What is replacement cost coverage in home insurance?

Replacement cost value (RCV) coverage is designed to repair or replace your damaged property with new, similar items or materials at today’s prices. The key feature of replacement cost coverage is that payouts are based on the full replacement cost rather than the depreciated value, which factors in age and wear.

What is replacement cost coverage?

Replacement cost coverage is a type of home insurance coverage that pays to repair or replace covered property with materials of the same kind and quality, without deducting for age, wear and tear, or depreciation. If a covered loss damages your home or personal property, once replaced, your insurance policy will reimburse you for the full cost at today’s price, up to your policy limits.

For example, if a 10-year-old roof is damaged by a covered risk (called a peril), replacement cost coverage would pay the cost to install a new roof today, not the reduced value of the old one. It works the same for personal belongings. If your clothing, electronics, or furniture are damaged or destroyed, replacement cost coverage helps pay for new items rather than their depreciated cash value. 

Typically, replacement cost claims are paid in two stages. Your insurer will issue an initial check for the item's current, depreciated value. Then, once you provide proof that the repairs or replacements are finished, they send a second check for the remaining balance.

Replacement cost value (RCV) vs. actual cash value (ACV)

Replacement cost value (RCV) and actual cash value (ACV) are the two most common methods insurers use to calculate claim payouts. The key difference is depreciation. RCV pays to replace damaged property with new items of like kind and quality, while ACV factors in age and depreciation, which usually results in lower payouts to the homeowner.

Types of replacement cost coverage

Not all replacement cost coverage works the same way. Insurance companies typically offer different levels of protection at various price points. Homeowners can choose the level of coverage they want to rebuild or replace their home. 

 The three main types of replacement cost coverage are:

• Standard replacement cost coverage: This coverage pays to rebuild or repair your home up to the policy’s stated dwelling amount. If rebuilding costs exceed your dwelling coverage limit due to rising labor or material costs, you are responsible for the difference.

• Extended replacement cost coverage: Extended replacement cost provides an additional cushion (usually 20% to 50% above your dwelling amount) if rebuilding costs exceed your policy limit. This option helps cover inflation, labor shortages, and unexpected construction expenses.

• Guaranteed replacement cost coverage: The most comprehensive option, guaranteed replacement cost coverage pays the full cost to repair or rebuild your home, regardless of your dwelling coverage amount. 

Now, let’s see each coverage type in action. Let’s say your home is insured for $300,000 and it’s declared a total loss after a natural disaster. The rebuild ends up costing $400,000 after labor and materials costs skyrocket.

With a standard replacement cost policy, you’d have to pay the additional $100,000. If you had 25% extended replacement cost coverage, you’d only have to pay $25,000, since the extended coverage gave you a cushion of $75,000. You wouldn’t owe anything if you had guaranteed replacement cost coverage.

Pros and cons of replacement cost coverage 

Weighing the pros and cons can help you determine if replacement cost coverage is worth the extra cost.

Pros of RCV

• Full replacement without depreciation: You receive payment based on current rebuilding or replacement costs, not depreciated values that continue to go down each year.

• Lower out-of-pocket expenses after a loss: Homeowners usually only have to pay their policy deductible out of pocket.

• Better protection against rising costs: Replacement cost helps account for inflation and fluctuations in labor and material costs. 

Cons of RCV

• Higher premiums: Homeowners typically pay 10% or more in home insurance premiums for replacement cost compared to ACV policies.

• Coverage limits still apply: Standard or extended replacement cost coverage still has caps that may not fully cover rebuilding costs if they exceed policy limits.

• Potential two-step claims process: Insurers may only pay the ACV for repairs or replacements upfront, waiting until work is completed before paying the full replacement cost.

How to estimate your replacement cost

Estimating your replacement cost can help you determine which level of coverage you need and prevent you from underinsuring your home. Common methods to help gauge how much coverage is appropriate for you include:

• Using online replacement cost calculators that factor in things like square footage, construction type, materials, and local labor costs

• Hiring a licensed appraiser and having a professional appraisal completed

• Getting an estimate from your insurance company, which uses its own valuation tool and your home’s characteristics and condition

• Researching local construction and materials costs to calculate the cost yourself based on your home’s square footage and other factors

The replacement cost should reflect the expense to rebuild your home. It is not the same as the home’s market value or purchase price, which both include the land it sits on.

When replacement cost coverage might not be necessary

Although replacement cost coverage is a great fit for many homeowners, there are situations where it may not be necessary:

• You have sufficient funds to cover depreciation costs

• You live in a low-risk area that isn’t prone to natural disasters

• You have the necessary skills to fix damage yourself

• You plan to upgrade or remodel your home after a loss 

Frequently asked questions

Is replacement cost coverage more expensive?

Yes. Replacement cost coverage typically costs more than actual cash value policies. This is because it offers better protection, paying the full price to replace your damaged property instead of just its depreciated, used value in the event of a covered claim.

Does replacement cost coverage pay to rebuild my entire home?

It depends on your coverage type and limits. Standard replacement cost coverage pays up to your dwelling policy limit. Extended replacement cost pays up to a specified percentage above your dwelling coverage amount if rebuilding costs exceed that amount. Guaranteed replacement cost pays the cost to rebuild your entire home, no matter the cost.

Do I have to rebuild to receive replacement cost benefits?

Yes. Initial claim payments may only be issued based on actual cash value (ACV). Often, insurers only pay the full replacement cost amount after you have repaired or replaced the damaged property and submitted the receipts.