What is Replacement Cost Value (RCV)?

Coverage for Replacement Costs

The homeowner's forms provide replacement cost coverage for the dwelling and associated structures. Suppose the amount of in-insurance covering a building at the time of a loss is at least 80% of the facility's replacement cost. In that case, the loss will be reimbursed on a replacement cost basis (without depreciation deduction) rather than an actual cash value basis. The insured must subtract the cost of excavations, pipes, wiring, or foundations below the basement to meet the 80 percent threshold (or below the ground if there is no basement). Only structures are covered at replacement cost; personal property is only covered at its current cash worth. Furthermore, carpeting, household appliances, awnings, outdoor antennae, and outdoor equipment are not covered by the replacement cost provision.

The extension, on the surface, prevents depreciation in settling losses if the insured has maintained the required insurance of 80 percent of replacement cost. In effect, the expansion allows the insured to obtain insurance on the building's depreciation. If the insurance coverage is less than 80% of the replacement cost, the firm will pay the greater of the two amounts:

The true monetary value

The percentage of the loss's replacement cost

If the loss exceeds $2500 or 5% of the policy, the building must be restored or replaced before the insured can get compensation on a replacement cost basis.

It can be helpful to explore some issues with establishing the insurance value of real estate here. Most insureds have a skewed understanding of what is meant by insurable value, which leads to insufficient insurance coverage.

Replacement cost and actual cash value are the two most common types of insurable value in residential property. The cost of reconstructing the structure using materials of the same kind and quality at current prices is known as replacement cost. On the other hand, actual cash value refers to the cost of a new item minus depreciation.

Some insureds think of insurable value in terms of an unsuitable metric like loan value or market value. The mortgagee typically requires insurance proportional to its interest in the property, supporting the erroneous belief that market value and insurable value are somehow related. There's no reason to believe the market value will be the same as actual cash value or replacement cost; in fact, there's cause to think it won't. The availability and demand for a specific form of real estate determine market value. The land value on which the building stands is included. However, the land value is not included in the insurable worth.

Consider a $50,000 home built 30 years ago to demonstrate the replacement cost provision (and show the effects of insurable value misconceptions). The owner recently purchased this property for $120,000 and insured it for the same amount. Assume that a loss happens, resulting in $8000 in roof damage. The adjuster determines that the building's current replacement cost is $200,000 when correcting the loss. The building's roof is estimated to be ten years old, with a 20-year life expectancy. The insurer will pay the greater of the actual cash value of the loss (50 percent of $8000, or $4000) or the percentage of the loss that the amount of insurance carried bears to 80 percent of the replacement cost when settling the $8000 roof loss. The insurer will pay 120/160 of the $8000 loss, or $6000, because 80 percent of the replacement cost is $160,000, and only $120,000 in coverage has been acquired. The policyholder will be responsible for $2000 of the loss. Payment for the same $8000 loss would have been provided entirely without a deduction for depreciation or a penalty for underinsurance if the insured had obtained insurance equivalent to 80% of the replacement cost.

Note that the recovery in this example exceeds the loss's actual cash value and that without the Replacement Cost clause, the insured would have only received the loss's actual cash value, or $2000. This indicates that, even if the insured is underinsured, Replacement Cost coverage is preferable.