Rebuilding your current house: why even after construction you should care about construction prices
Construction work at your house has become increasingly more expensive in recent years. ABN-AMRO reports that some resources have increased in price by over 70% from the previous year. Additionally, the current shortage of construction labor adds to the price and often leads to waiting times of more than a year. The economic institute for construction (EIB) expects this trend to continue for at least the next two years. Homeowners who renovated their homes several years ago consider themselves lucky. They are no longer concerned, affected, or bothered with the current peaks in construction prices. However, they should be.
Figure 1. Annual price increase of construction resources in the Netherlands
The big caveat for homeowners of an upgraded house lies in the way home insurance (‘opstalverzekering’) works. As the house serves as collateral, mortgage lenders demand homeowners to insure their house against fires, floods, storms, or other events that permanently and significantly damage the property. The insurance premium, like for any other insurance, depends on the likelihood of such an event and the expected damage incurred. For home insurance, this means that the premium depends on the rebuild value of the home. The kicker here is that, if the rebuild value rises without a consecutive adjustment in the insurance premium, the insurance company considers the property underinsured. In that case, instead of a reimbursement up to the maximum of the insured amount, they will only pay out a proportion of the loss. If the rebuild value has risen a lot, this has big consequences.
Figure 2. BCIS House Rebuilding Cost Index – United Kingdom
Let’s use an example. Imagine you bought a house in January 2020. At that time, an expert estimated the total rebuild value at 350.000 euros, and you took out insurance for this full amount. Now imagine, in 2022, your kitchen burns down in a way that is covered by your insurance. The total damage is estimated at 50.000 euros (note that this is comfortably below your maximum coverage of the insurance). You naturally expect the insurance to cover the full amount. However, the insurance company notices that the rebuild value has risen tremendously, while you did not adjust the insured amount upward. The insurance company estimates a current rebuild value (based on table 2; BCIS House Rebuilding Cost Index) at over 400.000 euros. Therefore, the insurance will only cover a proportion of the damage based on the ratio of the originally insured rebuild value to the updated value of the house: 43,7k (350k/400k x 50k). In other words, the insurance will pay the ratio of the kitchen in relation to the last rebuild value known to them. Effectively, the rise in construction prices will force you to pay over 6k out of your own pocket.
Intuitively, this seems unfair: you pay a premium for a set (limit) amount, which should entitle you to reimbursement of all amounts below (or at) the limit. However, this reasoning ignores changes in the expected loss amount in case of an event. The insurance premium is actuarially determined as the product of the probability of events happening times the expected rebuild value. While the probability will most likely remain unchanged, the expected rebuild value of the kitchen goes up. Hence, the probability of the burning kitchen is equal for the 350K valuation as well as for the new valuation of 400k, but the actual rebuild value increases. In other words, the damage of a destroyed kitchen in 2022 is equal to the damage of a kitchen and a hallway burning down in 2020. Since it is now more likely to get a 50k damage than two years ago, you should have paid more premium.
Luckily, it is not the case that every homeowner in the Netherlands is underinsured by default. A majority of insurance companies arrange regular checkups to update the rebuild value of the house and adjust the premium. Some insurance policies ensure that they will never exert underinsurance claims, as long as you adhere to some regulations (e.g. promise of providing correct information and timely updates, some hire external parties to check periodically, and others ask you to use a special calculation tool). However, the final responsibility legally resides with the homeowner. If you are unsure what your policy dictates, whether you adhere to it correctly, or whether your insurance company even has a clause stating they will not protest due to underinsurance, now is a good time to check. The current construction prices made the difference between years spike enough to create a significant dent in your financial situation. It’s time to put this small fire out before it spreads to your house and financial situation.