Replacement value is central to home insurance pricing. Here’s why

Rebuilding a property from the baseboards up after a fire, explosion, or extensive water damage is any homeowner’s worst nightmare.

Fortunately, insurance companies in Canada typically offer comprehensive plans that cover replacement value — the total cost of rebuilding a home, from timber to labour. Replacement value is the bedrock of home insurance premium calculations, governing the “building limit,” or total payout insurance companies are willing to give for replacing a home in the event of a total loss.

And as it turns out, replacement value has significant bearing on what you’ll pay for a home insurance policy.

“Under most packaged homeowners insurance policies, that building limit will have probably the single greatest impact upon how much the premium is going to be,” explains Stefan Tirschler, product and underwriting manager at Square One Insurance Services.

And a property’s replacement value ultimately depends on its characteristics: square footage, landscaping, even roofing materials. Here’s a peek at how insurance companies calculate replacement value – and how it can affect your premium.

How is replacement value calculated in the world of home insurance?

Most insurance companies use specialized software to calculate a home’s replacement value. Tirschler says whenever insurance companies ask a homeowner for details about their home’s age, square footage, or flooring, the answers are fed into this software to determine replacement value. This is far cheaper than sending in appraisers and happens to be pretty accurate.

“When you look at residential construction, it does become reasonably uniform,” Tirschler says. “When you’re choosing between different types of flooring and different types of windows, that’ll edit the cost a little bit, but it doesn’t necessarily change it a whole lot.”

But this software isn’t perfect — and Tirschler says many insurance policies offer guaranteed replacement cost coverage to compensate for an underestimate of a house’s replacement value. This is an endorsement, however, and must be purchased on top of your regular base policy. “If our estimate wasn’t quite right, don’t worry about it,” Tirschler says. “We will pay whatever it takes to rebuild your house.”

How does replacement value affect home insurance premiums?

Everything from new building materials to local labour costs are calculated by assessors or, more often, assessment software, and the final total forms a large portion of the premium you pay. How a house is constructed can change its replacement value — and the cost of a particular building material or finish is only part of the equation.

Take tile roofing, for instance: a material that is far more expensive than asphalt shingles. Tirschler says it might actually lower a home’s replacement value. Why? Because tile roofs can significantly lower the risk of hail or wildfire damage. In contrast, wood siding may be a lot less expensive than other types of materials but it burns very easily.

It may be easy to assume that the sheer size of a home is what matters the most to replacement value, but Tirschler disagrees. “What I would say to customers is: what about your home is actually special?” he said. Perhaps that’s a hardwood floor, custom landscaping, or a new deck. “That’s where cost differences really start to come into play.”

Replacement value and home renovations/upgrades

Insurance companies may calculate replacement value when signing up a new policyholder, but the reality is homes change in value all the time. Maybe a homeowner wants to renovate. Tirschler says that’s fine, so long as homeowners keep their insurance companies up to speed on everything they’re doing. If the replacement value rises beyond what a homeowner agreed to when they signed their insurance policy, it might not be covered.

The rules around how much value a homeowner can add to their house before informing their insurance provider, or their deadline to do so, varies by company. If a homeowner buys guaranteed replacement cost coverage and doesn’t tell their insurance company about upgrades, Tirschler says the insurance company might pull it – leaving them with whatever the appraisement software calculated in the first place.

The golden rule of replacement value

Premiums, as with anything in the insurance industry, are affected by a lot of different variables: a homeowner’s history of claims, the insurance company they’re signing with, even the geographical location of the home in question. But replacement value is still one of the most important factors to consider when hunting for the lowest home insurance rates possible.

Tirschler has some advice for anyone who wants to renovate or alter their home after signing off on a new plan. “The safest way to go [about it] is to talk to your insurance provider before [the renovations] start,” Tirschler says. “And if you’ve looped them in during the planning phase, they can also let you know about which upgrades will have the greatest cost impact on your insurance premium.”