Actionable data plays an essential role as policyholders choose the right amount of coverage to protect their homes in the event of a disaster. In today's tumultuous housing market, current, reliable information is more invaluable than ever as property insurers work to alert policyholders to changing variables that could increase the likelihood that their properties are underinsured.
Certainly underinsurance is no new problem in the property insurance industry. In past years, insurers frequently encountered difficulties creating replacement-cost estimates that adequately addressed properties' probabilistic risk. Only within the past decade have we been able to harness the power of enormous amounts of data containing construction rates and detailed structural information for millions of U.S. properties. Advances in analytical tools also enable us to drill down to specific zip codes so we can view local trends for common building materials and labor necessary to rebuild a structure. Thanks to these tools, we are now able to create a component-based estimate for a building that is based on costs being paid for actual claims in the area and supported by detailed construction market research.
Rising Reconstruction Costs
While the value at which a home can be bought or sold imploded during the past three years, the cost to rebuild that same home with like-kind-and-quality materials has continued to increase. Analysis of thousands of field surveys and millions of actual claim files and construction rates in all 50 states and the District of Columbia reveals that nationwide reconstruction costs increased 0.96 percent in 2009. As shown in below in Figure 1, Vermont, Arkansas, Texas, Oklahoma, and North Carolina experienced the highest increases in the overall cost to rebuild. Only Florida and Rhode Island reported decreases in reconstruction costs.
This growth appears anemic when compared to a 3.95-percent increase in 2008 and a 4.18-percent increase in 2007, but research shows that reconstruction costs jumped 16.22 percent since the housing market first began to plummet. Figure 2 illustrates the tremendous disproportion that currently exists between the U.S. median sales price and reconstruction costs. This research also demonstrates the amount of probabilistic risk many policyholders now face, especially the high number of homeowners who have opted to buy less insurance to cut expenses.
Under normal circumstances (an upward-trending economy), the market value of a property, including the land, is generally higher than the cost to reconstruct just the building. But market value and reconstruction costs are not tightly linked, and they do not have to move at the same speed or even in the same direction because they are affected by different factors. Reconstruction costs are influenced by the supply and demand of building materials and labor, while market value is influenced by the supply and demand of completed homes. In the current economy, land values and home values in some areas have deteriorated much more than construction costs. As a result, some homes' reconstruction costs are higher than their market value.
The following example provides a useful illustration: a four-bedroom, two-bath, 1,980-square-foot one-story home in Montpelier, Vt., is currently on sale for $224,000. According to an online replacement-cost estimator, however, it could cost as much as $323,400 to rebuild the structure. A homebuyer who decides to insure the structure at its sales price would have to pay as much as $99,000 out of his or her own pocket to rebuild, should a fire or storm destroy the structure.
Current technology gives underwriters and claim professionals the ability to access localized, up-to-date cost information for labor and materials as well as analytical tools that track critical trends in the construction and insurance industries. These provide valuable resources to explain the difference between market value and reconstruction costs and show policyholders the appropriate amount of coverage their properties need. This also increases transparency because policyholders can view detailed component-based estimates -- in other words, where each stick of lumber, gallon of paint, or hour of labor is accounted for in detail -- to ensure they are protected against any unforeseen risks.
It is uncertain when the housing market will rebound. The economy has lost significant ground, and it may take several years of sustained growth before a recovery takes place. It is reasonable to assume the market must correct in those areas where home values are currently less than reconstruction costs -- whether it be an increase in market values, a decrease in construction costs, or some combination of the two -- before the construction industry begins to produce more inventory. Experts predict this will take time.