Soaring Construction Costs, Vanishing Replacement Policies Leave Most Underinsured

San Francisco Chronicle

If a fire were to level your house tomorrow, do you think your homeowners insurance would cover the full cost of rebuilding it?

Think again.

Bay Area construction costs have soared in recent years. The long-standing rule of thumb that home replacement costs an average of $85 to $125 per square foot — depending on the complexity of the structure, the quality of building materials and the contours of the lot — has been rudely updated to $125 to $250 per square foot and beyond.

Adding insult to injury, most insurance companies in California have capped their potential liability for fires and other devastating losses by eliminating guaranteed replacement coverage — the obligation to pay the full cost of rebuilding your house, no matter what.

Even some homeowners who should know better neglect to keep a watchful eye on their insurance policies.

Brooks Walker, a prominent San Francisco architect, says he recently increased the policy limit on his 89-year-old Cow Hollow house by $400,000 — but only after his insurance agent called his attention to the huge difference between the coverage and the probable replacement cost.

“There was no way — even as an architect calling in favors — to replace that house with the same quality of materials for less than $300 per square foot,” he says. “The policy limits were set at $160.”

The demise of full-replacement policies is part of a nationwide movement by insurers to avoid catastrophic losses, particularly in high-risk regions such as California, with its fires and earthquakes, or Florida and Louisiana, which are prey to devastating hurricanes.

Most private insurers in California got out of the earthquake business a few years ago, shifting the burden of that coverage onto the state-created California Earthquake Authority.

The CEA will nominally insure you for the full replacement value of your home if you set the policy limit high enough. But you don’t really get full coverage, because quake policies carry a large deductible — 15 percent of the home’s value in the case of a bare-bones CEA policy, or 10 percent if you pay extra for the agency’s new supplemental coverage.

You still can get full coverage against fire in California, but you have to take an active role by requesting policy limits that will cover your potential costs in a disaster. Most insurers will pay only the limits stated on the policies — plus, in some cases, a certain percentage beyond.

The net result: Many of the region’s homes — perhaps most — are grossly underinsured.

Richard Harding, an editor with the Marshall & Swift Valuation Service in Los Angeles, blames the soaring building costs mainly on a shortage of materials — especially such major components as drywall, plywood, lumber and cement.

But the situation has been aggravated by rising interest rates, which boost the cost of construction loans, and by a Bay Area remodeling boom that has tipped the balance of supply and demand decisively in favor of the region’s contractors.

Probably most homeowners aren’t yet aware of the substantial cost increases. Few of them rebuild or remodel their homes often, and most have other things to do besides monitoring construction-industry statistics.

But in fact you must monitor the situation closely if you hope to financially survive the destruction of your home. Experts say that only 3 percent of home fires result in destruction — but try telling that to the nearly 3,000 families who suffered total losses in the 1991 Oakland hills firestorm.

You have to be prepared for anything.

Says Bob Rivinius, chief executive of the California Building Industry Association in Sacramento: “We can reasonably expect that the price of construction will go up every year.”

Stephanie Macandan, a spokeswoman for the Western Insurance Information Service, suggests that you consult a construction engineer every year before renewing your homeowners policy, to make sure you are fully covered.

If the cost of rebuilding exceeds your policy limit, ask your insurance agent to raise the limit; the few extra dollars you pay in premiums will seem well worth it if disaster strikes.

It used to be that policy limits didn’t necessarily matter.

Most insurers routinely offered guaranteed replacement coverage — a promise to pay the full amount needed to rebuild your house to the same specifications as the original structure. The stated limits on those policies were used strictly as a reference in determining the premiums.

A few insurers, such as the California State Automobile Association and Farmers Insurance, still offer guaranteed replacement coverage.

At Farmers, says spokesman Kenneth Adams, you have to be careful to ask for add-on “endorsements” to the standard policy to get guaranteed replacement.

At CSAA, however, guaranteed replacement is the standard type of policy, says Marjorie Berte, the vice president for underwriting. Practically every customer has one.

Berte says the annual premium rates on the CSAA policy vary widely — from $1 to $9 per $1,000 of rebuilding costs, depending on how elaborate the structure is, and also on such considerations as the proximity of the nearest firehouse and fire hydrant.

More common is the coverage offered by State Farm, the largest homeowners insurer in the state, which dropped guaranteed replacement coverage three years ago. It caps its coverage at 20 percent above the stated policy limits.

“The homeowner has to decide the limits,” says State Farm spokesman Bill Sirola. “If the limits represent 100 percent of value, there shouldn’t be a problem.”

The phaseout of guaranteed replacement coverage can be traced back to the Oakland hills fire, experts agree.

Suddenly, thousands of upscale homes needed to be replaced, and there weren’t enough contractors to handle the volume. Construction prices skyrocketed, and insurance companies were forced to pay through the nose to meet their obligations to their guaranteed-replacement policyholders.

There was a little-publicized flip side to that problem: Many Oakland hills residents didn’t have guaranteed replacement coverage, even though it generally cost only a few dollars a year more than standard coverage. The insurers held these homeowners to the stated limits on their policies, paying far less than the actual rebuilding costs.

Peter Scott, an architect whose mother died when the Oakland blaze consumed their home, says he wasn’t even aware at the time that he could have bought a guaranteed-replacement policy. His insurance agent didn’t bother to tell him, he says.

Scott sued the agent and received an out-of-court settlement from the insurance company. But he says the settlement fell $150,000 short of the actual cost of rebuilding the house and replacing his lost possessions.

In the aftermath of the Oakland fire, the state Legislature tried to prevent misunderstandings by passing a law requiring insurance companies to list in writing all the different types of homeowners policies they provide and to furnish the list to all their customers and potential customers.

The list provided by Allstate, for example, says the company provides guaranteed replacement coverage only for mobile homes. Another Allstate policy insures regular homes for up to 150 percent of the stated policy limits. Still another is fixed at 100 percent of the limits.

But consumer advocates have complained that the disclosure form — a standardized document created by the state Insurance Department — is written in dense legalese, making it tough for the average consumer to understand.

“Even I can’t figure it out,” claims insurance gadfly Harvey Rosenfield, head of the Foundation for Taxpayer and Consumer Rights. “I have to call my company and have them explain it. It is a mystery.”

He may have a point. Consider this passage from the Allstate list, describing something called “actual cash value coverage”:

“In the event of any covered loss to your home, the insurance company will pay either the depreciated fair market value of the damaged or destroyed dwelling at the time of the loss or the cost of replacing or repairing the damaged or destroyed dwelling with like or equivalent construction up to the policy limit.”

If that brings you up short — or if you have any other question whatsoever about your homeowners coverage — do as Rosenfield does. Call your insurance agent and don’t put the phone down again until you get an explanation that you can fully understand.