STR replacement cost insurance with increased building costs

[John Underwood]

I just received my Foremost insurance policy for our STR Lake house.

We have replacement cost insurance, but the amount seems low in today's costs to rebuild. Our Lake lot is a good chunk of the value but still I wonder what happens if you have a total loss like a forest fire in the Gatlinburg area. I know some of you went through this.

Anyone else raised the value of the insured amount or would replacement costs still cover you, and it is the insurance company job to keep up with any premium adjustments on a replacement cost policy?

I have a Real Estate Club meeting tonight and my insurance broker is always there. I'll ask him too.

FYI - Avery is virtually speaking to our club tonight (21 March).  We have over 500 members, but we usually have over a hundred in person members and guests.

[Kyle Nolen]

John, I do insurance work in the East Tennessee area and have several clients in the Smokies.  I also hold a Certified Financial Planner™ designation with a specialty in insurance planning, so I thought I'd weigh-in on the conversation.  

As has been mentioned, most companies have software that helps us estimate replacement cost.  However, as has also been noted, it is important for your agent to be in-tune with what local builders are charging, as these software programs allow for different finish grade scales to be used.  For example, in one of my last quotes, a normal replacement scale estimated about $300,000 for rebuild.  However, because I knew what those homes were selling for and what builders were charging for new 3/3 construction (minus land and furnishings), I adjusted the finish grade to a more appropriate scale.  Doing so increased the calculation to $700,000.  That was an incredible difference, but more like what my client would actually experience if attempting to rebuild in today's environment.

On a side note, I think it's also prudent to speak to some of the other comments that have been made for the benefit of the group.  It is super important to understand terminology and other contract features.  

1)For example, comments have been made about "Umbrella Coverage."  This type of insurance is extremely important, but has nothing to do with replacement cost coverage or payout in the event of physical damage claims.  Instead, Umbrella protection is a tool used to purchase additional liability protection for claims involving personal injury or damage to property of others.  

2)Secondly, almost all STR replacement cost contracts that I've seen have a little-known or little-understood contractual "Co-Insurance" requirement. The Co-Insurance requirement is usually a minimum of 80% but some companies are higher. This clause is super-important and is standard language in almost all commercial insurance policies (STR are usually considered commercial). If it is not met, then your claim payout would be reduced by whatever proportional amount you are short in coverage plus your applicable deductible. Consider the following example. Let's say you have a cabin with a true replacement value of $1 Million. The 80% co-insurance provision, then, would require that the client carry a minimum of $800,000 dwelling coverage. If, however, the client only had their cabin insured for, say, $500,000, then they would be 37.5% "underinsured." ($300,000/$800,000=37.5%) Since this means the insurance company was only collecting premiums on a house that was "partially-insured," the company has grounds to reduce one's payout by a similar percentage. For example, let's say you had a kitchen fire that did $100,000 worth of damage. Even though this amount is less than the $500,000 of dwelling coverage mentioned above, the company would only pay $62,500 minus whatever deductible you would have. In the event of a total loss, the total payout in the example above would only be $312,500 ($500,000x62.5%=$312,500) minus your deductible. That kind of reduction can be devastating. Because of this, we recommend working with your agent at least on an annual basis to ensure that your policy is always in compliance with whatever scale your insurance company would use to set the co-insurance provision. Folks who had inadequate policies really got hurt during the PF/Gatlinburg fires a few years back, as many insurance companies invoked the co-insurance clause to limit their losses during that massive catastrophic event.

3)I have noticed that some folks are referencing their lot values and furnishings when referring to "replacement cost." That is a mistake. First of all, insurance policies do not insure the land. Secondly, STR policies have different categories of coverage that need to be considered. For example, the empty house is typically insured under "dwelling" or "building" categories. The furniture, appliances, and other furnishings are insured under the separate categories of either "personal property," "business personal property," or "contents." With this in mind, your agent can help you divide the total value of your property among these 3 categories (land, building, and contents) to make sure your policy has adequate limits for the building and furnishings respectively. Lastly, I'd also recommend adding or reviewing a 4th category that is often overlooked. That is "loss of rents" or "loss of business income." If you were to have a claim, you'd not only have the damaged home and/or items to be replaced, but you'd also lose out on the revenue your STR would have generated if it were still operational. This coverage is very cheap and can keep you solvent if you were depending on your asset's revenue to pay the mortgage.

Some of this you may already have known, but I thought it worth clarifying for the benefit of the group and anyone who didn't!