A recent post, Insurance Agents and Determining Coverage Limits for Buildings, generated a number of very interesting comments about the differences between Replacement Cost Value of a building and the Reconstruction Value of a building. There is a difference between the two values and it is a big issue.

A.W. Hooker posted an article soliciting it services, Replacement or Reconstruction Cost Estimate, which discusses the difference and explains the significance of insuring to value and obtaining coverages which reflect reconstruction costs rather than replacement cost values when deciding on policy limits and coverages for structures:


How do insurance companies calculate the replacement cost?

There is no standard method used by insurance companies but most often a construction cost manual such as Marshall & Swift will be referenced for the unit cost per square foot of a similar type of building and multiplied by the area of the subject building.

Why is this a flawed way of calculating the replacement cost?

Because it is theoretical replacement with a similar type of building and not an actual reconstruction cost evaluation, which includes for all costs associated with reconstructing a building at today’s standards and codes. Other costs are not considered with replacement cost, such as demolition of the existing destroyed building. While replacement cost is merely the cost to replace the building using the same as or far as possible the same material and design as what exists.

When is a replacement cost appropriate, when is a reconstruction cost appropriate?

For many simple or standard types of buildings the replacement cost taken from a cost manual may be appropriate. However if there is any non-typical or unique characteristics to the property it will likely not be appropriate. For any special purpose property or special use property only a detailed reconstruction cost estimate prepared by a Quantity Surveyor will properly account for all the unique characteristics present.

In many cases, the replacement cost calculated from the ‘black book’ value will not be enough to cover the costs to rebuild the property. Should a loss occur, the owner would be out of pocket for rebuilding expenses over and above the ‘black book’ value. It is recommended that in all cases, a reconstruction cost estimate be used, particularly when the property is used for commercial purposes.

What sort of rebuilding expenses are not taken into consideration from the ‘black book’ value?

Demolition and clearance of the site, shoring up of neighbouring buildings, reinstatement of any non-structure components of the site (such as a parking lot, landscaping or below grade services) allowance for the escalation of the cost of labour and materials in the future, permit fees, and any premiums associated with construction for the property’s geographic area.

The ‘black book’ value also does not take into consideration that should your property need to be rebuilt, it would have to be built to be compliant with the current building code, which could have a serious impact on the design and materials you must use to rebuild. A Replacement Cost Estimate will only cover the cost to replace the building with one of comparable size, utility and materials. For example, it would not take into account that your new building will require an elevator (where a narrow staircase previously sufficed).

What are the other considerations that will be taken into account for a Reconstruction Estimate?

Heritage components, current building codes, construction standards, accessibility, building material availability, etc,

The Massachusetts Association of Insurance Agents held a seminar on the topic. The PowerPoint presentation, Replacement Cost v Reconstruction Cost v. Total Component Valuations: Is the Client Covered Effectively? provides an excellent discussion of policy coverage terms causing gaps in coverage. The author noted that the primary problem for the agent is found in the rules to determine valuations, policy limits, and policy language. The presentation warns through numerous examples that replacement cost values may leave the policyholder with significant out of pocket expenses.

The problems of properly insuring a structure with values that do not leave the policyholder with gaps of coverage and for limits sufficient to reconstruct are complex. I find it amusing that judges, not trained in the nuisances of insurance, write so many opinions that the policyholder is in the best position to make this analysis. Really? If agents cannot even figure out which values to use and have to be taught to understand the potential gaps of coverage, how can a uneducated consumer be in a better position?

Positive Thought For The Day

“The function of education is to teach one to think intensively and to think critically. Intelligence plus character – that is the goal of true education.”
—Malcom X

  • John Nixon

    Real estate appraisers typically licenses the Marshall & Swift MVS Book: I always heard it referred to as the “brown book”, not black.) The equivalent software would be SwiftEstimator and Commercial Estimator. When appraiser shows credentials as “Marshall & Swift Certified”, this is what that training covers – unrelated to insurance. This is the “New Construction” based tool set. While not used for insurance anymore (maybe 20 years ago), the book might still be referenced for some items (tanks).

