You’ve heard about Replacement Cost Home Insurance before but what is it?
Replacement Cost is something that you need to pay very close attention to. It will literally make the difference of thousands or tens of thousands of dollars with your claim payout.
Replacement Cost is not Market Value. People like to think “my home is worth $xxx,xxx so that’s what I should insure it for”. Well, you aren’t insuring your home against not being able to sell it. You’re insuring it in case you have to replace or rebuild your property. Replacement Cost values follow the current costs of labor & materials while Market Values are based on the supply & demand economics of your local real estate market.
Let’s talk first about how property insurance works.
Property Insurance Basics and Perils
When we talk about property insurance we are talking about protecting your tangible property. This means your home, other structures on your property, and all of your personal property that you have inside your home. Now, think about what kinds of things could damage or destroy your property? You’re probably thinking about things like fire, water, wind, theft, etc. Those are what insurance policies call perils and your policy will explain exactly which perils you have protection against. If you aren’t sure, give us a call and we’ll help you make sense of your policy, whether you’re our client or not.
You’ve had a loss, now what?
So, if one of these perils pays you a visit, and it’s not excluded by your policy (flood & earthquake are common exclusions, for example), you may consider making a claim against your home insurance policy. Our clients ask us all the time whether or not they should file a claim and whether or not the policy is going to cover the claim.
First of all we explain to them that, as their agent, we are not the one that has been trained to settle (adjust) claims. The claims adjuster from the insurance company is the only one that can determine whether or not your loss will be covered by the policy and authorize payment. The other thing to consider is the deductible. Personally, I probably wouldn’t file a claim if I expected the loss to be less than 2x my deductible, but that’s a personal preference and every household is unique.
What will my policy pay me for my loss – Replacement Cost vs Actual Cash Value
Your Home Insurance policy hopefully has Replacement Cost coverage. Again, if you aren’t sure, check with us and we’ll let you know. To understand how Replacement Cost Home Insurance works let’s first talk about Actual Cash Value.
A standard home insurance policy likely covers your losses on an Actual Cash Value basis. This is a simple equation:
ACTUAL CASH VALUE = COST NEW – DEPRECIATION
So, the claims adjuster is going to apply a depreciation factor to your damaged or lost property. This is going to be based on the age of the property and the condition and will be determined at the time of your loss.
Actual Cash Value example
If your home was built in 2007 (10 years ago at the time of this blog post) and your washing machine upstairs has a fixture that breaks while you’re away on vacation. You come home to water everywhere.
Now, look at the picture and think of what kinds of repairs you’re going to have to start making. Your walls, paint, baseboards, flooring, and electrical outlets will all need to be repaired or replaced. For these repairs your contractor is going to use new building materials, but your damaged property was 10 years old. Actual Cash Value is only going to pay the value of your 10 year old property, not the cost of new materials. Trust me, this is not how you want your claim to be settled.
Replacement Cost Home Insurance – the winner
In our water damage example, if you have Replacement Cost Home Insurance, your policy will pay the cost of the new materials that will be used to replace or repair your damage. You are replacing the old with new.
Replacement Cost examples are easy when you think about things like TVs, furniture or clothing. If you have a renters insurance policy and someone breaks into your home and steals your 5 year old 50″ TV you will want to go replace it with another 50″ TV. The question is do you want to go on to Craigslist and find a used, 5 yeard old 50″ TV like the one that was stolen, or would you rather go to a store and buy a new TV? I know what I would rather do.
You may not get all the money up front
Most Replacement Cost Home Insurance policies are not going to just write you a check for the full amount needed to replace your lost or damaged property. The claims adjuster wants to make sure that your claim payment is actually going towards replacing your property and not that Disney Cruise vacation you’ve been planning for years.
So, the claims adjuster will first pay you the Actual Cash Value of your property. Then, when you can show proof that you have replaced the property, they will pay you the difference. What this usually means is using your savings or a credit card to replace your property and then replenishing your savings or paying off your credit card with the Replacement Cost payment that will come after you have replaced your property. You see, if you aren’t planning to replace the property then why should your insurance policy pay you to replace it.