Replacement cost is a term you may hear when discussing homeowners insurance. However, many people don’t understand what it is, never mind how it might benefit you.
Here’s a short explanation of replacement cost value as compared to actual cash value; the two most common options found in most insurance policies.
What is Replacement Cost Value?
Replacement cost value refers the amount an insurer would pay to repair or replace your home or property if it is damaged or totally destroyed. In this case, the insurance company pays to repair or replace your home or property with something of similar quality and kind, based on today’s market.
Conversely, an actual cash value policy compensates you for your loss, less depreciation. While both types of policies can help you with costs associated with a loss, an actual cash value policy can lead to out-of-pocket expenses.
If you want to restore your home to its previous condition or replace damaged or destroyed items, you will need to make up the difference between your payout and actual costs.
Since everything is more expensive today and depreciation deductions can be significant, this can be a big financial blow if you experience a major loss.
Some Items Depreciate Quickly
Most homeowners don’t realize how quickly some items covered under their policy can depreciate. For instance, an item such as a laptop can lose value very quickly.
If you bought it two years ago for $1,000, it would depreciate by 20% each year. Insurers calculate depreciation value based on the initial cost and the estimated lifespan of the item. A laptop only has an estimated five-year lifespan so your relatively new laptop would only be worth $600 in a very short time.
The same applies to other items in your home. For instance, a roof with a 25-year lifespan would normally depreciate about 4% annually. If your loss occurs when the roof is 10 years old, your insurer would deduct 40% for depreciation.
How Do I Determine Replacement Cost Value?
Replacement cost value applies to your home, but not the land your home sits on. As a result, it is very important you ascertain an accurate coverage amount for insurance purposes.
A contractor, appraiser, or skilled insurance agent can help you determine the replacement cost of your home. They will price out the cost of materials, upgrades, and added living space to figure out your home’s insurable value.
Here’s an example. If you bought a new home for $350,000, the lot may be worth $50,000. Your replacement cost value would be $300,000, providing the market did not depreciate and you did not alter your home.
If you spent $50,000 upgrading the kitchen and put a $100,000 addition on the back, the replacement cost value would rise to $450,000.
If you own an older home, you may need modified replacement cost coverage. This can provide compensation if unique features such as plaster walls, hardwood floors, or specialty woodwork are damaged or destroyed.
To determine the value of your personal belongings, a home inventory is vital. One of our agents can review it and align your policy to your needs. You may need endorsements to protect high-ticket items which traditionally have low limits within a standard policy.
What About Premiums?
Since a replacement cost insurance policy provides greater protection, premiums are higher. However, considering the potential scope of financial loss these policies offer value.
Otherwise, any covered claim will not equal what it costs to replace or rebuild. This could end up costing you considerably more.
Policy Deductibles & Limits
Like any other insurance coverage, replacement cost policies include deductibles and limits. Your insurance agent can ensure your policy provides maximum amounts that protect your home and belongings. They can also balance your deductible against your premiums for optimal coverage.
Even if you don’t have your home inventory ready, give us a call. We’ll review your current policy with you and provide you with some options.