When you shop for homeowners insurance, you’ll likely come across terms in the application that you may not understand.
Terms like replacement cost, actual cash value, mitigation, loss of use, and depreciation are common for agents but may not be common for insurance shoppers.
Unless you pay cash for your home, you will be required to purchase adequate homeowners’ insurance and in some cases, the lender will require that you insure for more than its replacement cost because they think the insurance amount must be for at least the amount of the loan.
In these cases, the lenders are wrong. Homeowners’ Insurance covers your home for replacement cost, not the amount you paid for it.
As an insurance agent, one of the first five questions I would get from home insurance shoppers is “what does replacement cost mean in homeowners insurance?”
This article will answer that question and others so you’ll better understand the value of your homeowners’ insurance policy and more importantly, the difference between replacement cost and actual cash value. You also need to make sure your are using one of the top home insurance companies.
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What Does Replacement Cost Mean?
The simple answer is: the cost to rebuild your home as if it were new. Certainly, most people are aware that in a stable or better market, home values tend to increase. Not because the cost of labor and materials go up but because the home buying market has gone up.
But, again, your home will be insured for the amount to rebuild it, not to resell it.
This simply means that in the event your home is considered a total loss after a covered claim, your insurance company will pay to replace it with a new home that has the same characteristics of the totaled home.
For example, if you live in a 2,500 square foot wood frame home with a two-car garage and a shingle roof that you purchased in 1998 that is a total loss, the company will pay the amount it costs to build you a new 2,500 square foot wood frame home with a two-car garage and a shingle roof subject to the deductible you selected when you purchased your policy.
That terrible D-word (depreciation) will not be used to calculate your claim payment, only the deductible. In many states, the insurance company will simply pay the limit of the policy and then close the claim.
It’s essential, however, that every homeowner understands that replacement cost is the valuation for the dwelling, not your contents. Your payment for your home’s contents is calculated differently, contents are generally insured for their actual cash value. We’ll talk more about that in a few paragraphs.
Are there Exceptions to the Replacement Cost Rule?
Yes, there are exceptions. There are some insurance companies that have a clause in the homeowners’ insurance contract about the age of the roof. This clause generally states that the insurance company will pay the depreciated value of the roof if it has outlived its predicted age.
In other words, if your roof has shingles that were manufactured to have a 20-year life but your roof is 25-years old when the home is totaled, the insurance company can reduce your claim payment for the depreciation of the roof. Some companies have inserted this language in their insurance contract so that the applicant will be motivated to have an outdated roof replaced at the homeowner’s expense.
Insurance policies sold in a state that requires a “valued contract” will not have this type of clause because a valued contract requires the insurer to pay the total limit of coverage for a dwelling that’s considered a total loss that resulted from a covered peril.
What does Actual Cash Value Mean?
The actual cash value represents the depreciated value of an item at the time of a loss. Most homeowners’ insurance policies use the actual cash value amount to cover the contents (personal belongings) in your home.
If your totaled house had very expensive furniture throughout, your insurer would first determine how old that furniture is and then add depreciation to the cost of replacing it with new furniture just like it.
Actual cash value, however, can be tricky for both parties to the claim. For example, if you claim to have contents that are highly unusual and are out of the norm, your insurance company will likely require proof of purchase. Your insurer is not going to reimburse you for five expensive fur coats just because you say you owned them. They are going to require proof in the form of receipts, pictures, or videos.
How will I know what the Replacement Cost is on My Home?
There are several different methods for determining the replacement cost of your home. Most insurance companies provide widely accepted technology for agents to calculate replacement costs.
This software allows an agent to calculate a home’s replacement cost by entering the characteristics of the home such as square footage, year built, type of flooring and cabinetry, and so forth.
If you are taking a mortgage on your home purchase, your lender will require an appraisal which will include the market value based on other similar homes sold in the area and the replacement cost based on the same characteristics an agent would use.
If you’re uncomfortable with a replacement cost value from your agent or lender, you can verify their calculation by doing one yourself by using online software like Craftsman National Appraisal Software or DwellingCost.com.
What if I don’t agree with the amount of the Claim?
If there is one thing you’ll learn about homeowner’s insurance claims, they don’t always go well. An insurance policy is a promise to pay in exchange for a premium but what happens when the parties to the contract don’t agree?
Actually, this happens more frequently than you might think. When a total loss claim is filed, you can expect things between you and your insurer to become a little more serious. They are going to attempt to pay out as little as possible and you are going to try and get as much as possible. If you get to a point where you simply cannot agree or if you think you’re being treated unfairly, the quickest way to resolve the issue is to hire a public adjuster to handle your claim.
Public adjusters work similarly to personal injury attorneys although they are not usually attorneys. If they accept your case, they will charge you a percentage of the amount that is over and above what the insurance company is offering you. Most adjusters are familiar with how insurance companies operate and have a lot of knowledge about home construction. Their job is to help you negotiate a better settlement from the insurer so you can go on with your life.
Frequently asked Questions
What is replacement cost?
The cost to rebuild your home as if it were new without regard to depreciation.
Are contents covered for replacement cost?
In most homeowners policies, your contents are covered for actual cash value which is the new cost less depreciation.
Do I have to prove what contents I own?
In most cases, if your contents claim is unusual, the insurance company will want proof of what you own by asking for receipts, pictures, or videos.
Who calculates the replacement cost for my home?
Typically, the insurance agent who is writing your insurance policy will calculate your home’s replacement cost or the insurance company will provide it if you are buying direct from the company.