What is replacement cost coverage, and do you really have it? 

Anyone who owns a home or business should have appropriate and adequate insurance coverage.  Most home and business owners have coverage known as replacement cost coverage.  Replacement cost coverage comes in various assortments such as “Guaranteed” replacement cost coverage, “superior” replacement cost coverage, and replacement cost “guaranty”.  But, what is replacement cost coverage and how does it actually work?

Unlike coverage for a motor vehicle accident, where if your car is damaged you generally only receive the actual value of your car, often referred to as the actual cash value, most homeowner’s insurance policies will only provide you with the replacement cost coverage.  Assume you have a homeowners’ policy with $200,000 in coverage for your home and $100,000 in coverage for your personal property. In the event of a property loss, you would assume that if your home were completely destroyed, you would receive the entire $200,000 limit attributable to your building, especially if you have replacement cost coverage. However, most insurance companies will not pay this policy coverage limit in the event of a total loss due to the fact that most policies have replacement cost provisions.

Replacement cost provisions often state that in the event the loss exceeds a certain amount (often as low as $2,500), the insurance company only needs to pay you the actual cash value of your damages and is not obligated to pay you replacement cost damages until you fulfill certain insurance policy conditions.  Those conditions generally include replacing your home or personal property, and proving you have spent or will spend the full amount of your replacement cost coverage, as well as other additional coverage conditions and requirements.

Using our example, if your home was determined to be a total loss, the insurance company could apply a depreciation factor of upwards of 50% or more depending upon the age and condition of the home or personal property. Depreciation is the amount that is often withheld by the insurance company and represents the difference between the replacement cost damages and actual cash value damages. The insurance company will then agree to pay you the actual cash value amount, the total left after the depreciation amount is subtracted, and often times there are no obligations under the policy as to what you do with those funds.  In other words, you are not required to rebuild your home, you may take that money and simply move on.  However, in order for you to obtain the benefit of your replacement cost coverage and acquire the depreciation the insurance company has withheld, you must comply with insurance policy conditions which include rebuilding your home and spending the actual cash value funds you have received from the insurance company.

Another variation of replacement cost coverage is known as the “Guaranteed” replacement cost endorsement.  Some insurance companies offer this coverage, and while it does vary from company to company, generally the insurance company guarantees they will pay you the cost to rebuild your home even if that cost were to exceed the amount of insurance listed on your policy.  However, even with guaranteed replacement cost endorsements, generally the insurance company will only pay you the actual cash value of your loss, and they are still entitled to withhold depreciation until you comply with the policy conditions. There are some, but very few, insurance companies that do not require depreciation be withheld when they issue replacement cost endorsements.

You should check with your agent or insurance company directly to be sure you have adequate coverage and to confirm all improvements made to your home have been reported as well as adequately insured.  Also, be sure to determine whether you have replacement cost coverage and whether your insurance company can deduct depreciation in the event you have a claim.  Consider inquiring into whether guaranteed replacement cost coverage is available and what the insurance company will charge you in order to provide you with replacement cost coverage, or guaranteed replacement cost coverage.

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