Nearly half of all homeowners are confused by the concept of replacement cost and what it means for their home insurance coverage. Many people think the limits that appear on the "dec" page of their insurance policy are a good indicator of how much they'll be paid when they have a claim. But this isn't the case.
The limits on the dec page are the maximum you could be paid, not necessarily how much money you'll receive.
Here's what you need to know about how much you will get paid in a claim, and how replacement cost or actual cash value coverage make a difference.
How Much Will You Be Paid for Your Claim?
How much you can expect to be paid for your insurance claim depends on three key factors.
Accuracy of Lost Value
How accurately can you describe, document, and show the lost value of your property? Keeping a home inventory of items can really help. The more details and proof you provide, the less likely you are to be at the mercy of the insurance company's estimates.
Type of Policy
What type of policy do you have? Different insurance policies provide different coverages. You might have a homeowner's or condo policy, but the type of policy you've taken out will dictate the risks covered. It will also cite any exclusions or special limits for certain items.
Special limits aren't standard across all insurance companies. Those specializing in attracting consumers with high-value homes might have higher special limits in the areas of jewelry, fine arts, or even wine collections.
Basis of Claims Settlement
What is the basis of claims settlement? Will the insurer pay "actual cash value" or "replacement cost"? This is a critical distinction.
You can usually find this basis of claims settlement in the fine print of your policy. Very often, a homeowner is upset about how much they were paid, because they didn't understand the terms of making a claim.
Actual Cash Value and Replacement Cost
Actual cash value (ACV) is the depreciated value of an item of property at the time of the loss. This type of settlement does not allow you to replace what you've lost, at least not without some of the money to replace it coming out of your own pocket. Rather, it compensates you for the value of the item in its most recent condition before the loss.
Replacing your personal contents—or even worse, your home—on an actual cash value or depreciated basis leaves you at a loss, compared to replacement-cost settlements.
Replacement cost, on the other hand, provides you with the money needed to replace the lost items. It's far better than ACV, because it allows you to put yourself in the same financial position you were in prior to the loss.
One common misconception about replacement cost is how it will be paid. You must first replace the items before you're able to collect the payment. But there are some exceptions. For example, in many high-value home policies, the terms may be different.
Depending on the size of the loss and the type of claim, you'll likely be asked to provide a list of items and their values. Allow time for the insurance company to review the list and determine how and what they are going to pay you. Then, you will be able to review the company's offer.
If your basis of loss settlement was ACV, reimbursement may look different. You might be asked to sign off on the amount—agreeing that it's a final payment—before you receive a check.
What Information Do You Need to Provide?
- Descriptions of the items, with makes and models (if applicable)
- When you purchased each item
- The price you paid for each
- The item's replacement value today
- Any photos showing the condition of the items
- The original receipts, if possible
While you might not have a receipt for every pair of socks you owned, you might have kept the receipt for your big screen TV. Each insurance company has its own criteria. You can ask the insurance adjuster for a form or guidelines that will help you fill out your proof-of-loss items list.
You can expect to receive two payments before being fully compensated when your loss settlement is on a replacement-cost basis. The first payment will be for the actual cash value of the items.
Then, you must prove that you've replaced the items. At that point, you will typically receive the second and final payment. In most cases, you can submit your expenses along the way if you replace items over time. You can also talk to your adjuster about when you can expect payments. The timeframe often depends on the size of the loss.
Staying in contact with the adjuster on your claim will help you know exactly what to expect, and it will help you get paid for your actual loss.
Replacement Value vs. Replacement Cost
Some high-end policies might offer you the option to receive the full replacement value of your items—without being obligated to replace them.
These types of policies are generally more expensive. You can ask your insurance agent whether you qualify for one. They're often based on higher home values, or condo or tenant policies with higher contents limit requirements, as well as other criteria.
This is very different from replacement cost, where you might only be offered the depreciated ACV as an option if you choose not to replace the item or not to rebuild your home.
The insurance company often retains the right to repair or replace the items. It will review your list and let you know. If an item can be reasonably restored to its condition prior to the claim, you may be offered the option to repair it instead. If not, the company will offer you replacement cost.
Can You Negotiate?
You may have some room to negotiate replacement cost values. For example, the item might have been replaced in the market by a better model since the time when you first bought it. You may have had a three-year-old smartphone that can't be replaced by the same make and model today.
You might find an equivalent product and list that as the "replacement equivalent," along with its value. Always try your best to find the most similar item possible.
If you give a fair replacement cost price and do your research, you'll likely get what you're asking for. If you don't do the extra work, the adjuster will come up with their best solution, and you might lose out.
Some insurers are more lenient than others. It often depends on the circumstances and the company's own requirements.
What If Items Can't Be Replaced?
You might find yourself in a situation where you'll only be offered ACV if an item is determined to be obsolete, or by its "inherent nature, cannot be replaced."
A similar clause can apply to sets or pairs of items when only one part of a set or pair of something is lost, and the other was not damaged.
Special items that cannot be replaced, such as collectibles, antiques, and fine arts, should always be discussed with your insurance representative—before a claim occurs. This will allow you to get the proper advice about how to protect the value with the right type of insurance.
It will also give you the opportunity to get appraisals, and possibly schedule the items on a separate floater or rider to ensure a settlement to value. You might be very upset with what you receive if items of this nature are lost, and the proper insurance was not obtained.
Does Replacement Cost Include Ordinance Coverage?
Ordinance—or law—coverage is insurance for the costs to repair a damaged home if certain building codes came into play after your home was built. Even if your home is insured for replacement cost, some policies don't cover the increased cost of construction due to by-laws or city ordinances.
Endorsements are available to add by-law coverage to your policy. Some high-end policies will also include by-law coverage as a matter of course, but it could be a major problem in determining the actual cost of rebuilding if your policy does not include this coverage.
Many policies include a "guaranteed replacement cost clause," which allows some wiggle room around the total insured value of the home when it's been determined that the cost was a little off. It depends on the type of policy you have and its wording.
For example, some policies might state that you'll still be eligible for replacement cost if you were insured to at least 80% of the value of the actual reconstruction cost.
Do Insurance Companies Ever Pay the Full Limit?
Some insurers might pay out the full value for the home and its contents when the home and its contents are a total loss. That might be the case after a major disaster such as a fire, but the situation must make sense to the adjuster. It's up to the discretion of the insurance company.
An insurance company always has a right to ask for proof of loss, but the adjuster might come to a settlement without making you list every single item up to your policy limits in these types of major claims and total losses. Ask your insurance representative how your insurance company settles a total loss, to get an idea of how things would work.
Always be prepared with records of larger purchases stored in the cloud or a safe deposit box off the premises. Regularly document your home with photos. They could come in handy in a total-loss situation.
Frequently Asked Questions (FAQs)
How does replacement cost insurance work if the value of my personal property goes up?
Replacement cost insurance covers the cost of replacing an item, even if the value of that item increases or the price goes up. If your insurance policy includes replacement-cost coverage for personal property, it should pay to replace your item—even at increased cost. However, it's important to review your policy for coverage limits and deductibles.
What is the difference between fair market value and replacement cost?
Fair market value is how much a buyer would pay to purchase your home. It's affected by factors like the neighborhood, school district, and local housing market. Replacement cost is how much you would have to pay to repair or rebuild your home.