Before the 1994 Northridge Earthquake most insurance companies in the state of California offered Guaranteed Home Replacement Cost coverage. This meant that if certain conditions were satisfied, your home would be rebuilt (using materials that were of like kind and quality), no matter what the cost was. If your home was insured for $250,000. 00, but it cost $500,000.00 to rebuild it, your house was rebuilt at that cost.

Today, some 21 years after the earthquake most insurance companies offer Replacement Cost Extension. What is Replacement Cost Extension? Replacement Cost Extension takes the amount of coverage you have purchased to insure your house and extends that limit by a given percentage. For example, your house is insured for $100,000.00 and your homeowners insurance policy has Replacement Cost Extension 150%. The insurance company will extend the amount of coverage that you purchased by 150%. Your house would have a maximum cap of $150,000.00 ($100,000.00 x 150%).

This came about because prior to the quake, many insurance agents would under value the replacement cost of a house to make their quoted price more competitive. The actual replacement cost of the house might be $250,000.00, but they would insure it for $200,000.00. They would then state that $250,000.00 was not necessary because the policy holder had Guaranteed Home Replacement Cost coverage. Ultimately this burned the insurance company and nearly put companies like 21st Century out of business. 21st Century no longer offers homeowners insurance that is underwritten by them.

Why? The insurance company was not receiving the full amount of premium necessary to underwrite the risk. Their actuaries had calculated the cost to rebuild a 1,500 square foot home in the San Fernando Valley. The actuaries then based the premium that they charged on those calculations. When the agent under sold the replacement value of the home, the insurance company did not collect the right amount of premium to support the calculations of their actuaries. The insurance company essentially received a double whammy. They had to pay more, to rebuild the home, then their original calculations supported (as building costs were driven up by supply and demand). And, they did not collect enough premium to rebuild the house under normal conditions because their insurance agent undervalued the replacement cost to offer a more competitive price.

In an attempt to keep their agents honest, insurance companies decided to put limits (or ceilings) on the total dollar amount that the company would pay out to rebuild a home. It first started with Farmers, State Farm and Allstate the companies whose agents were the biggest offenders. It later carried over to most of the remaining insurance companies. Why should they give away more than their competitors.

Today, Farmers sells a 125% Replacement Cost Extension, State Farm a 120% Replacement Cost Extension and Allstate no longer sells homeowners insurance in the state of California. Think of that the next time you hear an commercial. My insurance companies, (Mercury, Safeco and Travelers) all have a 150% replacement cost extension coverage. A much better value for your dollar.



This article(s) represents the views and opinions of Garrett Parkinson and not the Insurance Companies that he represents or illustrates in his articles.