Replacement Cost in Home Insurance

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Because you have a homeowner's insurance policy, you assume you're covered for certain types of damage to your dwelling or personal property. But what does "covered" really mean?

Let's say a type of peril such as a fire, which is covered by your insurance policy, destroys your home. You probably have a payout coming from your home insurance, but what will this payout cover? Will it be enough to rebuild your home? That depends on the type of damage coverage you have.

Replacement cost insurance is a type of home insurance coverage designed to fix the damage at today's prices or buy an acceptable substitute.

What Is Replacement Cost Insurance?

There are two ways an insurance company can decide how much to pay for something that's been destroyed by an event covered by your policy:

  • Actual cash value. Actual cash coverage pays out what the item is worth today. Adjusting the value of something according to its age is known as depreciation.

  • Replacement cost value. Replacement cost coverage pays out what it would cost to repair or replace an item at today's prices.

Your home insurance policy will specify which method it uses. Either method should give you some compensation for loss or damage, but replacement cost insurance is more likely to pay out enough for you to repair the damage or buy a replacement without reaching into your wallet.

Even replacement cost damage is subject to coverage limits. So, if the cost of replacing lost or damaged items exceeds your coverage limit, you may have to pay for the difference yourself.

The higher you set your coverage limit, the more a policy is likely to cost. Insurance companies generally require that the coverage limit on a replacement cost policy be at least 80% of the estimated replacement cost of covered property.

Actual cash coverage pays out what the item is worth today.

For even more coverage (and a higher premium), you can get guaranteed or extended replacement cost coverage, both of which provide a margin of error when estimating the replacement cost of your possessions and home-rebuilding costs.

How Does Replacement Cost Insurance Work?

If you have replacement cost coverage and file a claim, the insurance company is likely to make an initial payout based on the actual cash value. They will later reimburse you for any additional amount after you fix or replace the covered item.

Homeowners insurance typically covers both your dwelling and other structures on the property as well as your personal possessions.

Dwelling coverage

Dwelling and other structures are usually covered on a replacement cost basis. That's fortunate, because what it would cost to rebuild a home is likely to be far out of step with the depreciated value of the home. After all, the cost of building materials and labor rises over time.

Personal property coverage

While dwelling coverage is often on a replacement cost basis, the standard for personal property coverage is actual cash value. However, you can upgrade this to replacement cost coverage by paying a higher premium.

The upgrade to replacement cost coverage for personal possessions is worth considering. Actual cash value might not adequately compensate you to replace your personal possessions.

Whether you choose actual cash value or replacement cost coverage, it's important to keep a detailed and up-to-date inventory of your personal possessions. That can be a basis both for deciding on a coverage limit when you get a policy and for filing a claim if anything is stolen or damaged.

Replacement Cost Examples

Here are some examples of how replacement cost can apply to certain types of covered property:

  • Construction materials. As you look around your house, you may see that things like doors, countertops and carpets have quite a bit of wear. However, if they were destroyed you'd have to replace them with new materials. Also, the work would have to be done at today's labor costs. This is why replacement cost is so important for your dwelling and other structures.

  • Electronics. That 10-year old sound system of yours may have depreciated in value, but if it were lost or destroyed, would you be able to go out and find a similar 10-year old system to buy at its depreciated value? More likely, you'd have to buy a whole new system, in which case replacement cost would be more relevant that actual cost value.

  • Art and collectibles. While many personal possessions do depreciate in value over time, things like art and collectibles are often bought with the idea that they will grow in value. If you have possessions like that, replacement cost coverage for your personal property may be especially important.

  • Jewelry. If you have nothing but costume jewelry, there may not be a big difference between actual cost value and replacement cost. However, if you have fine jewelry made from precious metals and gems, their market value may have increased over time.

Replacement cost coverage pays out what it would cost to repair or replace an item at today's prices.

How Replacement Cost Is Determined by Insurance Companies

While replacement cost insurance is designed to pay you what it costs to repair or replace your property, the amount you receive is subject to coverage limits. That's why it's important for you and your insurance company to make an accurate estimate of replacement cost for the purpose of setting those limits.

Also, when it comes to personal property it's important to have a clear record of what's been lost or damaged should a covered event happen.

When you first get a policy, chances are the insurance company will make a detailed inventory of your property and make a trained assessment of its value. You have to make sure the record is kept up to date over time or else you won't get an accurate payout.

If you acquire a lot of personal property, keep your inventory up to date. Depending on the value of the new property, you may want to reassess your coverage limit.

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How Is My Home's Replacement Cost Calculated?

When it comes to estimating the cost of replacing a home, the insurance company will take several factors into consideration:

  • Size

  • Style of house

  • Building materials

  • Number of rooms

  • Local construction costs

  • Other insured structures on the property

This process will take place when you first buy the policy. After that, you should check whether coverage limits are automatically updated each year, or simply ask your insurance company to raise them.

Even if your coverage limits are automatically updated annually, they may not accurately reflect the increase in the replacement cost of your home and its contents, especially in periods of high inflation.

If you think the adjustment of your coverage limits has lagged behind the rise in the replacement cost of your home, you can request a more detailed reassessment. Or, you could start fresh by shopping for a new policy, which may cost less too.

Do I Need Replacement Cost Coverage?

Actual cost value coverage is based on depreciation over time, so it's usually more expensive to replace property than an actual cash value insurance payout.

For that reason, here are some factors that may make replacement cost coverage especially attractive:

  • How long you've lived in your home

  • Whether it would be essential to replace most of your property

  • Upgrades to your home

  • Valuable personal property

Dwelling and other structures are usually covered on a replacement cost basis.

Home Insurance Replacement Cost Coverage FAQs

What if the market value of my home is more than the replacement cost value?

Market value is greatly affected by location, but that doesn't much factor into what it would cost to rebuild your home. Imagine two identical houses, but one is in a very fashionable neighborhood while the other is in a less popular location. Chances are the one in the fashionable neighborhood would sell for a lot more, but the two houses would cost more or less the same to rebuild.

I got my insurance policy many years ago; does that mean my replacement cost estimate is out of date?

It certainly means you should check, especially since construction costs have risen sharply lately. Even if your coverage limit has been adjusted automatically, those adjustments may not reflect the actual rise in construction costs. You can easily check to see if your coverage limits have kept up with inflation, and if you have any concerns ask an insurance company to make a new assessment.

What if I don't agree with the insurance company's replacement cost estimate?

You can assemble facts and figures to back up your estimate of the replacement cost, and see if this information gets the insurance company to reassess. Or you could try another insurance company.

How To Get Replacement Cost Insurance

Replacement cost coverage should be an option available from most insurance companies. It will often be a standard part of the coverage for your dwelling and other structures, but you may want to extend replacement cost coverage to your personal items.

Replacement cost coverage may be pricier, but you can keep a lid on the cost if you compare quotes from different insurance companies. Enter some basic information below to find the most cost-effective way to get the replacement cost coverage you need. The quotes from insurance agents are free.

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