Why is my building limit more than I paid for the building?

A common question when giving a quotation on insurance is when a client may ask “You tell me the building coverage is $385,000, but I only paid $265,000 for the property and that’s including the land. Why?!” This is a common question and we will provide a short answer and a longer answer

The Short Answer

The short answer is that the sale price and the cost to rebuild your property if there were a total loss, are not related. Take this for example: a home in Oshawa could cost $200,000 to purchase and $400,000 to rebuild if there was a total loss. Home prices in Oshawa are generally less than in Etobicoke. If that exact home was built in Etobicoke, the cost to build that house would be very close to $400,000, but may cost upwards of $700,000 to purchase.

The Longer Answer

The market value for your home has no bearing on your home insurance and is simply the price someone is willing to pay for your property. When trying to arrive at an insurable value for your home, insurance brokers are equipped with an evaluation program which calculates the cost to rebuild your home in today’s dollars. When calculating the cost to rebuild a few factors need to be considered such as:

  • The cost in material to rebuild today: if your house was built 50 years ago, the material to rebuild then was much cheaper than it is today as inflation increases prices year after year.
  • The cost in labour to rebuild: just as above if your house was built 50 years ago labour was less expensive then it is today.
  • Demolition and debris removal: the cost of removing damaged and undamaged portions of the house and the cost to remove the debris from the property.
  • The increased cost in material: when your home was first built, many times it was developed at the same time as other houses in the area. The developer would have purchased all materials in bulk at discounted pricing. Whereas if only one house to were to be built it would be more expensive per material
  • The increased cost in labour: the same concept as above when a developer builds they subcontract out trades, the more work that is being completed the more favourable the pricing is to a certain point.

What is Co-Insurance? & Insuring Less than Your Evaluation

Some clients may ask about insuring less than the evaluation of their property because they feel that the evaluation is too much and in an effort to save money on insurance. Although we always will suggest to be insured to 100% of the evaluation, in some cases you can be insured to less without being penalized. Typically, personal home insurance policies will always require you be insured to 100% of the evaluation. In some commercial policies there will be a co-insurance clause which stipulates a percentage they must be insured to which is either 80%, 90% or 100%. If a policy has an 80% co-insurance clause this means that they can insure for only 80% of the assessed value without being penalized. For example: you have a building evaluated at $100,000 and decide to insure it for $80,000. If a full loss occurs you will only receive $80,000.

What Happens when you insure for less than the co-insurance value?

When you insure a building less than the evaluated value you could be hit with a co-insurance penalty in the event of a partial loss. Take for example a building evaluated at $100,000 in rebuilding cost. With an 80% co-insurance clause if you decide to insure for $50,000 and a full loss occurs you will receive $50,000. If a loss for $20,000 occurs with a $1,000 deductible you will be penalized by a co-insurance penalty and the payout will be calculated as below:

calculation for co-insurance

Because you insured for only 62.5% of what you should have insured the building for ($80,000) you will be penalized in the event of a partial loss and only receive a partial amount of the claim. Which is why we always recommend to insure to 100% of the evaluation. This is why when getting quotes on home insurance or property insurance to always check the building values on the quotation.

How do I know what I should actually be insured for?

Ultimately that decision is up to you, it is always best to hire a reputable property inspection company to conduct a property appraisal. A property appraisal from a reputable company will evaluate your house or building and determine an accurate replacement cost for your building in today’s dollars.