RANDS AND SENSE
By Andrew Kruger
Homeowner’s cover continues to be an important and valuable topic. If you own a home it is crucial that you understand the various aspects involving this type of insurance, since it protects your valuable asset when unexpected events happen like the 2022 floods in Kwazulu-Natal and the recent gas tanker explosion in Boksburg. Our hearts go out to the families and individuals affected by these devastating events.
If you have homeowner’s insurance, or you’re in the process of applying for it, you may have come across the term “replacement value”. And you may be wondering what it is and why it’s important. Let’s take a closer look.
What is meant by the replacement value of your home?
Replacement value refers to the current cost to rebuild your home if it’s damaged or destroyed – for example, by fire, a flood, or an explosion. The initial replacement value of your home is the best estimate of the property’s value at the time you bought it, but it’s worth remembering that this value can change over time.
Why is the replacement value of your home so important?
The replacement value determines how much cover you’ll need if you ever need to replace or rebuild your home. Also known as building structure cover or building insurance, homeowner’s cover protects the complete structure under the roof of your house and includes walls, water pipes, electrical work, ceilings, geysers, and more. This type of insurance is not the same as home contents cover, which protects your personal belongings and household goods – the things inside your home – against loss or damage.
How is the replacement value determined?
Several factors are taken into consideration when deciding on the replacement value of your home:
- The building cost per square metre to rebuild your home.
- Any excavation or demolition work needed to get the property back to a point where it can be built on again.
- Any architectural work required to draw up building plans for the new structure.
- Any engineering work needed to ensure that the building is built according to regulatory standards.
- The value of the vacant land or stand is excluded from the calculation of the replacement value.
Who determines the replacement value?
If you have a bond on your property, your bank will estimate the replacement value at the time you buy your home. The banks use property data experts as well as independent valuers to determine this value. Your insurer may also re-evaluate the replacement value of your home each year.
What is the difference between the replacement value and the market value of your home?
The market value of your home refers to how much the property is worth and what it should sell for on the open market. It includes the stand and home structure and is determined by recent sales of similar properties in your area.
Over time, the market value of your property typically fluctuates. If, for example, the neighbourhood becomes a little run down, your fixtures and fittings become outdated, and general wear and tear and a lack of continuous maintenance take their toll, the market value of your home may decrease. If, on the other hand, your neighbourhood is well looked after and your home is well maintained, the market value will likely increase.
In contrast to the market value, the replacement value of your property almost always increases over time as materials become more expensive and building cost inflation rises. So, for example, if you were to buy a newly built home, its replacement value would be equal to the recent building costs – remember that the replacement value of your home excludes the stand or vacant land. But five years down the line, the replacement cost is likely to be much higher because of building inflation.
Your building replacement value and market value are almost never aligned. In fact, according to our data, which is based on approximately 85 000 houses over the last three years, the average market value of the property is 76% of the replacement value. This is a national average and includes new and existing buildings.
The market value as a percentage of the replacement value can be broken down into the major metropolitan areas as follows:
- Cape Town: 93%
- Durban: 73%
- Pretoria: 78%
- Johannesburg: 75%
- Gqeberha: 64%
- Bloemfontein: 62%
Why are replacement values in the spotlight?
The Russian-Ukraine war is still impacting supply chains worldwide which, in turn, causes inflation to rise. Most of us have already felt the impact of fuel increases over time causing rising inflation which affects basic food prices and influence all other sectors, including the building industry.
According to the Construction Materials Price Indices for May 2022 released by Stats SA, Construction Input Price Index, also referred to as building cost inflation, is expected to be approximately 14% over the next year. In other words, if the replacement value of your home is currently R1 million, it would increase to R1.14 million. And as the replacement value of your home increases, so will the amount you’re paying for homeowner’s insurance.
The expected building cost inflation for the next twelve months is predominantly driven by an increase in the price of these building and construction components over the past twelve months:
- Site preparation: 18.4%
- Civil engineering – building of complete structures: 14.5%
- Building installation: 12.1%
- Building completion: 15%
- Renting of construction or demolition equipment: 26%
What is underinsurance and what are the risks?
If the replacement value of your home and the level of cover you have don’t keep up with inflation, you’re at risk of being underinsured if your home is destroyed.
While insurers review the replacement value of your home every year and increase it in line with inflation to minimise your risk of being underinsured, it’s also your responsibility as the policyholder to make sure that you have the right level of cover.
So, if you make any improvements to your home – for example, you renovate a bathroom or kitchen, add on a study, or put in a pool – you must inform your insurer of these changes and increase your replacement value. If you don’t, your insurer has no way of knowing about them and you’re likely to be underinsured.
Andrew Kruger is Head of Business Analysis at BetterSure Financial Consultants