Replacement cost

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Insuring your home or rental is a smart decision that comes with many variables to consider. One of the most important options you’ll need to decide on is how you’d like any losses or damages to be reimbursed.

Most insurance companies provide you with two primary options — replacement cost coverage and actual cash value. Understanding the pros and cons of either option is essential to make the best choice to protect your property. Take a closer look at replacement cost insurance and whether it’s the best choice for you.

What is replacement cost?

Replacement cost insurance will pay to replace your home and/or property with what’s currently available. It’s the default type of homeowners insurance. Say you insured your home for its value of $400,000 (not including the land). If your home was lost in a fire, a replacement cost insurance policy will pay to rebuild your home up to $400,000 using new goods and materials to replace the lost ones.

Replacement cost coverage is also helpful if you’re insuring electronics such as a home security system. If your system was lost in a fire, you won’t have to worry about finding the same older model. Replacement cost value coverage would reimburse you for a new version of your lost security system.

Guaranteed or extended replacement cost coverage

Besides standard replacement cost coverage, you can upgrade to guaranteed or extended replacement cost insurance. Extended replacement cost insurance accounts for inflation and other circumstances that could make rebuilding more expensive than you planned.

For example, the cost of rebuilding a home 10 years ago was probably less than it is today. If you insured your home years ago at a certain amount, guaranteed replacement cost insurance will cover the set limit, plus an additional percentage as high as 50% to account for the increase in labor costs and materials over the years.

Extended replacement cost coverage is more expensive than standard replacement cost coverage but may be worth the expense. Besides adding some cushion to how much you can spend to rebuild your home, it can help you hedge against other factors that could drive the cost of rebuilding your home up higher.

A good example is having to rebuild your home after a large flood or hurricane. Rebuilding your home after a major weather event could cost you more because of the high demand for contractors. Extended replacement cost will reimburse you for the higher cost of rebuilding after a disaster.

How replacement cost is determined by insurance companies

Replacement cost doesn’t necessarily correlate with how much you paid for your home. Insurance companies look at figures such as building materials and labor costs for your area when underwriting your policy.

To get reimbursed for replacement cost after a loss, you may have to prove to your insurer that the lost property is worth what you claimed as the replacement cost value. Presenting receipts for bigger-ticket items is vital. An inventory checklist showing all the items you own, a good description and value will also be helpful for getting a claim paid.

If you’re not able to provide receipts, photos or other documentation for your home, you may be able to go with the alternative “Scope of Loss” to maximize the amount of replacement cost value reimbursement you’ll receive. You’ll need to hire a contractor to write a comprehensive report detailing all the items that need repairs or replacement as well as recommendations on what aspects of the rebuild are a higher priority.

Actual cash value vs replacement cost

Now that you have a better idea of the meaning of replacement cost insurance when it comes to renters or homeowners coverage, it’s time to point out the biggest difference between actual cash value coverage and replacement cost insurance.

Replacement cost value coverage allows you reimbursement for the new version of items to replace older ones. Actual cash value coverage costs less than replacement cost value insurance, but pays for the goods you lost at a lower, depreciated price.

In an actual cash value policy, if your 5-year-old granite countertops need replacement, your insurance company will depreciate the countertops accordingly and you’ll be reimbursed a lower value than what you originally paid for them. With a replacement cost value policy, if the granite countertops cost $6,000, you’ll be able to buy a newer version of your granite countertops for the $6,000 in value or a certain percentage above the coverage limit.

Actual cash value vs market value

Actual cash value vs market value differ. Market value is the amount an insurance company or appraiser set a property’s value at. It’s based on what the current market is willing to pay. Actual cash value is the cost to replace the items or property minus the cost of depreciation based on the age of the goods.

Frequently asked questions

Is actual cash value coverage better than replacement value insurance?

Choosing the way you’d like your insurance carrier to reimburse you in case of loss depends on the age and quality of your property, as well as how much home insurance you’re able to afford. Replacement value insurance is a safer bet, since you’ll be reimbursed for new versions of the items you’ve lost. Actual cash value is less expensive but means that the value of your property will get depreciated according to age, resulting in less money in your pocket to rebuild your home.

How much homeowners insurance should I buy?

When deciding on the amount you’d like to assign for replacement value coverage or an actual cash value policy, it’s important to determine what your home’s value is based on similar homes in the area and the types of improvements your home features. Create a list of valuables and home improvements, including a ballpark cost, to put together a more accurate value of what your home is worth.

What happens if the cost to rebuild my home is higher after a hurricane?

When disaster strikes, a shortage of materials and qualified contractors is typical. As demand for rebuilding increases, so do prices. If you have extended or guaranteed replacement cost coverage, the homeowners insurance policy adds a percentage over your home’s declared value to account for inflation and increases in building and labor costs.