    Appraisers also use some free on-line calculators for the cost approach section of their market value analysis. All the ones I’ve researched are new construction based tools, not for insurance.

    The “quantity surveyor” can use the segmented method. This allows these professionals to build a building from scratch: no internal model to tell them how many 2x4s or concrete, how many labor hours, or unit costs of all factors. This might be needed for unique structures with no statistical base from which to build a model (stadium, or historic structure). These appraisers could add in for insurance related contingencies, but you’d have to tell them in the scope of work.

    Insurance carriers license different products from another division of the same company (Marshall & Swift/Boeckh): RCT for residential, and BVS for commercial/agricultural. There is no book version of these products. These are the “reconstruction” based tools.

    Competing products from 360-Value and e2Value use the same interface for commercial and residential; no books for either. Bluebook has a tool for residential.
    There are differences between residential and commercial for line items like demolition and debris removal based on how coverage is written. For commercial, parking lots and landscaping aren’t included in the building replacement cost estimate, foundations are optional (recommended).

    The PowerPoint from MassAgents does a very good job of highlighting coverage issues.
    Software can address national building codes, but they don’t do local codes/zoning.
    If the policyholder knows that they have a “grandfathered” building code issue (need to add sprinklers, elevators, historic wallpaper, ADA issues, hurricane glass/doors), these need to be reviewed relative to coverage extensions – sublimits can be increased, but the underwriters will need to know why.

    Asbestos removal was mentioned as a cost driver for debris removal. For commercial, this is a separate exclusion/limit. Exposures need to be discussed with underwriters.

  • Frank Lombard

    You are failing to mention the Replacement Cost provisions of most homeowner insurance policies base REQUIRED amounts of insurance on the current cost to build a structure prior to a loss. Reconstruction Cost is an after the loss estimate based on worst case scenario conditions. Insurers are requiring consumers to purchase inflated amounts of insurance which seems most unfair to me.

    You also fail to mention most insurers offer policyholders endorsements at a nominal cost to cover any actual difference between the Replacement Cost and the Reconstruction Cost.

    The MAIA seminar failed to refer agents to the HO-3 policy terms and rate/rule filings with the Division of Insurance which they all should be familiar with. These terms and rules refer to REQUIRED amounts of insurance based on Replacement Cost. The term Reconstruction Cost does not appear anywhere in the policy. To REQUIRE policyholders to purchase amounts of insurance based on the significantly greater Reconstruction Cost is a deceptive practice.

    This seminar also failed to address the endorsements available to consumers at a nominal cost to cover any potential difference between the estimated Replacement Cost and the worst case scenario Reconstruction Cost. Agents know or should know of their availability and make sure they are offered to their clients as an alternative to purchasing inflated amounts of insurance.

    It seems important to point that out.

    • Chip Merlin

      Thanks for the comment. What endorsements are you referring to?

      • Frank Lombard

        ISO calls these endorsements-Specified Additional Amounts of Insurance, other companies call them Extended, Enhanced or Guaranteed Replacement Cost Endorsements. In each case, in exchange for purchasing an amount of insurance equal to 100% of the Dwelling Replacement Cost (the basic policy requires only 80%) and a nominal additional premium, additional amounts of insurance are provided should a loss exceed the limit shown on the declaration page. Additional limits of 25%, 50% or unlimited (Guaranteed Replacement Cost) are generally available.

        Insurers, however, are disregarding Replacement Cost guidelines and wrongfully REQUIRING policyholders to purchase the inflated Reconstruction Cost limits.

        Insurers and their agents need to be called on that.

        • John Nixon

          I wouldn’t characterize “reconstruction” as worst case, but it is an estimate to rebuild rather than build new. I envision “worst case” as having to rebuild in a post-CAT environment with associated short-term inflation of labor, material, and equipment prices. I’d want the cushion from the Extended/Enhance endorsements for CAT-related and other unforeseen contingencies rather than relying on them to cover the gap between a new construction based cost estimate and reconstruction.

          For my clients, I will continue to recommend they report the best estimate of cost to rebuild, not new construction. This aligns with advice from State DOIs and carriers.
          By submitting current values, accompanied by detailed supporting documentation, they’re then in the most favorable position to attract more competition and negotiate for best terms and pricing.

