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Replacement cost coverage may allow homeowners to repair or replace their eligible belongings at today’s market value following a covered claim. While most homeowners insurance policies include replacement cost value for dwelling and other structures coverage, personal property is often issued at actual cash value, unless the homeowner pays to increase this coverage. Understanding what replacement cost is and how it differs from actual cash value and market value may help you make an informed decision when purchasing home insurance.
What is replacement cost?
The value of most things depreciates over time, including your personal belongings and the materials used to build your home. A standard HO-3 home insurance policy will usually include replacement cost value (RCV) for your dwelling and other structures coverage, which means that the insurance company will pay for the covered structures to be rebuilt with materials at current costs up to your coverage limits. The same policy may only cover your personal belongings at actual cash value (ACV), or their replacement cost minus depreciation, unless you opt to add an endorsement for replacement cost coverage for personal belongings.
Replacement cost coverage on contents may be worth considering if you want to replace older items with newer ones. Like dwelling replacement cost, contents replacement cost usually has a coverage limit maximum as defined in your home insurance policy. If you have specific high-value items, like jewelry and fine arts, you may want to consider scheduled personal property coverage as these types of items typically have lower per-item limits.
Actual cash value vs. replacement cost value
Now that you have a better idea of the meaning of replacement cost value (RCV) coverage when it comes to renters or homeowners insurance, it is time to point out the biggest difference between actual cash value (ACV) coverage and RCV.
Replacement cost coverage is designed to reimburse you for new versions of damaged items after a covered claim. Actual cash value coverage may cost less than replacement cost value insurance, but it will only pay out the depreciated value of your item following a covered loss. For example, if you have an old couch with ACV coverage, your insurance company will subtract depreciation from the initial cost of the couch to determine your payout. If you have RCV coverage, the company will pay to replace the couch with a similar new version at today’s prices.
Replacement cost value vs. market value
RCV and market value are not the same, especially when it comes to home insurance. Market value is the amount an appraiser deems a home or property is worth or the amount that someone is willing to pay for that home or property, including the land. It is based on what the current market is willing to pay.
Homeowners insurance companies do not use market value when calculating costs for dwelling or personal property coverage. With RCV coverage, the cost to rebuild the home’s structure or replace personal property at today’s prices is accounted for in the dwelling coverage and is paid for following a covered loss. This will likely be lower than the market value, as it does not take land value into consideration.
How replacement cost is determined by insurance companies
Insurance companies evaluate your home’s characteristics, such as building materials, age, square footage and labor costs in your area to calculate your home’s dwelling coverage amount. Your personal property coverage amount is determined based on a percentage of your dwelling amount. Once those figures are determined, your policy would cover either RCV or ACV for damaged or destroyed items that fall within these coverage categories.
Therefore, replacement cost is not determined by your insurance company, per se. The coverage amounts where replacement cost can apply, dwelling, other structures and personal property coverage, are determined by you and your insurance company. In many cases, replacement cost coverage will apply to your dwelling and other structures coverage. However, personal property coverage varies by insurer. It may be best to review how replacement cost coverage applies (or does not apply) to your coverage to avoid surprises should a claim occur.
Guaranteed vs. extended replacement cost coverage
When you first purchase your home policy, your agent calculates the current replacement value of your home. However, there are situations where the replacement cost of your home can change drastically throughout the year. Inflation impacts the cost of materials and labor throughout the year and as the economy fluctuates. In situations with widespread loss, the sudden high demand for materials and labor, along with transportation difficulties, can also drastically inflate the replacement cost of your home. To account for this, many companies offer replacement cost endorsements for your dwelling that may help you avoid expensive out-of-pocket expenses.
- Guaranteed replacement: This coverage helps pay for rebuilding the structure of your home after a covered peril, even if the current cost is higher than the coverage limits listed on your declarations page. For instance, if your dwelling coverage only covers up to $250,000, but the cost to rebuild your destroyed home is $300,000, guaranteed replacement cost could cover the rebuild even though it exceeds the coverage limits.
- Extended replacement: This coverage considers a certain percentage, often 25 to 30 percent, over the dwelling coverage limits specified in the policy. For example, if your coverage limit was up to $200,000, but the cost of rebuilding your home is $250,000, an extended replacement cost endorsement that covers up to 25 percent more than the policy limits would cover the cost to rebuild.
These endorsements are typically more expensive than standard dwelling coverage. However, if you want more complete financial protection over the long term, they may be options worth considering. Speaking with your insurance agent may help you determine if these types of coverage are right for you.
Frequently asked questions
Replacement cost coverage is usually included in standard home insurance policies for your dwelling or detached structures. It is not usually included in the same standard home insurance policy for your personal belongings but can typically be added as an endorsement at additional cost. Replacement cost coverage for personal belongings might be a better bet for some since you would be reimbursed for new versions of the lost items. Actual cash value coverage is less expensive but would likely leave you with higher out-of-pocket costs to replace items after a loss.
Replacement cost coverage is typically included for the dwelling and other structures components of a standard home insurance policy. It does typically cost more to add a personal property replacement cost endorsement to a home policy, but the cost will vary and some carriers may even offer it as part of a standard home policy. When deciding if replacement cost personal property coverage is right for you, you may want to create a home inventory of your personal property. Understanding the current value of your contents may help decide if RCV is the right choice for you.
The best homeowners insurance companies depend on your needs and wants from a carrier. You may want a company that has longevity in the industry and a good track record of paying claims. Or, you may be more focused on mobile services and price. Determining what is most important to you from an insurance company may help you find the best home insurance carrier to meet your criteria.