Replacement cost is one of the two valuation methods insurers use for establishing property value.
Its purpose is to determine the amount your insurance company will pay if you experience a covered loss.
A covered loss is defined as the financial losses incurred by a party that they are eligible to receive insurance reimbursement for under the terms of their insurance contract.
What is Replacement Cost Insurance?
When you buy replacement cost insurance, your insurance company compensates you at today’s prices, so you can buy new items of a similar kind and quality, up to your policy’s limits.
In the case of a house, your insurer pays for a rebuild of your home with similar specifications.
This is normally restricted to a rebuild on the same site.
When buying a replacement cost insurance policy, it is extremely important you obtain an accurate valuation of your belongings and your home.
This affects your premiums and your payout should you experience a loss.
An up-to-date home inventory gives your insurer a good idea of the value of your belongings.
You will also need an accurate assessment of the value of your home.
This amount does not include land, so it is not the same as market value.
Your insurance agent, an appraiser, or a contractor can assess the value of your home based on its age, custom features, quality of finishes, size, and local building codes.
- Cost of coverage is higher
- Provides full compensation if your property is damaged or destroyed
- Relies heavily on property values set when you buy your policy.
What is an Actual Cash Value Policy?
An actual cash value policy can help you with the costs associated with a loss.
However, there is a major difference compared to replacement cost policy.
You are compensated for items damaged or destroyed, less depreciation.
How an insurer calculates depreciation and actual cash value compensation depends on your policy.
Some items depreciate very quickly and most items cost more than they did in the past.
As a result, these policies may lead to significant out-of-pocket expenses should you experience a loss.
- Cost of coverage is lower
- Provides partial compensation if your property is damaged or destroyed
- Extra coverage is crucial for expensive items such as electronics, antiques, fine art, music and sporting equipment, collectibles, and more
Replacement Cost vs. Guaranteed Replacement Cost
A replacement cost policy protects your belongings and home, up to the policy limits.
However, a guaranteed replacement pays whatever it takes to restore your home and belongings, often regardless of policy limits.
This guarantee can be advantageous during times of high inflation, supply chain interruptions, or frequent climate events.
All these factors can push up the cost of materials and labour.
Consequently, the actual price of a repair or rebuild could be higher than the valuations set when you bought your policy.
- Most expensive coverage option
- May provide compensation to rebuild or replace with new items of similar kind and quality, regardless of policy limits
- Some policies have limits, but they are higher
- May not warrant the steep price unless the policy ignores limits
Frequently Asked Questions
- What is an example of replacement cost?
A fire destroys your 10-year-old living room furniture. The insurance company pays for a new set of similar quality and kind. They don’t pay you for the value of the furniture, less 10 years of depreciation.
- What is meant by replacement cost value?
Replacement cost value refers to how much your insurance company will pay if you experience a covered loss. If you buy a replacement cost policy, your insurer pays to repair or replace your property with items of similar quality and kind, based on their value in today’s market.
For instance, if your home burns to the ground and it was valued at $450,000 when you bought your policy, they would pay up to that amount to restore it. As a result, when you buy a policy, it is very important you obtain an accurate valuation. Otherwise, you won’t receive adequate compensation.