One question we hear quite a bit is, “Do I need replacement cost coverage on my home (or commercial property) insurance?”
While only the parties with an interest in the property can answer that question, it is important to know the differences, advantages and downfalls.
Actual Cash Value is the method for calculating a property’s value that DOES consider depreciation of the structure and its materials. Depreciation comes by way of many forces – hail, rain, wind, heat, cold, and the culmination of the elements known as general wear and tear.
Replacement Cost valuation does NOT consider any depreciation. When your property insurance or homeowners insurance is covered on a replacement cost basis, the insurance company is agreeing to replace the building with like materials and makeup, up to the limit of insurance shown on the declarations page of the policy. In simpler terms, they agree to replace the building or home for the dollar amount stated in the policy.
Let’s use an example of a home and homeowners insurance. In the policy language, the home is referred to as the Dwelling, and the specific coverage piece for the property insurance is Coverage A. For our example, let’s use a 25 year old, 2,000 square feet, 1 story home, built on level ground outside of a “flood zone” in the beautiful Southwest region of Oklahoma. In the 25 years since the home has been standing, it has endured countless thunderstorms, high winds, blistering heat and even some snow fall (let’s be real, mostly ice). The roof has taken a beating since the last time it was replaced in 2005. Well, most companies don’t like a roof that old so they will try to force an Actual Cash Value endorsement on the policy. This means that when the homeowner decides to get a new roof after the next hail storm, the company will say, “we will pay for the cost to replace the roof, minus the value of 15 years worth of depreciation.” That leaves you footing the rest of the roofer’s bill on top of your Wind & Hail Deductible.
Now I’ll make a quick distinction about insurance and its view towards depreciation. Insurance is designed to cover a loss from an event, or peril. Wear and tear, or gradual depreciation, is not an event. In most cases, insurance will not respond to a loss in value of a property that has slowly taken place over an extended period of time.
[An insurance policy is a contract between at least 2 parties. You have a need – an asset to protect or replace in the event of a loss. You are asking the other party to replace/repair the asset after a loss. The other party considers as many factors as they can, like the quality of the asset, the location and the likelihood of certain losses taking place. They offer you a price (annual premium) along with several conditions, including additional money out of your pocket (a deductible) should a loss occur – as long as the conditions have been met, which you agree to by signing and paying the premium, then the company will replace or repair the asset for the covered losses as stated in their offer. If a loss occurs that falls outside of those covered perils in their offer, or that particular type of loss is specifically excluded (such as a flood or an earthquake) then they are not obligated to replace or repair.]
Whew – got into the weeds a bit there, sorry!
Again, it is not your agent’s job to recommend one over the other. Only you (and any other interest in the property, like a mortgage company) can make that decision. What is factual is that Replacement Cost coverage is the broader coverage option.
Still not sure which is right for you? Set up an appointment with us to discuss your situation and we will help as best we can.