Mortgage Value vs. Insurance Replacement Cost

One of the biggest questions insureds have regarding Property insurance revolves around the amount of insurance to place on their property. When purchasing a building, the mortgage company requires the property owner to obtain insurance prior to closing. Most building owners assume the amount of building coverage will be equal to the amount they paid for their property. This is incorrect in some cases.

There are different methods to determine the value of a building. Market value is the price paid for your building. Replacement cost is the price or cost it will take to rebuild your building in the same spot, same size and same quality of construction, at today’s costs. Insurance companies use the replacement cost valuation. These can be two completely different numbers.

For example, a building purchased in a depressed city neighborhood, may have a market value of $1,200,000. The exact building, located in a nice suburb, may have a market price of $1,600,000; however, the cost to rebuild the property after a loss would be the same in either location. The insurance company is looking to insure the building for the full replacement value, not the current market value.

Here is another different example. If an 18 unit / 2 story / brick building / 12,000 sq ft had a replacement cost of $1,500,000 and you had a mortgage of $1,000,000 and used the mortgage value / market value as a basis for building insurance, the following would happen:

  • If there was a total claim and the insured went to rebuild, they would have an out of pocket expense of $500,000 as their policy would pay only $1,000,000.
  • If there was a partial claim, $100,000, the insurance carrier could pay based on a co-insurance penalty, $66,000, as the building was not insured to the correct replacement cost value. ($1M mortgage vs. $1.5M Replacement Cost = 66% of replacement cost value)

As you can see the property owner did not insure the building correctly and could suffer a major financial loss.

For insurance purposes, you should insure your property to 100% of its replacement cost. This will ensure the ability to rebuild the entire building (of like kind and quality – not including code changes which can be insured with Building Ordinance coverage), the way it is now, in the event of a total loss. One thing to remember, you’re not insuring the land so leave this out of the replacement cost valuation of the property.

Let us help you with your customers insurance needs so they do not have a problem with a claim at the time of a loss.

If you should have any questions or concerns, please do not hesitate to call me in the office or on my cell phone at (201) 213-6590.