When you buy homeowners insurance, you expect it to provide adequate protection when you experience a covered loss. Some are surprised to find their coverage only provides the actual cash value of their belongings, which includes depreciation. Replacement cost provides more protection, repairing or replacing the dwelling or contents at today’s value without depreciation. Understanding what replacement cost is and how it differs from actual cash value and market value can help you make an informed decision when choosing coverages for your homeowners insurance policy.

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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 coverage for your dwelling and other structures, 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, 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.

Guaranteed or extended replacement cost coverage

There are a couple of special types of replacement cost coverage for your dwelling that you could consider as well.

  • 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. But if you want more complete protection over the long term, they may be options worth considering. Speak with a licensed insurance agent at your home insurance company to determine if these types of coverage may be right for you.

How replacement cost is determined by insurance companies

Insurance companies evaluate your home’s characteristics, such as building materials and 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 replacement cost or actual cash value 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 is always best to review how replacement cost coverage applies (or does not apply) to your coverage to avoid surprises should a claim occur.

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 is 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 may cost less than replacement cost value insurance but pays for your items at a depreciated price.

In an actual cash value policy, if your 5-year-old couch needs replacement, your insurance company will depreciate the couch accordingly. With a replacement cost value policy, you will be able to purchase a comparable couch at the current price.

Actual cash value vs. market value

Actual cash value 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 belonging coverage. With actual cash value coverage, depreciation is subtracted from the repairs and replacement costs. Because of this, your claim payout will typically be significantly less with actual cash value coverage than if your policy included replacement cost coverage.

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