AIG Private Client Group

BULLETIN

The following information was compiled to help you educate your clients on the importance of proper insurance to value on their homes. We hope you find it useful.

Due to a mathematical error, the previous bulletin - Global Demand for Materials Drives Up Construction Costs - has been revised. Click here for the updated announcement.

Hot Markets Inflate at a Faster Rate

The Office of Federal Housing Enterprise Oversight (OFHEO) publishes a quarterly housing price index. The most recent release, dated December 1, 2005, shows housing trends from September 2004 to September 2005:

House Price Appreciation by State

Top 20 Metropolitan Statistical Areas and Divisions with Highest Rates of House Price Appreciation

OFHEO Key Findings

The average cost of a home in the U.S. rose by over 12 percent, compared to 7.7 percent for the same period in 2004.
Costs rose by double digits in 50 percent of the ranked states.
Houses appreciated by over 20 percent in 37 of the 265 ranked metropolitan areas.
Of the top 20 locations where housing costs went up by over 25 percent in the past year, 11 are in Florida and five are in California.

If average home costs are on the rise, home costs in high-demand areas under current economic conditions are likely to escalate even more quickly.

Rising Contractor Profits Inflate Rebuilding Costs
Although construction costs are not directly related to the market value of a home, developers and contractors can expect higher profit margins when the demand for housing exceeds the supply.

Standard & Poors recently reported that the residential construction industry, reflecting the upbeat housing market, has experienced 30 percent annual earnings growth since 2000.* When rebuilding costs are calculated in "high-demand" areas such as Palm Beach, FL; Beverly Hills, CA; Greenwich, CT; and Lake Forest, IL adjustments need to be made to account for the contractors' ability to achieve higher profit margins.

According to Marshall & Swift/Boeckh, homebuilders' normal profit margins are typically 10-12.5 percent but can easily rise to 20-25 percent when demand is high. For example, a Palm Beach builder who demands a 20-25 percent profit margin - instead of the standard 10-12.5 percent - will tack on an additional $200,000- $250,000 to the construction cost of a $2 million home. This additional profit margin must now be factored into the overall construction index.

*Standard & Poor's Homebuilding Industry Survey, August 11, 2005.

The current economic climate continues to present new challenges for our industry. AIG Private Client Group makes every effort to help establish accurate rebuilding costs when a policy is issued, but the accuracy of our estimates will deteriorate over time unless sufficient adjustments are made at renewal. Not only do we need to account for normal inflation, but also we must consider supply and demand issues, market pressures and unreported upgrades. We strongly encourage you to raise the issues surrounding ITV with your clients. If you have any questions, please contact your underwriter or business development manager.