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Now More Than Ever:  The Importance of Insuring Your Home to its Reconstruction Cost

Current global economic conditions are greatly impacting everyday life in this country. Americans are making adjustments to their discretionary spending, and some have even decided to place home renovation and construction projects on hold. Many assume there is a corresponding decrease in residential construction costs. Plus, as home market values have plunged as much as 30% in parts of the country, some homeowners think insurance premiums should decrease too.
 
Contrary to popular belief, however, while home market values continue to plummet nationwide, construction costs remain strong and are even on the rise, although at a slower rate than in the past. The Engineering News-Record Construction Cost Indices calculated a 4.9% increase in construction costs from Dec. 2007 to Dec. 2008.
 
Market value vs. replacement cost
As a result of increased construction costs, approximately 58% of U.S. homes are underinsured by an average of 21%, according to Marshall and Swift/Boeckh, a leading provider of building cost data. Many homeowners don’t realize that insurance premium is based on the replacement cost to rebuild a home in the event of a major loss, not market value, or what the house would sell for today.
 
MARKET VALUE VARIABLES
REPLACEMENT COST VARIABLES
Sub-prime loan crisis implications
Foreclosure rates
New housing starts
Housing shortages in some locations
Location factors
Land value  
Trends in material costs
Fluctuating fuel costs
Labor costs and availability
Changing construction code requirements
Changing construction standards and practices
New technology
 
Key factors that contribute to rising construction costs
• Fluctuating energy costs.
• Rise in the cost of skilled labor.
• Reduced competition as some builders go out of business.
• Increased overseas demand for raw materials and building products.
• Price increases for roof shingles and wallboard.

Building materials cost increases from Dec. 2007 to Dec. 2008
CONSTRUCTION COST COMPONENT ANNUAL % INCREASE
Millwork (windows, doors, cabinets)
Appliances
Concrete Block and Brick
Hardware
Asphalt Roofing
Concrete
Gypsum Products (drywall)
Paint
2.1%
4.0%
4.7%
12.5%
58.0%
3.9%
7.5%
16.7%
 
Sources: Engineering News-Record, Marshall and Swift/Boeckh, RSMeans, and Reed Construction Data, 2009. 
 
Reconstruction costs more than new construction
When rebuilding a home after a loss, contractors must work with and match existing materials, which requires skilled labor that costs more. Plus, when a contractor rebuilds a single home, there are no economies of scale. The cost to rebuild is always higher than the initial cost to build.
 
Varying profits for general contractors and subcontractors
The replacement cost for a home includes the builder’s profit and overhead, which averages 10-20% of the building cost or even more for larger, more ornate homes. Architectural fees for additions and renovations add another 10-15% of building cost.  Decorator fees can be as much as 20% added to the total cost, since custom interior designs have to be replicated and integrated.
 
U.S. environmental factors
Recent natural disasters such as hurricanes in coastal regions, floods in the Midwest, and wildfires in the West have contributed to shortages of building materials and overall cost increases. For example, following Hurricane Katrina in 2005, the costs of materials like concrete, steel and copper increased at a double-digit rate, while the cost of lumber more than doubled. Also, a heightened emphasis on building “green” with environmentally friendly materials and ultra-efficient technology has contributed to rising construction costs.
 
Rebuilding custom and historic homes
The materials used to reconstruct custom homes or restore historic homes are more expensive than those used to build average homes due to finer quality and the fact that specialized homebuilders buy these materials in relatively small quantities. Also, fewer craftsmen specialize in custom construction and historic renovation, and greater demand for these specialists has led to increased skilled labor costs.
 
 


 

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