          What advantage do you think can be gained by arguing with carriers on the appropriate valuation basis? Assuming you could get underwriters to (knowingly) make an exception to their internal guidelines and accept a value below 100% estimated reconstruction cost for a premium basis, would you expect no offsetting rate impact? Even with endorsements (short of unlimited GRC) wouldn’t the maximum potential recovery be reduced?

          Is unlimited GRC available in the US homeowners market anymore?
          If it is, can you control what value is used when that option is offered?

          • Frank Lombard

            Most insurers utilize software provided by CoreLogic (formerly MSB) to generate the Reconstruction Cost valuations used to determine required amounts of insurance. This “Insurance to Value” concept assumes the “worst case scenario”, their words not mine. I trust you would agree their algorithms utilize data from catastrophic events.

            I understand and accept your recommendations to your clients but the practice I question is the reference in the policy terms of millions of Americans. The policy terms state the required amounts of insurance will be based on the Replacement Cost of the structure, the cost to build “prior to a loss”. The policies state required amounts of insurance to qualify for Replacement Cost coverage are based on the cost to build “prior to a loss”. It seems to me if insurers intended to base required amounts of insurance on the Reconstruction Cost, a significantly greater cost to rebuild following a loss, they would have said that in the policy and their rate filings.

            The question I raise is why the deception? If you are going to require Reconstruction Cost, say so. Don’t say Replacement in the policy and then slip in a Reconstruction Cost valuation as though they mean the same thing.

            You are recommending a Reconstruction Cost limit to your clients; I’m referring to insurers using Reconstruction Cost to determine the “required” amount of insurance, that’s a big difference.

            I’m not asking underwriters to make an exception, I’m asking underwriters to follow the rules they print in their policy forms and rate filings.

            Guaranteed Replacement Cost is still available in my part of the country and if it’s not in yours, I would have to ask why not? Do you feel this risk is better retained by homeowners or assumed by the insurance industry?

          • John Nixon

            At one time I was head of MSB’s Commercial Solutions Group, so I have some familiarity with those products, and their competitors’.
            To the best of my knowledge, none of the insurance RC calculators use a “worst case scenario” that would include temporary post-CAT spikes in labor and material costs. I’m not aware of any collateral that used that phrase, but it’s possible, and if I found it, I’d reach out to their current product management leaders to correct it.
            Yes, local cost data collection continues during post-CAT periods. However, the research teams have methods to mute the short-term spikes for the RC estimating tools. If they didn’t, you’d see localized spikes in RC estimates from quarter to quarter, and I’ve seen no evidence of this. I believe there are software updates for claims use that do incorporate the spikes, but this isn’t my domain.
            I can’t answer your question about why the policy forms don’t change wording from “replacement cost” to some other term. However, I’ve never been in an internal policy wording discussion where “deception”, or anything like it, was an objective. If you have suggested improvements, you can reach out to ISO and AAIS.
            If you were successful, I wouldn’t expect a premium change, it would come with a corresponding adjustment to the rate.
            I’ve lived in several states and I’ve never had GRC offered on my homeowners. Maybe on newer, higher valued homes, with enough premium to support on-site inspections and appraisals, the option might be available (I’ll ask). No carrier in CA asked me for value, they all just ran me through RC questionnaire and quoted both limit and premium – I think this approach has merits. I think it would be foolish to offer GRC without bringing the valuation in-house as part of the underwriting process.

          • Frank Lombard

            Maybe there is another word for it, John, but when the policy terms, underwriting rules and rate filings refer to required limits of 80% of the Replacement Cost and insurers then require limits of 100% of the Reconstruction Cost, I find it difficult to describe it in another way.

            When the policy forms indicate the replacement cost of the structure will be determined “prior to the loss” and insurers then use the significantly higher structural rebuilding costs “following a loss”, that seems “misleading” or deceptive to me. Those values are not the same.

            I submit there is nothing foolish about insurers offering GRC. Who knows what conditions will exist “following a loss”? Post –loss conditions could have little impact on rebuilding costs or a significant impact. Is it fair to require insurance consumers to purchase coverage based on unpredictable potential worst case scenario events or does it make sense to base premiums on the more accurate predictable “prior to any loss” construction costs?

