For most people, a home is their most valuable and prized possession. As such, homeowners have a pretty good idea of what it’s worth, often based on their perception of current market value. Most insurers and agents are comfortable explaining why market value is not the same as a replacement cost estimate, but a property owner still may not be satisfied, particularly if a replacement cost estimate is higher than expected.
In such cases, it may be helpful to explain two unique factors that influence residential replacement cost estimates. First, properties typically cost more to replace than to build. Second, in most cases, the older the home, the more it costs to replace.
New construction vs. reconstruction
All reconstruction projects, regardless of the home’s age, may result in differences that increase costs compared with new construction. Most of the differences relate to economies of scale, site accessibility, and customer service.
- Economies of scale: Reconstruction contractors never know when the next job will start. That makes it difficult to plan projects, arrange work agreements with subcontractors, and buy materials in bulk. The one-off nature of insurance reconstruction work is a significant driver of increased reconstruction costs.
- Site accessibility: In insurance reconstruction environments, contractors often need to work around landscaping or nearby structures, making site access more difficult and costlier.
- Customer service: Because reconstruction contractors deal with homeowners who recently suffered a significant loss, they often employ a larger, well-trained staff to help homeowners through the process.
Research from Xactware, a Verisk Analytics company, shows that, on average, accessibility and customer service add 5 to 10 percent in labor costs to a reconstruction project, and the inability to plan ahead adds to both labor and materials costs.
Reconstruction of older homes
In addition to the standard differences between new and reconstruction costs, insurers and property owners need to consider other factors that influence replacement costs for older homes.
Residential reconstruction has changed significantly over the years as advances in building materials and construction techniques have increased efficiency and reduced costs. For example, homes built before 1920 likely contain custom-designed and crafted interior features, because commercial manufacturing of building materials wasn’t common at the time. Today, most interior finishes are available at local building supply stores.
The intent of replacement costs is to estimate the cost to rebuild a structure to its original state using the same materials. For homes built before 1920, this often means replicating custom interior features, which greatly adds to reconstruction costs compared with current building practices.
For older homes, an alternative to the actual replacement cost estimate is a functional replacement cost, which estimates the cost to replace the structure using current building techniques. Below are examples of advances in residential construction that explain how an estimate will differ using actual rather than functional replacement costs.
Today, most roof systems use pre-engineered wood trusses. Manufacturing plants assemble them according to each home’s specifications, typically using 2x4 materials. Before 1960, pre-engineered trusses weren’t available; the framing carpenter typically custom-built the roof system on-site using larger-dimensional lumber (2x6, 2x8, or 2x10). That method is commonly referred to as “stick building” the roof. The stick-built method is considerably more expensive than truss systems because it requires higher material and labor costs. For homes built before 1960, actual replacement cost estimates project costlier stick-built framing for roofing components; functional replacement cost estimates project the less expensive construction of a truss system.
Wall and roof sheathing
Today, homes are sheathed with a combination of plywood or oriented strand board (OSB, also commonly called wafer board) and insulated panels. Plywood and OSB provide the same structural value for sheathing walls and roofs; builders will often choose the material that’s more economical at the time of construction. Before 1940, plywood wasn’t available, so exterior walls and roofs were sheathed using 1x8 material installed in a diagonal pattern to provide structural support. The 1x8 sheathing is considerably more expensive than plywood because of higher material and installation costs. For homes built before 1940, actual replacement cost estimates factor in use of 1x8 materials for wall and roof sheathing; functional replacement cost estimates factor in plywood or OSB.
Most homes built before 1945 included interior finishes such as hardwood floors and walls of lath and plaster, which builders typically no longer use because of the high cost of labor and materials. Today, hardwood floors are typically installed only in higher-end homes. Walls in nearly all new homes use a gypsum board material (drywall or Sheetrock). Lath and plaster is still in use today, but in limited regions of the country or in high-end or historic homes. The actual replacement cost to rebuild walls in homes constructed in or before 1945 is typically higher than for homes built during or after 1946.
Those are just a few examples that demonstrate why replacement cost estimates for older homes are typically higher than newer homes. Differing homeowner preferences and insurer approaches affect the way each carrier addresses increased costs to replace structures.
As insurers compete to add and maintain policyholders, satisfying customer questions and concerns about their home’s replacement cost estimate may be a deciding factor.
Scott Amussen is vice president of property products for Verisk Insurance Solutions – Underwriting. He was an assistant vice president with Xactware’s 360Value®. He has a computer science degree from Brigham Young University and an M.B.A. from the University of Utah.
Addressing the year-built challenge
Actual replacement costs for older homes rely heavily on accurate year-built information to determine a reliable estimate. To develop the estimate using current building techniques and materials, the functional replacement cost estimate replaces the year built with the current year. 360Value® from Verisk Underwriting offers the functional replacement cost option for any property built before 1986, when almost 70 percent of housing in the United States was constructed. Below is the breakdown by year built for all housing units in the United States.
360Value uses Xactware technology and research to generate residential and commercial reconstruction costs based on extensive material and labor cost surveys of 430 regions in the United States, annual analysis of more than 3 million actual damage-repair estimates, and real-time feedback from tens of thousands of Xactimate® users in the field. Xactimate is a system for estimating the cost of repairs and reconstruction. 360Value allows users to tailor replacement cost calculations based on age, finishes, type of building materials and techniques, and reconstruction method selected (actual or functional).