Shuman Roy is an entrepreneur, business owner, and musician. He started RoysNoys, LLC in 2013 as a music production and education service company. He also offers small business consulting and advisory services to help businesses get from start-up mode to turn-key operations. Shuman earned his M.B.A from the Stern School of Business in 2001 and has an undergraduate degree from Manhattan College in ...

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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He has an MBA from the University of South Florida. Joel...

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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Jul 19, 2021

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Roughly fifty to seventy percent of Texas homes are underinsured, according to a study performed by Southwestern Insurance Information Service (SIIS).

But don’t let out a sigh of relief if you live in any other state. Just because a study hasn’t been performed in your particular state doesn’t mean this isn’t the case for you.

The press release noted that the information was “dramatically pointed out following a series of hurricanes in Florida and wildfires in Arizona and California when people found out there were not enough insurance dollars to replace what was destroyed.”

According to SIIS President Jerry Johns, “it is unfortunate that many people living in Texas do not come to this realization until they have sustained catastrophic damage and discover their insurance coverage falls far short of the cost to rebuild their home.”

How Much Coverage is Enough?

You should expect a reasonable homeowner’s insurance company to estimate your home’s value anywhere between $75 and $110 per square foot. Quite a disparity, right? Well, the number is based mostly on the “grade” of fixtures your kitchen and bathrooms are constructed with. Your average bedroom costs almost the same to rebuild no matter what…drywall and nails.

It doesn’t matter where you live. The cost of basic building materials are marginally different by region and certainly do not cost more by zip code or neighborhood. The same basic construction materials are used in Beverly Hills and the poorest neighborhoods in Los Angeles.

When it comes to bathrooms and kitchens however, you can go with builder’s grade fixtures all the way up to custom and designer. If you opted for granite counter tops rather than Formica and you want your home rebuilt with the same materials, you should expect to insure on the higher end of the estimate.

How Do Homes End Up Underinsured?

Insurance professionals deal with this issue on a daily basis. Many homeowners, in an effort to reduce the cost of their insurance, request to insure their home for less than what an insurance company insists it would cost to completely rebuild it.

Furthermore, there are many insurers who are more than happy to insure your home for less than it may cost to rebuild. What do they have to lose? They get to charge a lower insurance premium (which makes the uneducated consumer happy and helps them sell a lot more insurance) and are certainly not on the hook to pay the additional cost to rebuild your home in the event of a total loss.

For the insurer it’s a “win-win” scenario. They get your money and don’t have to pay out any more than the policy limits if the worst occurs…a total loss.

For the insured it’s a “win-potential lose” scenario. If you don’t suffer a total loss, you save $100-$200 per year on your insurance costs. If you do suffer a total loss, you lose. Perhaps left with only enough to rebuild a fraction of the home you originally purchased.

Three Home Valuation Techniques

The reality is there are three basic “values” of an average home at any given time. Market value, actual cash value and replacement cost value.

Market Value: The market value of a home tends to be what most people are familiar with. This is the amount of money any one person or entity is willing to pay you for your home. This number may have dropped by 35 percent between 2007 and 2011.

Fortunately or unfortunately, depending on where a real estate market sits, insurance companies are not the slight bit interested in how much someone is willing to pay you on any given day for your home.

Imagine if your insurance premium was adjusted monthly based on projected sales in your neighborhood! Sounds great now, but you would have been unhappy as your premium increased month over month between 2000 and 2007.

Actual Cash Value (ACV): This is the current, DEPRECIATED, value of the tangible materials of which your home is constructed. Similar to a new car, the actual cash value of your home drops every year older it get, independent of its market value.

A roofing shingle bought for five cents in 2005 is worth little more than a penny today. Perform that calculation for every single piece of wood, brick and any other tangible item your home is made of and you’ll arrive at your home’s ACV.

It’s possible to purchase an ACV homeowner’s insurance policy – and the value for which to insure your home is completely up to you if you don’t have a mortgage. If it’s worth $100,000 and you chose to insure it for $20,000 because that’s all you care to get out of it in the event of a total loss, more power to you. Congratulations on owning outright.

However, if like most of us, you still have some years left on the mortgage, the bank will likely demand a replacement cost policy be issued for your home. As a mortgagee, the bank will want to protect its financial interest in the property.

Replacement Cost Value: This is the amount of coverage your insurer believes it would cost to completely rebuild your home from scratch in “today’s” money…both in materials and labor.

Also keep in mind that the replacement cost value of a home includes other costs. Johns points out that “some of the things a homeowner should consider are any improvements such as upgraded bathrooms, kitchens or other unique features to a home, local building codes and increases in construction costs.”

Other insurance professionals point out the cost to remove the debris remaining from your total loss and the costs for permits (city and county), as well as costs associated with procuring a new home loan. All things you might not have considered when calculating the cost to rebuild.

See: Replacement Cost vs Actual Cash Value

The Reality

There are a couple of things to keep in mind when it comes to properly insuring your home. First, your insurer expects you to be active in the process of insuring your home. This means a yearly review of your coverage at or before renewal. One hour per year may mean greater savings and less heartache over an inadequate policy.

The best way to be in control over how much you insure your home for is to own it outright and obtain an actual cash value policy for however much you think it’s worth. Until that time, your bank will likely require a replacement cost policy to insure their financial interest in your home and insurance companies will err on the side of caution to avoid being sued in the event your idea of the home’s value is inaccurate.

Finally, don’t put too much trust in an insurance company based on television and radio commercials. A smiling celebrity face reassuring you about how much a company cares for you is no consolation when you suffer a total loss and find out you are underinsured by several thousand dollars.

Remember, when dealing with insurance, we are dealing with large corporations out to make a profit. Constant television and radio commercials are expensive and require a lot of collected premium dollars to keep running. McDonalds runs ads about how healthy their food is. Just because something is on TV doesn’t mean it’s true.

Contact a local independent insurance agent to shop your rate with several companies to be certain you are getting the best coverage at the best price.

Tip: How much homeowner’s insurance do I need?