Decreasing insurance may be costly

There are a number of steps every homeowner should take to lower the cost of property insurance. But reducing the amount of coverage to match today's lower values is probably not one of them.

Because it costs more to rebuild than it does to start from scratch, the market value of a house is not a reliable indicator of the amount of insurance you need.

Too little coverage and your policy may not assume the cost to return your place to its original condition should tragedy strike.

"There has been a lot of noise lately around market values, but market value and the cost to rebuild are two totally different things," says Elaine Baisden, vice president of national property for Travelers, the Hartford, Conn.-based property casualty insurer.

"So lowering policy limits could leave you underinsured."

Despite the downward spiral in housing prices, home-repair costs increased nearly 4 percent nationally, according to Xactware, whose software products estimate building and repair costs.

And Marshall & Swift, an authority on building-cost data, says it can cost up to 30 percent more to rebuild a house as opposed to building a new one.

Reconstruction costs are greater because the process usually involves the demolition and removal of damaged property.

On-site mobility often is limited by the need to work around existing landscaping, power lines and other buildings.

There are no economies of scale like there are when building row upon row of houses, either. And then there's the issue of newer, often more rigid building codes that might have to be met.

Market value, on the other hand, is often influenced by factors that have absolutely nothing to do with the cost to rebuild -- the quality of nearby schools, for example, the local tax base or the proximity to rapid transit.

Value also is impacted by the cost of the land on which the house sits, and that is something you should factor in when considering how much coverage to carry.

Although mortgage companies require borrowers to carry 100 percent coverage when they take out their loans, it's not necessary because the land under your place isn't at risk -- not from fire, theft, windstorm or any of the other perils covered in most homeowners' policies.

It's not necessary to continue 100 percent coverage once you leave the settlement table, either. So if you include the value of the building lot in deciding how much insurance to buy now, you'll be paying a higher premium than you should.

Typically, the building lot accounts for 25 percent of a home's value.

But you can get a better reading from your tax bill, which usually separates the value of the land from the value of the house.

You shouldn't use the property's assessed value to determine how much coverage you need, but you can use the percentage ratio of the lot to the total to get an idea of what's needed.

Still, it's probably not a good idea to arbitrarily make these kinds of decisions without first sitting down with your agent and discussing your needs.

The wrong choice could prove to be an expensive one, says Travelers' Baisden.

Lew Sichelman has been covering real estate for more than 30 years. He is a regular contributor to numerous shelter magazines and housing and housing-finance-industry publications.