            Consumers now have a choice; purchase Replacement Cost limits and optional endorsements at nominal cost to extend coverage to cover potential additional Reconstruction Costs- Extended, Enhanced or GRC. But insurers often don’t offer that choice; they simply require everyone to purchase higher Reconstruction Cost limits. To me, that just does not seem fair.

            I can’t explain why you were never offered these enhanced endorsements. The only explanation I have is you are already paying for the higher Reconstruction Cost limits and these endorsements would only reduce your premium. Insurers and their agents are not always forthcoming with ways to reduce your premium. The emphasis is on generating more premium and commission income, not less.

  • Andy Baker

    Without consideration of premium cost, I have come to believe the coverage amount should be the point its cheaper to tear down and rebuild instead of repair.

    I write a lot of estimates on flood claims in litigation and also prepare a reconstruction cost valuation on them using MSB RCT. On more than one occasion, my estimate to repair was substantially higher than the reconstruction valuation leaving me having to justify my estimate, which wasnt a problem

    Valuation programs work the same as estimating software, it only includes costs for typical repair steps. A home with foundation damage, to the point it requires slab/footer replacement is not uncommon. But its repair steps are not considered typical and therefore not factored into the valuation.

    Slab replacement requires the home to be separated from the foundation, lifted to a height allowing slab replacement, and lowered back down onto the new slab. These steps are not included by MSB RCT and explained why their valuation were often lower than my estimate of repair.

    • Frank Lombard

      Notwithstanding the dwelling flood policy Replacement Cost loss settlement provisions, I find your comments interesting. I also wanted to point out the “Replacement Cost” value is supposed to be determined “immediately before the loss” (V.1a(2)).

      The MSB RCT valuation estimates the Reconstruction Cost “following the loss”. These valuations are often 30-50% greater than the actual Replacement Cost and I suspect homeowners are often unfairly penalized for non-compliance with the replacement cost requirements as the calculations are made using incorrect values.

      In your experience, would you agree with that?

      • Andy Baker

        It depends on the type of damage, from an NFIP coverage perspective, RCT is closer in true contractor repair costs then most other valuation platforms which tend to be on the low side.

        Estimating and valuation software calculate costs on what I refer to as a lowest common denominator system, if the repair step is not common to all similar repairs, the cost or value is not included. Flood damage contains a lot of non-typical steps versus damage repair from other perils.

        I look at valuations and estimates different than most people in the industry, they are not estimates or valuations for the cost of repair, they are estimates and valuations for the cost a contractor would charge. It may sound insignificant, but it’s not.

        If you have 10 contractors giving an estimate for repair on the exact same job, all 10 estimates are going to be different. Xactimate discusses this in several of their white papers and state it is typical to see a 50% difference between the average cost and the high and low bid. As a contractor for over twenty years I know that to be accurate from a real world standpoint as well.

        The swing in repair costs does not mean one contractor is way too high and the other is way too low; overhead and other factors differ and therefore costs do as well. Market forces determine whether a contractors price is accurate, if the job is under bid the contractor loses money, overbid and they don’t get the job.

        Valuation and estimating software use an average price but the insured is not bound to that average. I can make a legitimate argument for 50% above or below that valuation. Imo none of them are a gold standard that the carriers make them out to be.

        • Frank Lombard

          I accept repair estimates “following a loss” can be all over the place but my question is “How do you determine the Replacement Cost of the structure “immediately before the loss”? Don’t you need that valuation to determine compliance with co-insurance requirements?

          Exactimate and MSB RCT estimate reconstruction costs “following a loss”. It would seem improper to use the higher Reconstruction Cost valuation when the insured is only required to maintain 80% of the Replacement Cost- the current cost to build prior to a loss.

          • Chip Merlin


            Xactimate does have new cost pricing. Pricing for how much it costs to build a home new. It is usually materially less than the repair costs pricing after a loss.

