Building Costs and Insurance Protection—How to Avoid Coverage Gaps and Shortfalls

Building costs and insurance protection are intrinsically linked. Rising building costs can have the potential to create coverage gaps and shortfalls when it comes to insurance if you’re not careful. Here’s what you need to know about building costs and insurance protection to avoid coverage gaps and shortfalls:

Building Costs Are Rising

The past year has created some serious potential for costly dilemmas relating to building new structures, repairing old structures, and rebuilding structures that have been destroyed for various reasons.

It is no secret that materials have risen at unprecedented rates and the availability of goods is very tight. Building contracts that were signed mid to late 2020, locking in cost and timelines, are placing contractors in a very tight situation with regard to meeting deadlines and breaking even, financially, on their current projects.

We recently inquired with our local lumberyard concerning the cost of materials and how they have changed over the last 9 months. Here is what we found:


Item Approx. Cost Aug 2020 Cost Dec 2020 Cost Apr 2021
2x4x8’ $2.32 $4.63 $6.95
2x6x8’ $3.59 $7.19 $10.78
2x6x12’ $6.21 $12.42 $18.63
4X8 OSB Sheet 7/16 $12.52 $25.03 $37.55
4×8 OSB Sheet ½ $13.67 $27.33 $41.00
4×8 x ½” Sheet- Treated $22.32 $44.64 $66.95
4×8 x ¾” Sheet- Treated $24.32 $48.64 $72.95

It’s fair to say some materials have tripled in just 8 months.

To use some general assumptions to get an idea of what has happened to construction costs, let’s assume building a new home for a total cost of $300,000. This would be a typical average dwelling in our geographic area built in early 2020 or prior. A fair split of cost between materials and labor is somewhere about 50/50. So, using this formula with our example, materials would be $150,000 and labor would be $150,000.

If the material cost in August 2020 is $150,000, then, by December 2020, it has increased to $300,000, and by April 2021 it is at $450,000. As a point of clarification, this increase is most likely seen in the rough construction materials and not in all finishing materials such as drywall, paint, etc. Labor would remain nearly constant.

Taking all this into consideration, home construction costs have likely increased 30-40% depending on your geographic location. Now, the $300,000 home has just become a $400,000 home!

This has all taken place in about 8 months and there is no crystal ball that will tell us when things will be back to previous levels or if they will ever get back there. As you can see, this quickly creates a situation where homeowners may find themselves in an unwelcome and unanticipated financial bind if they have damage or loss to their home and do not have insurance protection.

If we take this scenario into the agricultural and business settings, the cost of building construction would be a higher percentage in the raw/rough materials; 2×4, 2×6, 4×8 sheeting, etc. The increased cost of these materials could see building costs easily approaching 50% increases and would now make these types of structures even more costly to build or to rebuild in case of damage.

Insurance Implications of Rising Building Costs

The questions that need to be asked are, “how does this impact my insurance protection, and what negative implications does it present if I have a claim/loss?” There are several scenarios we can look at to illustrate financial dilemmas that may arise from coverage gaps caused by building costs and insurance protection shortfalls:

1. Disparities in Replacement Cost in Cases of Total Loss

First, let’s look at the situation of a total loss. If your home cost you $300,000 to build in 2019 and was totally destroyed in a fire in April 2021, and you have it insured at the $300,000 limit, you will receive a check from your insurance carrier for $300,000 to replace it.

You now contact a contractor and sign the agreement to have your home rebuilt. You sign over the insurance payment you received to the contractor and tell them to replace your house in the same size and with the same quality construction.

This is why replacement cost is one of the most important coverages for homeowners policies. But, the rising costs of materials have created a situation where it’s not enough to cover a true replacement. With the increase in material costs, replacing your house will cost closer to $400,000.

In this situation, you are short $100,000 to complete an exact replacement. Your remedy is either to dip into your savings, if you have that much, go to the bank and take out a loan, or opt to build a smaller house. This is why it is essential to insure to value, the cost to buy or cost to build.

2. Risk of Co-Insurance in Cases of Partial Loss

If you have a partial loss, you could have a co-insurance situation. Co-insurance is an insurance term addressing the minimum limits needed on a policy to trigger replacement cost coverage. Straight, unendorsed insurance policies pay property damage claims on a depreciated or actual cash value basis.

With the co-insurance endorsement added, you can expect to have your claim paid in full minus your deductible. Co-insurance simply means that there is a percentage limit you must meet on the building value on the policy for the loss to be paid in full. Essentially, it is giving “new replacement” for the “old portion” that was destroyed.

Many policies have an 80% co-insurance clause. This means that you must have the limit on the policy at least equal to 80% of what it would cost to build the structure.

Co-Insurance Examples Taking Rising Building Costs Into Consideration

Residential Buildings

Our $300,000 house needs to be insured at a minimum of $240,000. Keep in mind, you will not receive more than the limit on the policy at any one claim. Going back to our example of the $300,000 house now costing $400,000, the minimum limit needed on the policy to meet the co-insurance clause would be $320,000 (400,000 x .80).

Agricultural and Commercial Buildings

If we look at agricultural and commercial buildings, the gaps can be even greater. For example, a hog confinement structure that cost $500,000 to build 10 years ago quickly approaches $1,000,000 or greater. In many situations, the income from these structures is paying the mortgage on the farm.

To just take the insurance check and not rebuild is not an option. This is one of the risks of having the wrong commercial property coverage, farm insurance coverage, or homeowners insurance coverage. And, rapidly rising building costs are creating situations where insurance protection that was enough previously is now not enough.

The pure language of the policy would indicate if your limits do not meet the co-insurance threshold then the company will only pay the actual cash value/depreciated value of the property lost or destroyed. This could easily translate to a payment of 60-80% of the actual loss.

3. Loss of Use or Loss of Business Income Limits Could be Insufficient

Another area to keep in mind is the downtime that may occur until the structure is rebuilt or repaired and what financial burdens it may cause. In the situation of the dwelling, you may need to rent a home or stay in a motel for a period of time.

With the demand for building materials, this time frame may be longer than it would have been previously. Homeowners’ insurance policies provide a “Loss of Use” limit. This may be a specific limit, 20% of the dwelling value, or the “Actual Loss Sustained”. It is important to know what this limit is on your policy.

On agricultural/commercial buildings, you would be looking for protection for “Loss of Business Income“. This usually is a limit determined by you and possibly tied to a specific time frame. Again, with the reduced availability of building materials, the downtime of your operation until the structure can be rebuilt could be considerably longer than in previous years.

Make Sure You’re Fully Covered

Exactly how insurance carriers will address these scenarios will differ between companies. A conversation with your agent/insurance company may be prudent. It may be wise to increase your limits for a period of time and closely monitor costs and then reduce the limits when construction costs retreat.

To say the least, there is a very real potential for financial situations to arise that were not on the radar as little as 8 months ago. We suggest that you take time to evaluate your circumstances and make the necessary adjustments to protect you and your family against the unknown.

The past year has produced unprecedented stress at multiple levels. Insufficient insurance limits do not need to one of those added stressors. If you wish to discuss your particular situation, call Ruhl Insurance at 1-800-537-6880 or 717-665-2283.

Disclaimer: Information and claims presented in this content are meant for informative, illustrative purposes and should not be considered legally binding.