The cost of rebuilding: Navigating coverage challenges in shifting markets

The cost of rebuilding: Navigating coverage challenges in shifting markets | Insurance Business Canada

Property

The cost of rebuilding: Navigating coverage challenges in shifting markets

How to master replacement costs in today’s property market

Property

By
Nicole Panteloucos

This article was produced in partnership with Davies.

Lisa Carter (pictured), associate vice president of Canadian operations – Risk Services, Davies, spoke with Insurance Business about the critical need for precise replacement cost calculations in property insurance. Carter explained how replacement costs differ from market values, emphasized key factors in calculating replacement costs, and addressed the challenges posed by pandemic-related disruptions and hyper-inflation in maintaining accurate property coverage.

Insurance Business: How do you define replacement costs in the context of property insurance?

Carter: In property insurance, replacement cost refers to the amount specified by the broker on the policy to cover the cost of rebuilding a dwelling, building, or structure in the event of a total loss. Unlike market value, which can fluctuate based on various factors, replacement cost is focused solely on the expense of reconstructing the structure with similar materials and quality, excluding land value.

Essentially, it’s about “putting the insured back to pre-loss position.” For instance, if a house is destroyed by a fire, the insurance would cover the cost to rebuild the house, as well as additional expenses like contents and temporary living arrangements. It’s important for policyholders to recognize that replacement cost and market value are not always aligned, and understanding this difference is crucial in ensuring adequate coverage.

IB: What factors are typically considered when calculating the replacement costs for a property?

Carter: That depends on what type of structure is being replaced. Key factors include the size of the building or dwelling, construction materials, foundation type, and the roofing style and finish.

Policyholders need to be aware that, depending on the location, site access, zoning bylaws, or permitting, there are always several other costs associated outside of just the rebuild materials and labor costs. One of the largest expenses can be debris removal. Once a building or dwelling is damaged, the debris must be cleared and removed from the site, which can be quite extensive depending on the scope of the loss or simply the size of the structure.

IB: What challenges do insurance companies face when calculating accurate replacement costs for properties?

Carter: The primary challenge for underwriters and producers in determining accurate replacement costs is often the lack of detailed information. Brokers usually receive the purchase price of a building or dwelling, which does not reflect the true rebuild cost, as land value is not included. To accurately calculate rebuild costs, underwriters must effectively use industry tools and consider various factors. For instance, a custom-built home may have lower costs due to its rural location, or DIY labor, which can differ significantly from standard construction rates and require adjustments for additional expenses like debris removal and permits.

At Davies, we employ industry-standard tools and have expertise in construction classifications. We verify square footage and occupancy use and collect all relevant data to confidently produce an accurate replacement cost for the structure.

IB: What are some common signs that a policyholder’s property might be under-insured?

Carter: This is a really good question. Since insurance policies are issued annually, any under-insured buildings can and should be identified by the broker on record and rectified before renewal. Common signs of under-insurance include significant increases in property values, changes in construction costs, or recent property improvements that haven’t been accounted for in the policy.

Given the current economic climate with rising interest rates and tax hikes, consumers should be prepared for increases in their premiums. No-one wants to be under-insured, as it defeats the purpose of having insurance to adequately protect one’s assets.

IB: Did the pandemic have any impact on replacement costs and property insurance?

Carter: The pandemic brought global unease and uncertainty, marked by supply chain disruptions, labor shortages, and nearly three years of hyper-inflation. Housing prices soared, commercial buildings sat vacant, and vehicles were unused as people worked from home. Business owners employed hedging strategies to offset rising costs and limit losses. As a loss control and risk mitigation company, we saw a significant spike in requests for building valuations from our insurance partners, a trend that continues post-pandemic.

IB: How are insurance policies being adjusted to account for hyper-inflation and its impact on replacement costs?

Carter: I am confident that insurance companies continuously strive to keep replacement costs accurate and up-to-date, as these figures directly impact premium income, a key revenue source for insurers. A major challenge is that many insurers offer guaranteed replacement coverage, obligating them to cover the full replacement cost regardless of the policy’s coverage limit. This issue is likely to persist, with insurers relying heavily on data from claims and loss control experts to accurately account for factors such as hyper-inflation.