          • Frank Lombard

            CoreLogic (formerly MSB) markets “cost new” software too (SwiftEstimator), probably similar to Xactimate. But the license agreement to use this portion of the software prohibits it’s use for “insurance purposes”. I can share that with you.

            Both of these software providers offer good data but both utilize “following the loss” rebuilding costs while the policies and rate filings of the insurers still base required amounts of insurance on “prior to a loss” cost new construction costs.

            Insurers changed the valuation terms, from cost new to reconstruction cost, but never changed their policy terms or rate filings. As a result, insurance consumers, most likely you as well, are being “required” to purchase an inflated amount of insurance and pay “billions” of dollars more EVERY year than required by their policy’s terms.

            Would you consider that “fair”?

          • Chip Merlin


            Why not required, why wouldn’t I want to insure with reconstruction costs so I can fully rebuild in a post loss environment?

            Now, if I wanted to take the chance and be underinsured in the sense that I know that I do not have enough insurance to rebuild in a post loss scenario, I would agree that I could insure at Replacement Cost and even down to 80% without having to worry about a coinsurance penalty.

            But as an insurer, I would think that insuring to a value that will allow a policyholder to fully repair in a post loss scenario is good for the policyholder and good for the company. Why not?

          • Frank Lombard

            Your question requires a dual response.

            First, the standard terms of most policies require policyholders to maintain at least 80% of the structure’s Replacement Cost to qualify for Replacement Cost coverage. Insurers, however, are disregarding these policy terms and filed rating rules and requiring policyholders to purchase 100% of the often 30-50% higher estimated Reconstruction Cost. This requirement inflates the annual premium hundreds if not thousands of dollars per year per policy. This is the main issue I raise, millions of policyholders are being “forced” to purchase more insurance than the terms of their policy require.

            Then your question, what if a policyholder, like you, wants to make sure they have an adequate post-loss limit to cover the potential difference between the Replacement Cost (the current cost to build a similar structure prior to loss) and the actual Reconstruction Cost (cost to rebuild following a loss). You simply purchase the 100% Replacement Cost limit and an endorsement offering additional amounts of insurance to cover this potential gap. These endorsements, offered a nominal cost, generally increase the limits 25-50% or in some cases to an unlimited amount with the Guaranteed Replacement Cost endorsement. So on a $500,000 Replacement Cost home, additional amounts of insurance of $250,000 or more can be purchased for a nominal cost.

            Instead of offering policyholders this option, insurers are “forcing” insureds to purchase the full Reconstruction Cost limit for hundreds if not thousands of dollars more per year.

            I suggest this is an unfair and deceptive practice and needs to be addressed.

            As an example, a client of mine recently purchased a new home. The insurer estimated the Reconstruction Cost at $767,049 and required that limit indicating an annual premium of $1418.

            The real estate appraisal calculated the Replacement Cost New, the cost to build a similar structure using current local building costs, at $538,465. The annual premium for a policy with that limit was $945. Both policies provided Guaranteed Cost Replacement Coverage, an unlimited amount of insurance should it be needed following a loss.

            Homeowners are unable to purchase homeowners’ insurance coverage without purchasing an inflated amount of insurance. To me, that is flat out wrong.

            Comments are welcome and appreciated.

        • Chip Merlin


          This is a very good comment.

          I appreciate the view that wide swings in estimated value can occur-especially on smaller jobs. Ther truth is that the manner contractors conduct their business also varies and good contractors with good construction practices usually have more overhead and may, but not necessarily, charge more than those doing shoddy and often illegal construction which harms the policyholder in the long run.

          Thanks for taking the time to make your comment.

  • Brenda French

    I’ve just gone through hurricane Micheal. And have a pretty well known insurance co. for our homeowners insurance. I’ll start by saying I’m in anything but good hands with allstate. I’m tired of jumping through hoops to get whays owed me. I’m tired of living in a camper in my driveway.There has to be an easier way to get my house repaired. To date its been 2 1/2 months and nothing has been started. I have no roof. Hardly any electricity w/o the help of extension cords running all over the place. Am I the only one this is happening to? My husband is so brain damaged he’s of no use in getting our house repaired. I’m tired of fighting this fi g ht on my own. Any suggestions would be much appreciated.