Replacement Value Insurance: Is It Worth The Switch?

When buying an insurance policy, you may be given the choice of insuring your property at replacement cost value or actual cash value. These are two different methods used to determine how much you will receive from your policy to cover an item if it is lost or damaged. Replacement cost coverage pays for the replacement of damaged items so you can buy new, equivalent items. This type of coverage does not account for depreciation. Actual cash value policies, on the other hand, are based on the depreciated value of the items.

Replacement cost insurance vs. actual cash value

When buying an insurance policy, you may be given the choice of insuring your property for its replacement cost value or its actual cash value. These are two different methods used to determine how much you will receive from your policy to cover an item if it is lost or damaged.

Replacement Cost Insurance

If you have replacement cost insurance, your claim will cover the cost of restoring items to their original condition or the cost of buying new items of like kind and quality to the ones lost; there will be no deduction for depreciation. This means, if your four-year-old TV is stolen, the claims payment you receive will allow you to buy a new TV with features as similar as possible to the stolen model. The payment you receive may not be the same as you originally paid for the TV, as a similar model is likely cheaper now.

Premiums for replacement cost policies are generally higher than those for actual cash value policies.

Actual Cash Value

If you have an actual cash value policy, your claims payment will be based on the cost of buying items in a similar condition to the ones you lost; depreciation will be factored into your payment. For example, if your six-year-old washing machine is damaged in a fire, your insurance company will determine the current value of that machine in its used condition and provide you with that amount as a payment.

You’ll likely be charged a lower premium for an actual cash value policy.

However, if you purchase new items to replace the ones you’ve lost, you’ll have to pay the difference between the insurance payout and the cost of a brand new item. Or, if you choose to replace with an older or used item, you may find it hard to find something satisfactory.

Both types of insurance have their pros and cons. Before choosing one or the other, make sure you discuss the options with your financial advisor, who can help you determine which works best to protect your property and stay within your budget.

Pros and cons of replacement cost insurance

Replacement cost insurance is a type of coverage that pays for the replacement of a damaged item with a new one. It is usually the default option for homeowners insurance and covers the house and other structures on the property. It may also apply to personal belongings, depending on the policy.

Pros

With a replacement cost policy, you will receive enough money in your claims payment to replace your lost items. This means you won't have to pay out of pocket to buy new items.

Cons

Premiums for replacement cost policies are generally higher than for actual cash value policies. This is because the insurance company is on the hook for more money if you need to file a claim.

Actual Cash Value vs. Replacement Cost

Actual cash value policies are based on the depreciated value of an item, whereas replacement cost coverage does not account for depreciation. For example, if your TV is stolen, a replacement cost policy will reimburse you enough to buy a new TV of a similar model and quality. However, an actual cash value policy will only reimburse you for the depreciated value of the TV, which may be less than the cost of buying a new one.

Pros and cons of actual cash value insurance

When you buy an insurance policy, you may be given the choice of insuring your property at replacement cost value or actual cash value. Here are the pros and cons of actual cash value insurance:

Pros

When calculating items at actual cash value, you’ll likely be charged a lower premium.

Cons

• If you purchase new items to replace the ones you’ve lost, you’ll have to pay the difference between the insurance payout and the cost of a brand-new item.
• If you choose to replace with an older or used item, you may find it hard to find something satisfactory.
• The more proof you can provide of the items you’ve lost, the easier it will be to determine their current value. That means it’s always a good idea to keep an updated home inventory and receipts for expensive items.
• Actual cash value insurance policies are generally higher than premiums for replacement cost policies.

How to calculate the replacement cost of your home

The replacement cost of a home is the amount it would cost to rebuild your property using similar materials in the event that it is damaged. This is different from the market value of your home, which is the price it would sell for on the real estate market.

There are several ways to calculate the replacement cost of your home. Here are some methods to help you determine this value:

• Get an appraisal from your insurance company: When you get a quote from a homeowners insurance company, they will use their own replacement cost estimate tools to calculate your home's replacement cost value. The accuracy of this appraisal will depend on the information the insurer has about your home, such as its square footage, age, and materials used.
• Hire a professional appraiser: A professional appraiser will perform an on-site home inspection and provide the most accurate calculation, taking into account your area's building ordinances and costs. This option tends to be the most expensive.
• Use an online replacement cost calculator: Several independent companies offer replacement cost estimates online, some of which are free. These calculators use similar questions and data to insurance company tools but may not reflect accurate construction costs in your area.
• Calculate it yourself: You can also estimate the replacement cost yourself by multiplying the local cost per square foot to build a home by your home's square footage. This method is less accurate but can give you a ballpark figure. According to HomeAdvisor, the average cost to build a house in the US was $280,226 in 2022, or about $150 per square foot.

It's important to understand the factors that can influence the replacement cost of your home:

• Age: Older homes may have materials and characteristics that are harder to replace and thus more costly.
• Square footage: Generally, larger homes cost more to replace since they require more materials and labour.
• Home features and fixtures: The quality and number of home features, such as flooring, roofing, cabinets, and countertops, will affect the replacement cost.
• House style and foundation type: Complex home designs and certain foundation types, such as a basement or crawl space, can increase the replacement cost.
• Cost of labour and location: The availability of skilled workers and the average labour costs in your area should be considered. Typically, homes in popular large cities cost more to replace than those in rural areas.

By understanding these factors and using one or more of the methods mentioned above, you can calculate the replacement cost of your home, which will help you make informed decisions about your homeowners insurance coverage.

How to upgrade to replacement cost coverage

Upgrading to replacement cost coverage can be a good idea if you want to ensure you can replace older items with newer ones. Here is a step-by-step guide on how to upgrade to replacement cost coverage:

• Understand the difference between replacement cost coverage and actual cash value coverage: Replacement cost coverage pays for the replacement of damaged items so you can buy new, equivalent items. It does not account for depreciation. Actual cash value coverage, on the other hand, reimburses you for the value of destroyed or stolen property minus depreciation.
• Check your current policy: Review your current homeowners insurance policy declarations to see if you already have replacement cost coverage. If you are unsure, contact your insurance provider.
• Consider the costs: Replacement cost coverage generally costs more than actual cash value coverage. Evaluate your budget and decide if you can afford the higher premiums.
• Contact your insurance provider: Get in touch with your insurance company or agent to discuss upgrading to replacement cost coverage. They will be able to guide you through the process and provide you with a quote.
• Provide necessary information: Your insurance company will need information about your home and belongings to calculate the replacement cost coverage amount. This may include details such as the age and square footage of your home, the value of your personal belongings, and any upgrades or renovations you have made.
• Review the quote: Once you have received a quote from your insurance company, carefully review the coverage amount and the associated costs. Make sure you understand the coverage limits and any deductibles that may apply.
• Make the upgrade: If you are satisfied with the quote and the coverage offered, go ahead and make the upgrade to replacement cost coverage. Remember to keep your insurance provider informed of any future changes or upgrades to your home to ensure your coverage remains up-to-date.

By following these steps, you can upgrade to replacement cost coverage and have the peace of mind that you will be able to replace your belongings with new, equivalent items in the event of a covered loss.

Frequently asked questions