Many property owners don't understand that market value and replacement costs are independent values. While both pertain to the owned property, each applies to different uses.

Market value is the current price at which a property can be bought or sold in a real estate transaction. Market value includes the land on which a house stands and all related structures, such as landscaping, fencing, detached garages, sheds, or swimming pools. Market value for real estate in a local area varies based on supply and demand.

The replacement-cost estimate is the approximate cost to rebuild a structure on the original site with materials of like kind and quality. A replacement-cost estimate does not include the value of the land or any detached structures on the property. The estimate will vary based on cost fluctuations for local building materials, labor, and equipment used in reconstruction.

While both values fluctuate, they don't necessarily change at the same time or in the same amount. The current housing downturn illustrates this perfectly because market values in many areas have fallen at a much faster pace than reconstruction costs.

Tip No. 2: Show clients they are not alone.

For the past year, Xactware has tracked the differences between market value and replacement-cost estimates in several metropolitan areas by comparing median home sale prices reported by the National Association of Realtors with the median replacement cost estimate as calculated using 360Value, Xactware's replacement-cost estimation tool.

The results revealed large disparities between the two values in many markets. The most extreme example is Ft. Myers, Fla., where the median replacement-cost estimate was 160 percent higher than the median home sale price in the first quarter of 2011.

Tip No. 3: Demonstrate the consequences of underinsurance.

Homeowners need to understand the potential impact of not insuring their property to full replacement value. Insurance agents can cite examples to demonstrate the consequences of underinsurance. Some recent examples have been documented in news stories that show the pain homeowners endure after a loss when their property is underinsured. These stories have been plentiful in the wake of the record-breaking storms and other catastrophes of 2011.

An underinsured property can also have an effect in the event of a partial loss, which means it's important homeowners understand their specific policy language regarding insured limits and coinsurance clauses.

Be an advocate for the client

Cost is almost always a primary factor in insurance purchasing decisions. But agents should help homeowners make certain that saving money on a policy doesn't come at the expense of adequate insurance coverage.

Helping homeowners understand the difference between market value and replacement-cost estimates—and the consequences of not insuring the property to value—may help them avoid financial catastrophe after a natural catastrophe.