Insuring your home for market value is always a bad idea

Did you know that insuring your home based on the market value is almost always a bad idea?  (It can leave you significantly underinsured and exposed to catastrophic loss)
  • December 22 2010 - Cincinnati
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Answers (5)

Profile picture for Mills Realty
Why would anyone insure for market value?  I wasn't even aware that was an option. 
  • December 22 2010
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Do you have a good way to explain to your customers that they need rebuild value?

  • December 22 2010
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Jack:

 

When people ask me why their insured value is not the same as the estimated market value of their property this is what I tell them.  Insurable value that is estimated for your homeowner's insurance considers the cost to replace your home in the event of an insurable loss.  The replacement cost estimate is directly affected by the cost of construction materials and construction labor costs.  On the other hand, market value or the value estimated by a real estate appraisal reflects the real estate market for the type of property being appraised.  Think of it this way, if a majority of homes for sale in your competitive price range are foreclosures or bank-owned properties these market conditions have an impact on the market value of your property but don't affect the cost of construction materials or construction labor costs if your home were to be a complete fire loss.

  • December 22 2010
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It happens more than you think.  A survey completed (Forgot the source) showed that as many as 40% of households are underinsured.  Several years ago a perspective client was referred to our independent insurance agency in Cincinnati and he insured his home for the purchase price.  

I alerted him to the fact that he was significantly underinsured.

He wisely secured the coverage he needed and three months later his house burned right down to the ground!
  • December 23 2010
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Market value can be a good fit for an investor.

Word of the day, "moral hazard" It is an insurance term used to describe a situation where a person would gain from a loss.

If you buy a home for $5,000 and insure it for $150,000, this has become a moral hazard. In some states the insured has the option to "cash out" the policy and move on to another property. This is an example of where a small fire becomes a large fire because the insured is encouraged to let the home burn down to collect a profit of $145,000 minus the deductible of course. The payout would actually be higher because of other coverages that would kick in but I am trying to keep it simple here.

An investor could insure a home at market value to protect their cash investment. This is a good option because it reduces the risk of a moral hazard which keeps rates down and insures the investor at the right amount.
  • May 28 2012
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