take to repair or rebuild a property using materials of similar type and quality to those that were originally used. This cost can be lower or higher than the market value, depending on various factors.

To ensure adequate insurance coverage, it is recommended to understand the insurable value of a property and to update insurance policies regularly to keep up with changes in construction costs and other factors that can impact the insurance value.

Actual cash value (ACV)

Insurance values are often higher than actual values because of the many hidden costs involved in rebuilding or replacing a damaged asset. These costs are considered in the calculation of the actual cash value (ACV) of an asset. ACV is a metric used by insurance companies to determine the value of an asset that is getting repaired or replaced after it has been damaged. It is calculated by subtracting the depreciation from an item's replacement cost value. This metric is used for both personal and business assets.

For personal assets, such as homes, renters, or condos, insurance policies may cover the ACV or the replacement cost value (RCV) of the asset. The RCV is the amount it will take to replace the asset without any deduction for depreciation. The ACV, on the other hand, is the RCV minus depreciation. This accounts for the age and wear and tear of the asset. For example, if a couch bought for $3000 five years ago is damaged, the RCV would provide $3500 for a new couch of a similar make and model. The ACV, however, would provide $1500, reflecting the couch's value after five years of depreciation.

For business assets, the ACV is calculated similarly. For instance, if business computers bought for $10,000 are damaged in a fire after four years, and they were supposed to last for ten years, the computers would have depreciated by $4000. Thus, the ACV at the time of the loss is $6000. With ACV insurance, the claim check would be for $4000 minus the deductible.

The choice between ACV and RCV insurance depends on the insurer, policy, coverage type, and personal preference. ACV insurance is usually more affordable but provides less coverage, whereas RCV insurance offers more coverage at a higher premium.

Agreed value insurance

In the case of car insurance, the agreed value is usually determined at the start of the policy and is fixed for the policy period, which is typically 12 months. This agreed-upon value is the payout amount the insurer is committed to paying in the event of a total loss claim. With agreed value insurance, classic car owners can insure their vehicles for their real value within the collector car market. This is in contrast to regular auto insurance, which generally insures vehicles for their actual cash value (ACV), i.e. the cost to replace the vehicle minus depreciation.

For homes, the insurance value is typically based on the cost of rebuilding the house, which can be higher than the market value of the property. This is because rebuilding costs include labour and materials, as well as preparing the land, which can be expensive.

Frequently asked questions