07/07/2025
𝗪𝗵𝘆 𝗰𝗮𝗻’𝘁 𝗜 𝗰𝗵𝗼𝗼𝘀𝗲 𝗺𝘆 𝗼𝘄𝗻 𝗹𝗶𝗺𝗶𝘁 𝗳𝗼𝗿 𝗮 𝗯𝘂𝗶𝗹𝗱𝗶𝗻𝗴?
This is a question we get asked all the time, so I wanted to take a moment to hopefully provide some insight:
The idea of "insurance to value" is a principle of insurance that does have a legitimate purpose, which is to stabilize insurance rates. If the policy pays on a replacement cost basis, agents and policyholders have always been required to insure buildings to their full replacement cost to value. In fact, most policies have provisions that reduce claim payments if the property is underinsured.
In the past, policyholders were less likely to be questioned about the limit they chose. This is because insurers often didn’t have the means or inclination to verify a building’s replacement cost. Underinsurance was usually only flagged in clear-cut cases, like an obviously low limit per square foot. Instead, the insurance companies relied on the underinsurance penalties to encourage compliance.
These days, insurers almost always require a replacement cost estimate to establish the limit 𝗯𝗲𝗳𝗼𝗿𝗲 a policy is purchased. Note that this estimated "replacement cost" should not be confused with "market value". The limit on the policy is not a reflection of what your home is worth, but rather what it would cost to replace. You could have a building that has a very low market value (due to location or other factors) and still have a high replacement cost. For instance, our office building, due to its solid brick construction, likely has a much higher replacement cost than its market value.
People often assume that the estimates include the land value, much like a traditional appraisal. They do not. They do, however, include the cost of debris removal, which would not be considered in a traditional appraisal.
Various estimators are available, and different insurers use different estimators. The estimates are either run by the insurer, or the agent is required to run the estimate and submit prior to binding. Sometimes it’s established at inspection.
I can see why some folks might think of this as a money grab, and in the cases where the estimates are exceedingly high I get it. But why should insurers be allowed to insist on insurance to value? Why can't we choose our limit? The reason relates to a principle of insurance called “adverse selection”.
Let’s assume most policyholders would prefer to carry a limit that is lower than replacement cost. This would mean that only the policyholders who are likely to have a loss would choose to carry higher limits. That is, the limits are “adversely selected” against the insurance company by the policyholder. This means the insurance company extends insurance coverage to an applicant whose actual risk is substantially higher than they had rated for. The resulting losses would be costly, as the insurer would have charged much more, or declined the risk altogether, had they been aware that those buildings were likely to suffer a loss. After all, a commercial building occupied by a dynamite factory is not the same risk as an office!
This can create a negative spiral:
• Premiums rise to cover higher expected claims.
• Even more low-risk customers leave.
• Risk concentration gets worse.
• Premiums rise again.
To combat the adverse selection problem, all insurance companies have a requirement that policyholders "insure to value". If everyone is following the same rules, it will result in lower rates overall.
I agree, though, that cost estimators vary wildly from company to company, and I don't like that there's not more flexibility there. But in all honesty, with cost of construction as high as it is, they probably aren't that far off even at the high end.
The problem we had after Hurricane Ida is that our area got a double whammy. They had triple-digit rate increases, and on top of that the companies that remained started heavily enforcing Insurance to Value. Since so many folks were underinsured (having not increased values since Katrina), they were hit extra hard due to the added cost of the increased limits.
If you have any questions about insurance to value, or other insurance questions, we are always happy to help!
Alan Case
President
