Property insurance policies typically will stipulate whether your coverage is based on replacement cost value or the actual cash value. Selecting the right amount of coverage can safeguard your property against unexpected events, such as a fire.
Replacement cost insurance is the amount it would cost to rebuild your damaged or destroyed home to its previous design or to purchase new items to replace ones that were damaged or stolen.
The actual cash value covers the amount an item is worth at the time it is lost, including depreciation.
Most homeowners’ insurance policies automatically will insure the property at replacement cost value. It will cover the actual cost to replace items or rebuild your exact or similar home in today’s market. Factors insurers use to determine the value include the age and square footage of the property and renovations made.
Replacement cost value is the more expensive insurance option because it pays for the full amount it would cost to replace the damaged or destroyed items with new ones. Covering 100 percent of a property’s replacement cost will protect you in case of a total loss. Insurance should be recalculated following upgrades or improvements to the house. The replacement cost value also may increase if the cost of labor and materials in the area rise.
Actual cash value is less costly coverage for homeowners’ policies. This coverage pays the cost for damaged or destroyed items as they were at the time they were lost, which is typically less expensive than buying a new item. For example, a three-year-old couch is worth less than a brand new couch.
Some items, such as jewelry, art, or a vintage car, might gain value as they age. These items might need to be insured separately to be certain they are covered for the appropriate amount.
No matter which policy you choose, remember insurance will cover only what it costs to replace a comparable item. Policies will not pay for an upgrade to a pricier option – such as an inexpensive loveseat to a designer sectional sofa.
Replacement cost is the price to rebuild a property using the same materials, the same quality of construction and in the same location. It includes the structure along with fixtures, systems, and finishes.
Some insurers offer policies using functional replacement cost, which means less costly materials that perform the same function as the original structure will be used.
Market value is the price that would be paid for your house in the current market. Land value is included in the market value but is not covered under replacement cost value in a homeowners’ policy.
The market value -- which is partly determined by the property’s location, local crime statistics and proximity to good schools -- may be less than the cost of materials and labor required to replace a home. If a property is insured to market value, a homeowner might have to pay out-of-pocket for some of the replacement cost.
Insurance is a key part of protecting your assets. Considering all your insurance options is the best way to decide which coverage will best fit your budget and needs. Learn more about insurance for landlord and investors, check out our Essential Guide to Landlord Insurance.