Replacement cost is an option for coverage on property insurance policies. For instance, you can choose to insure your property for the value of its replacement cost. That is the amount it would cost to rebuild your property as it was in like kind and quality before it was destroyed. It also could cover the cost of new items if your belongings are damaged or stolen.

Replacement cost insurance carries a higher premium because the claims are more expensive for the insurer.

Comparing replacement cost value

Most homeowners insurance policies automatically will insure the property at replacement cost value. It will cover the actual cost to replace items or rebuild your exact or similar home in today’s market. Factors insurers use to determine the value include the age and square footage of the property and renovations made.

Actual cash value vs. replacement cost

Replacement cost value is the more expensive insurance option because it pays for the full amount it would cost to replace the damaged or destroyed items with new ones. Covering 100 percent of a property’s replacement cost will protect you in case of a total loss. Insurance should be recalculated following upgrades or improvements to the house. The replacement cost value also may increase if the cost of labor and materials in the area rise.

Actual cash value is less costly coverage for homeowners policies. This coverage pays the cost for damaged or destroyed items as they were at the time they were lost, which is typically less expensive than buying a new item. For example, a three-year-old couch is worth less than a brand new couch.

Some items, such as jewelry, art, or a vintage car, might gain value as they age. These items might need to be insured separately to be certain they are covered for the appropriate amount.

No matter which policy you choose, remember insurance will cover only what it costs to replace a comparable item. Policies will not pay for an upgrade to a pricier option—such as an inexpensive loveseat to a designer sectional sofa.

Market value vs. replacement cost

Replacement cost is the price to rebuild a property using the same materials, the same quality of construction and in the same location. It includes the structure along with fixtures, systems, and finishes.

Some insurers offer policies using functional replacement cost, which means less costly materials that perform the same function as the original structure will be used.

Market value is the price that would be paid for your house in the current market. Land value is included in the market value but is not covered under replacement cost value in a homeowners’ policy.

The market value—which is partly determined by the property’s location, local crime statistics and proximity to good schools—may be less than the cost of materials and labor required to replace a home. If a property is insured to market value, a homeowner might have to pay out-of-pocket for some of the replacement cost.

The benefits of replacement cost value

       • Insuring a property for 100 percent of its estimated replacement cost provides the most protection. It will cover all costs to replace or rebuild damaged or destroyed property with a new one.

       • Full replacement cost value also will limit the amount a property owner will pay out-of-pocket for expenses.

       • Property covered in full will allow you to return to the quality of life you had before your property was damaged or destroyed.