Insurable Value vs. Market Value

A common reaction we receive when issuing a homeowners' policy is one of bewilderment when the insured looks at the replacement cost for their home after having just gone into contract for a home they are about to purchase.  One of two scenarios happen: 1) we most often run into situations where someone just bought a home for the market value of $600,000, but their insurable value is $350,000.  And 2) the opposite situation when someone buys a home for $300,000, but the insurable value is $550,000.  Many people are quick to think that they either overpaid for their home, or that they are over insured and are being ripped off.  Neither is likely the case.

Insurable value for a home is the replacement cost in the event of a total loss.  For instance, take the first scenario- Someone purchases a newly built 2,800 sq. ft. home on a 1.5 acre plot near the coast with ocean views for $750,000.  Now take that exact 2,800 sq. ft. newly built home on 1.5 acres and move it inland 15 miles to the next town over to a less wealthy area.  This home was purchased for $350,000.  Now assume that both of those homes burn to the ground and need to be rebuilt.  In this situation, the replacement cost would be identical regardless of paying a market value of $750,000 or $350,000.  The same contractor would be buying the same materials at the same location and charging the same rates to rebuild.  Market value takes into account a number of factors, where insurable value only looks at what it would cost to rebuild the structure only (and its contents).  Land value and location are not factors in this equation.   

Conversely, we have situations where homeowners have put more into their home than they could possibly sell it for in a particular town, or area of town.  They may put their home on the market for $400,000 because that is the predicted maximum price they will be able to receive (market value).  This home's insurable value may exceed what it can get on the market, meaning that in the event of a total loss the structure's insurable value may exceed $650,000 regardless of what it could sell for.  Again, market value is affected by a number of factors- ultimately driven by supply and demand.