Replacement Cost Coverage:

Almost everyone who owns real or personal property needs to have it insured. The type of insurance coverage they purchase will determine the extent of their financial recovery following a loss. In all property damage losses the valuation method used to indemnify the insured is critical to their actual recovery.
Many insurance policies are sold as Actual Cash Value (ACV) policies, which pay for the cost to repair or replace damaged property with property of like kind and quality. Depreciation, however, will be deducted from the restoration cost to eliminate any “betterment” which may be created. As an example, since you can not replace an old roof which is damaged with another old roof. You have no choice but to replace it with a new roof which will provide a betterment. Without the proper coverage you will have to pay for the enhancement beyond the depreciated value yourself.
Example: If you need to fully replace a 10-year-old roof that has an expected useful life of 20 years, the insurer will only compensate you for 50% (the remaining useful life) of the replacement cost.
In theory the insurer is indemnifying you for the actual loss sustained. However, you will be responsible for 50% of the cost of the replacement of the roof.
Many years ago to close this void, the insurance industry began to offer Replacement Cost coverage.
This innovation, expanded the basic Actual Cash Value coverage beyond the indemnification principle. Therefore, the policyholder, who had a property loss, did not need to suffer the additional financial loss as a result of depreciation.
Depreciation may not be an issue in cases where only repairs are being made instead of actual replacement (for example: if only a small portion of a roof is being repaired instead of an entire replacement). Also, in some state jurisdictions, depreciation is not permitted to be deducted on partial losses.
Although replacement cost coverage compensates the insured for the difference between the depreciated cost and the actual cost of making the replacement or repairs; almost all policies require that the property be repaired or replaced before the depreciation is paid.
The insurer will hold back the depreciation and initially pay only the ACV loss. The withheld depreciation will be paid only after the actual replacement has been completed.
Many policyholders believe that they must restore the property to its exact condition prior to the loss or replace the property with exactly the same property.This is not true! The courts have been liberal as to what constitutes actual replacement. Generally, as long as the replacement dollars are spent, the depreciation will be recoverable. For example, several of our clients have purchased other real property rather than effect repairs to the damaged location.
When contested in the courts, this practice has been upheld in favor of the insured. Additionally clients have actually purchased multiple properties to replace a single property to meet the criteria of spending all of the replacement cost monies available.
In addition to real property, replacement cast coverage is available for personal property, including machinery, equipment, office furniture household contents,etc.
Policyholders should strongly consider buying this coverage on their personal property because depreciation is often a major factor on this type of property.
After suffering a loss, is not the time to find out that you did not buy enough insurance. A mistake like this could cost you a lot of money— be it based on ACV or replacement cost basis. It is important to realize that to be eligible for full replacement cost coverage, adequate coverage must be purchased. If you do not insure adequately to replacement values, you may only recover a portion of the full replacement cost benefits.
How much coverage is enough? The owner should insure the property for at least 80% of the full replacement cost of the property. Some policies may require that the insured purchase 90% of replacement cost. Note that if there are multiple buildings and locations, it is helpful to have blanket coverage (building and contents) under one aggregate limit.
Many policies also require that the policyholder make claim for replacement cost within 180 days of the loss.
This does not mean that they have to actually reinstate the property within that period of time. Rather, they have to notify the insurer within that period that they intend to exercise their replacement cost option. (Barring a coinsurance penalty which may occur in certain types of policies, it is always advisable for the insured to select their replacement cost options versus actual cash value.)
When making claim for replacement cost, the insured only has to effect the repairs within a reasonable period of time after the loss. Some policies have a one-year to two-year requirement. Should the need arise, this requirement may sometimes be extended by the carrier.
Many homeowner insurance carriers, and some commercial carriers, offer Guaranteed replacement cost coverage. This means the insured can recover an amount in excess of the face amount of the policy— provided they can establish that the actual replacement costs exceeds the amount of insurance.
In order to qualify for guaranteed replacement cost coverage, the carrier normally has the property inspected, valued, and approved for this type of coverage. The valuation is done, prior to placing the coverage, to ensure that a sufficient amount of coverage be purchased. It is incumbent upon the insured to ask the agent/broker if the coverage is available. If you do qualify for guaranteed replacement cost coverage, buy it.
Buying the wrong property insurance coverage can be financially devastating. Be sure to make a thorough review of your insurance portfolio before the loss occurs— or have an independent, professional review it with you.
Knowing what you can and cannot expect from the policy’s coverage before a loss occurs is critical to helping the insured manage their risk. It is also extremely valuable during a property loss adjustment. 
Replacement cost coverage was developed to serve both insureds and insurers. But like all of the provisions in the policy, the degree to which it benefits each depends on how well it is understood and then applied when the insurance is called to deliver!

Ronald J. Papa, SPPA works for Adjusters International (AI) in Buffalo, New York.


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