"The total value that a property should be insured for goes over and above a brand-new construction cost alone."
Beware of outdated replacement cost estimates when choosing home insurance
Home insurance is a balance between minimising the cost of the insurance premiums paid and maximising the peace of mind that comes with knowing you’re adequately insured. Too often home owners focus only on the premium and are not even sure how a replacement cost estimate is calculated. A little knowledge goes a long way, as there are often associated reconstruction costs that have been overlooked. It’s important to understand the dangers of outdated replacement cost estimates and the breakup of the estimate itself.
Firstly, a replacement cost estimate (RCE) report is an estimate of the cost to replace a particular building in today’s economic climate. Of course the economic climate is not static, so the cost to build two identical properties over time varies based on a multitude of factors such as fluctuating material and labour. A home owner could be forgiven for estimating the cost to build a brand-new home on their block based on current costs advertised for project homes or the latest display homes at their local display centre. However, there are costs over and above the construction of a new house that must be included in a full replacement cost estimate. These include, but are not limited to:
1. The demolition and removal of the remainder of the original structure – a house destroyed by fire, for example, will not be left neatly packed away in a skip bin. There will be costs associated with removing and clearing the debris, which could include hazardous materials (like asbestos) if the property is of a certain age.
2. The cost of constructing the new building based on current planning constraints and building codes – what is built on the block at the present time may not necessarily comply with the current building codes if it were to be reconstructed. The property may require repositioning on the block, or it could have to be rebuilt subject to BASIX requirements.
3. Consultants and preliminaries fees – these include architects’ fees, costs associated with the development application and the like.
Additionally, you’ll need to consider cost escalations associated with the time it takes for planning, design and documentation, the calling of tenders and tender evaluation as well as the construction fit out period itself.
As you can see, the total value that a property should be insured for goes over and above a brand-new construction cost alone.
The risk of being underinsured exposes the home owner to significant losses in the event of a disaster. Even if the property only requires partial reconstruction, it’s possible to be out of pocket when the insurance company does not release the total insured value for the property.
A replacement cost estimate also works in reverse to ensure that if the replacement value of a building is overstated, it can be brought back in line with an appropriate current replacement cost to minimise the insurance premiums. Nobody wants to pay more than is necessary, and an RCE will identify if this is the case.
It comes back to a balance between ensuring the premiums are not based on an overstated replacement value, and confidence that you’ll not be out of pocket should the worst happen. A replacement cost estimate is the best tool to ensure the balance is achieved.
Mike Mortlock is a director of MCG Quantity Surveyors specialising in tax depreciation deductions for property investors.