Ask the Adviser: Why should I insure my home for more than I can sell it for?

Have you ever been surprised when your property and casualty insurance agent tells you how much you should be insuring your home for? Did you ever respond to him or her with, “Why is it so much? I can’t even sell it for that!”

Invariably, in the decade that I was involved in property and casualty insurance as an agency owner, my clients always balked at the number I gave them when they asked me for a quote.

Why did this happen? What is the “correct” or the “right” amount for which you should have your home insured? Many clients feel it’s the amount they paid for the home. Others feel it’s related to the taxable value. But what is actually the right number?

The right number is the number that it will take in order to rebuild, repair or replace your home in the event you sustain a total loss.

If you think about it, that makes perfect sense. What difference does the amount you paid for your home five or 10 years ago make to your insurance company? What difference does it make that your county appraiser feels that your home is worth X dollars, unless you’re discussing your tax bill. When you buy an insurance policy, regardless of the type of insurance policy you buy, what you are really buying is fair and prompt claims service.

If you were to come home from work tomorrow afternoon, and find your home a pile of burning embers sitting on a slab, for what amount would you like your insurance company to indemnify you for the loss on what, for most people, is their most expensive asset? What you paid for it? Its taxable value? What you could’ve sold it for? No, no and no! You want to be made whole. You want your home replaced and rebuilt. You want the amount needed to pay the builder to replace your home, having enough left over to also replace your personal belongings, right?

In order for that to happen, your agent and the company or companies he or she represents will require that you insure your home for a minimum of 80% of its replacement cost. (This is not a universal rule, but 80% is a common coinsurance requirement.) What that means simply is if you have a $200,000 home, and you want losses you incur to be repaired at replacement value, you would need to be insured for a minimum of $160,000. If you chose a lesser amount, say for example, $150,000, and you incurred a $10,000 loss to your home, because you were not insured at 80%, but rather at 75%, you would only recover $7,500 for your $10,000 loss.

And here is the sad fact: The difference in premium dollars between insuring your home for $160,000 vs. $150,000 would be so small it would be irrelevant. Basically, pennies a day.

“But wait a minute,” you say, “Don’t agents just want to charge me more so they can earn a higher commission?” The answer to this myth is also a resounding no.

Often you hear commission-based agents are only looking out for themselves, so they will increase the insured amount so as to get a higher commission. The actual numbers will show you why this is a myth. Using the same example as earlier, a $160,000 insured amount would pay an average commission of 10%, or a one-time payment of $160.00. The commission for a $200,000 insured amount is a one-time payment of $200. So if you are going to believe agents will increase premiums just to enrich themselves at your expense, you have to believe agents would run the risks of losing your business altogether for a dollar or two a month of additional income. If your premiums were not competitive, you could simply buy your policy from another company.

So the next time your agent recommends an amount for which you should insure your property, and you think it is too high, thank him or her for looking out for your best interests, because that is what he or she is doing.

Kevin Lynch holds the Charles J. Zimmerman Chair in Life Insurance Education, at the American College for Financial Services, in Bryn Mawr, Pa. He spent more than four decades in financial services, including lending, property and casualty insurance, and life and health insurance.