When it comes to insuring your home, you might assume one of two things:
“I’ll keep the coverage low and save some money.”
Or…
“Let’s insure it for as much as possible. More insurance means a bigger check if something happens, right?”
Unfortunately, neither approach is quite right.
Homeowners insurance is a little like Goldilocks and the Three Bears. You don’t want too little. You probably don’t want too much. You want an amount that is just right.
And here’s why.
Too Little Insurance Can Trigger the Coinsurance Penalty
Most homeowners policies require your home to be insured to a certain percentage of its replacement cost—commonly around 80% or more, depending on the policy and coverage involved.
Replacement cost is not what you paid for your house. It’s not necessarily what Zillow says it’s worth. And it’s definitely not what your neighbor thinks it’s worth after watching three episodes of HGTV.
It’s approximately what it would cost to rebuild the insured structure using today’s construction costs.
If your home is significantly underinsured, you may run into something commonly called a coinsurance penalty or an insurance-to-value requirement.
Here’s a simplified example:
Suppose your home would cost $500,000 to rebuild, and your policy requires you to carry at least 80% of that amount, or $400,000.
But you only insure it for $250,000.
Then a storm causes $100,000 in covered damage.
You might think:
Not necessarily.
Because you didn’t carry the required amount of insurance, the policy may reduce what it pays on the claim according to its terms.
That can turn your money-saving strategy into a very expensive surprise.
Saving a few dollars on premium isn’t much of a bargain if it leaves you tens of thousands of dollars short after a major loss.
So Why Not Just Insure It for a Million Dollars?
This brings us to the other side of the insurance seesaw.
If underinsuring is bad, why not insure a $500,000 house for $1 million?
Because homeowners insurance generally follows a basic principle:
Insurance is designed to make you whole after a covered loss—not create a profit.
If it costs $500,000 to rebuild your home, having $1 million of Coverage A generally doesn’t mean the insurance company hands you a $1 million check after a total loss.
The policy pays according to the actual covered loss, replacement cost provisions, policy limits, deductibles, endorsements, and other terms and conditions.
In other words:
You don’t get to burn down a $500,000 house and retire to the Bahamas with the other $500,000.
Please don’t test this theory.
Your Home’s Market Value Is NOT the Same as Its Replacement Cost
This is one of the biggest sources of confusion in homeowners insurance.
Let’s say you bought your home for $700,000.
That doesn’t necessarily mean you need $700,000 of dwelling coverage.
Your purchase price may include:
- The land
- Location
- Waterfront or beach proximity
- School district
- Neighborhood desirability
- Real estate market conditions
- The fact that three other buyers desperately wanted the house
Your homeowners insurance is primarily concerned with the cost of rebuilding the insured structure, not repurchasing the land underneath it.
The opposite can also happen.
You might buy an older home for $350,000, but because of its size, construction type, materials, labor costs, building codes, and other factors, it could cost $500,000 or more to rebuild.
That’s why simply using your purchase price or current market value to determine your insurance amount can be misleading.
But My Mortgage Is Only $200,000…
Your mortgage balance isn’t the right number either.
If your home would cost $500,000 to rebuild but you only owe the bank $200,000, you still have a $500,000 house to rebuild after a covered total loss.
Your mortgage tells us how much you owe.
It doesn’t tell us how much lumber, roofing, drywall, electrical work, plumbing, labor, permits, and contractor services will cost after a hurricane.
Unfortunately, Home Depot doesn’t care what your mortgage balance is.
The Goal: Get the Number as Close to “Just Right” as Possible
At SIA Insurance, our goal isn’t simply to sell you the highest amount of insurance possible.
It’s also not to cut coverage just to advertise the cheapest premium.
Our goal is to help you insure your home appropriately.
Insurance companies use replacement cost estimators that consider factors such as your home’s:
- Square footage
- Construction type
- Number of stories
- Roof
- Flooring and finishes
- Kitchens and bathrooms
- Garages and porches
- Special features
- Local construction and labor costs
These tools aren’t perfect—no estimate is—but they help us arrive at a reasonable estimate of what your home may cost to rebuild.
Review Your Coverage as Your Home Changes
Did you add a new kitchen?
Enclose a porch?
Add 800 square feet?
Build an elaborate outdoor living area that now looks suspiciously like a Caribbean resort?
Tell your insurance agent.
Construction costs also change over time. A dwelling limit that made perfect sense several years ago may no longer be adequate today.
That’s why reviewing your homeowners coverage periodically is important.
The Bottom Line
When insuring your home:
Too little coverage can leave you exposed to inadequate limits and, depending on your policy, possible insurance-to-value or coinsurance penalties.
Too much coverage can mean paying unnecessary premium for limits that may exceed what the policy would actually pay to repair or replace your home.
The right amount of coverage is based primarily on a reasonable estimate of what it would cost to rebuild your home—not simply its market value, purchase price, tax assessment, or mortgage balance.
Think Goldilocks.
Not too little.
Not too much.
Just right.
If you’re not sure whether your home is properly insured, contact SIA Insurance. We can review your current coverage, discuss your home’s estimated replacement cost, and help make sure your insurance still makes sense.
Because finding out you bought the wrong amount of insurance after the hurricane is a really bad time to learn how coinsurance works.
Coverage varies by insurance company and policy. Coinsurance, insurance-to-value requirements, replacement cost provisions, deductibles, coverage limits, and claim settlement terms are subject to the specific language of your policy. This article is for general educational purposes and does not modify or replace the terms of any insurance contract.
