Insurance Coverage and Replacement Costs

You just purchased a new house, and your insurer told you that the policy coverage amount will be far greater that the amount that you paid for the house. You want to know, "Why?" It's likely that your insurer is requiring you to buy coverage at the home's replacement cost rather than its actual cash value.

Replacement Cost Defined

Replacement cost is the amount of money it would take to repair, replace or rebuild your home with materials similar to the kind and quality used in constructing your home. If replacement cost is used to determine claims on your home, there is no deduction for depreciation, a decrease in value over time due to age or wear and tear.

In contrast, the actual cash value method for settling loss claims is the amount of money needed to repair or replace your home based on its depreciated value. This means you'll receive less money to rebuild or replace your home.

Why You Should Have Replacement Cost Coverage

Construction costs increase over time, and the cost to rebuild your home with similar materials and workmanship could be higher than the amount that you could currently sell your home for. While the market price of a new home includes the cost of construction, the market price of a used home might go down because of age and deterioration.

Factors such as changes in building codes, for example if new, additional or more expensive components are required upon reconstruction for things like energy efficiency or fire safety, replacing all or part of your home could cost more than the home's market value. Most insurers and some states require that your house be valued at its replacement cost in determining adequate coverage. Your mortgage lender may require replacement cost coverage as well.

Where replacement cost is used in determining coverage, the policy limit is usually set for at least 80% of your home's replacement cost. If you fail to insure your home for at least 80% of the replacement cost, your insurer will assess a penalty on partial loss claims.

For example:

  • If the replacement cost of your home is $125,000, 80% of that is $100,000 in coverage.
  • So, if you insure your home for $100,000 and suffer fire damage of $20,000, your insurer will pay the full $20,000 loss claim.
  • However, if you only insure your home for $80,000 to cover the mortgage and then suffer fire damage of $20,000, your insurer will pay only a part of the $20,000 fire loss.

As you make improvements to your home, keep track of your home's value. Each improvement and inflation increases the replacement cost of your home. You should check with your insurance agent each year to be sure that you have adequate coverage.

Optional Coverages

Guaranteed replacement cost can be purchased can be purchased in addition to your standard policy to provide the most complete coverage on your home. Your insurer may require you to comply with certain rules and conditions.

An inflation guard endorsement automatically adjusts the replacement cost coverage limits of your home to ensure that your coverage is adequate.

A scheduled personal property endorsement provides protection for such personal property as jewelry, furs, stamps, coins and fine art. Normally, these items are covered on an actual cash value basis with sub-limits that limit the items' replacement cost. Also called a personal article floater, the additional protection requires each item to be itemized and described.

Questions for Your Attorney

  • How much of your practice involves insurance?
  • Does my state require replacement cost coverage or have other minimum insurance requirements?
  • What endorsements or additional coverages are recommended in my situation?
Related Resources on Lawyers.comsm

- Homeowner's and Renter's Insurance FAQ
- Insurance Coverage and Actual Cash Value
- Insurance Coverage for Loss of Use of Your Home
- Property Insurance articles and information
- Finding an Insurance Attorney
- Find a Property Insurance attorney in your area
- Visit our Insurance Claims message board for more help

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