How is home insurance calculated?

Understanding how home insurance premiums are calculated isn't just about peeking behind the curtain. It's about taking an active role in the process and equipping yourself with the knowledge to make smart decisions about your cover.

This guide aims to navigate you through the essential methods insurers use, how to gauge your own insurance requirements and the different elements that shape the overall cost of your premium. So, let's dive in!

How insurers calculate home insurance premiums

Insurance companies calculate your premiums by evaluating the 'sum insured'—the cost to rebuild your home and replace your contents—alongside factors such as your home's age and location, claims history, chosen excess and a range of additional risk factors.

So how is ‘sum insured’ determined? 

Your house

You might be tempted to think the ‘sum insured’ is based on your home’s value. But that’s not correct. It’s about how much it would cost to rebuild your home from scratch. That’s likely a very different figure than what your house is worth in the property market.

There are two major methods insurance companies use to estimate rebuild costs:

• Cost-per-square-metre method. This method gives a basic estimate by multiplying your home's total area by an average cost per square metre. It's straightforward and good for general estimates but might not fully reflect what makes your home unique.
• Elemental estimating method. This method offers a comprehensive look at your home's costs by examining each component separately. From the materials used to build your home to the labour involved in its construction, it assesses each aspect to give you a precise estimate.

The contents

In assessing the contents of your home, insurers typically consider two approaches:

• Replacement cost method. This calculates the expense of replacing your belongings with new equivalents at today's market prices. It's designed to cover the cost of buying new items, disregarding depreciation.
• Actual cash value method. This calculates the value of your items considering depreciation, meaning it accounts for age and wear, offering a payout that mirrors their current worth, not the replacement cost.

For most items, apart from high-value pieces like jewellery, you'll usually be asked to provide these estimates yourself.

The underwriting process 

After arriving at a sum insured for your home and contents, your insurance company wraps things up with the underwriting process. This is when they scrub this sum insured against all the other premium factors we mentioned earlier, using statistical complex models. It's this detailed process that finally nails down your premium, ensuring it fits like a glove.

How to estimate your home’s value yourself

Estimating the replacement cost of your own home is a great way to walk into insurance negotiations with confidence. Here’s how to do it:

• Calculate the build area. Measure your home's total square metres, including all living spaces.
• Research average building costs. You can usually find the latest per-square-metre construction costs in your region through local builders, real estate websites or government publications.
• Adjust for special features. Account for unique features like high ceilings or custom-built elements that can cost more to replace. On the flip side, garages and outbuildings might be valued lower.

Of course, you can save time by leveraging online calculators provided by insurance companies or by consulting with a professional. However you decide to do it, going through this process will empower you with the knowledge to navigate insurance discussions and decisions more effectively.

The importance of accurate calculations to avoid underinsurance

Getting your estimates right is important in helping you avoid underinsurance. This is when your ‘sum insured’ is lower than the cost to rebuild your home from the ground up.

This can happen due to miscalculations or by not updating your policy to include new renovations or rising building costs. 

It may not seem urgent—after all, what are the odds of your home being totally destroyed? But consider this: if it costs $1 million to rebuild your home, yet you've insured it for only $500,000, you're in a risky spot. Should a disaster cause $300,000 in damage, you might expect full coverage when it comes time to claim. However, since your policy covers just half of your home's rebuild value, you could end up with only $150,000 from the insurance, leaving you $150,000 short. In other words, it’s prorated.

That’s why it’s imperative to regularly check and adjust your insurance to match your home's true value.

Bottom line

Estimating what it would cost to rebuild your home and knowing what impacts your premium puts you in a strong position to make smart choices about your home insurance. It's the secret to ensuring you're neither underinsured nor overpaying.

Happy estimating!