How does “Replacement Cost” coverage really work?
November 22nd, 2010
Invariably when I talk to a property owner who has experienced a significant loss 7 out of 10 times they think the insurance company is going to give them the full amount of money (in one check) that they will need to replace all of the damaged contents lost in a fire. They believe that because they have “replacement cost coverage” that the insurance company owes them for the full value it would take to buy another item of like kind and quality whether they ever replace that item or not. As a Tennessee and Kentucky public adjuster I hear this kind of thinking all of the time but they are inaccurate in their assumptions and expectations.
It’s normally not the agent or adjuster’s fault that they believe that… it just seems to make sense to most people that that is what “replacement cost” means. The fact of the matter is that the insurance carrier only owes the insured for the full value of a damaged item AFTER that item has been replaced.
Example: a homeowner had a living room couch that was completely destroyed in a fire. They bought it 10 years ago for $1,500. The insured goes to several furniture stores looking for a couch that is similar in brand, size and quality to the one that was lost and discover that the price tag for such an item is now $2,000. For the sake of argument let’s say the insurance company agrees with that price. Since the couch was ten years old the insurance company will take the position that the couch had
lost some of its original value due to normal wear and tear and thus, in this example, will apply 40% depreciation ($800) to the replacement value of the new couch ($2,000 x 40% depreciation = $800). They will then deduct the $800 from the replacement cost value of $2,000 to arrive at the Actual Cash Value (ACV) of $1,200 for that couch.
Until the homeowner actually buys another couch to replace the couch lost in the fire the insurance company only owes the insured the Actual Cash Value of $1,200; and that’s all they will initially give the insured. But what normally happens is this: the homeowner (with $1200 in their bank) then goes to XYZ Furniture Store and, using their credit card, buys a new couch for $2,000. They take the receipt from that purchase and send it to the insurance company proving that they have replaced the couch. The insurance company will then send the homeowner a check for the $800 that was originally held out for depreciation. The policyholder has now received the full benefits of their replacement cost coverage for their couch as outlined in their policy.
Of course the insurance company doesn’t issue individual ACV checks for each item. They will issue one check for the entire Actual Cash Value of the loss for all of the contents and included within that sum is the amount for the couch ($1,200). This may not sound as simple as most people would like it to be but it is how it’s done. Hope this helps clear up some of the common misconceptions that policyholders have about replacement cost coverage.
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