Understanding replacement cost vs market value

Overview: When you buy home insurance, it’s important to understand that replacement cost and market value are not the same. A replacement cost estimate is what it may cost to rebuild your home at today’s construction prices, while market value is what your home and land might sell for in a competitive market. Separately, depending on the terms of the contracts, policies may settle covered losses using replacement cost value (RCV) or actual cash value (ACV). RCV generally does not subtract depreciation once policy conditions are met, while ACV typically does. To confirm whether your dwelling and personal property are paid on an ACV or RCV basis, review your declarations page, endorsements and policy language. Loss settlement is subject to your deductible, policy limits, and policy terms and conditions.

When you purchase homeowners insurance, you'll make a number of decisions. One of the most important is the amount of coverage that you want to best meet your needs. Understanding the terms below can help you make a more informed decision that helps safeguard your home and your family’s finances.

Key facts to consider

• A replacement cost estimate is an estimate of what it may cost to rebuild your home’s structure at today’s construction prices.
• Market value is what your home and land might sell for in the current real estate market.
• ACV vs RCV describes whether loss settlement for a covered loss will be based on the cost to replace the property, or whether depreciation will be deducted based on the age and condition of the property prior to the loss.

What is replacement cost?

Replacement cost is the estimated cost necessary to repair or rebuild your home’s dwelling structure with like kind and quality materials and workmanship. When you insure your home for its estimated replacement cost and experience a covered loss, your insurer may reimburse you (subject to your policy terms and limits) for the cost of rebuilding or repairing your home based on the size and structure that was lost or damaged.

One way to estimate the replacement cost of your home is to hire a building contractor or other building reconstruction professional to produce a detailed replacement cost estimate. Your State Farm® agent can also help you obtain your estimate from an estimating tool. The estimated replacement cost of the property's structure and its associated systems, fixtures and finishes will be included in the estimate. Although land value may influence the market value of your home, it is not part of a home’s replacement cost and should not be factored into the amount of dwelling insurance you choose to buy. Remember, the ultimate decision on how much to insure your home for is yours.

Benefits of replacement cost

In the event of a covered loss, insuring your home to at least the estimated replacement cost may give your family a better chance to repair damage to the home with less financial disruption. Consider insuring your home for at least 100% of its estimated replacement cost. Some policies may require you to insure the home to a minimum percentage of its replacement cost estimate to qualify for certain benefits.

Keeping your homeowners coverage up to date

Rebuilding costs can change over time, so consider reviewing your homeowners policy annually to help you ensure the coverage you selected still fits your needs. Inform your agent or insurer if you upgrade or improve your home, since changes may increase the estimated cost to rebuild. Labor, materials and transportation costs can also rise and affect rebuilding costs. For additional protection, ask your agent whether your policy includes an inflation guard (or similar feature) that automatically adjusts your coverage limits as rebuilding costs change. You may also want to ask about ordinance or law coverage, which may help pay for certain additional costs if rebuilding requires meeting current building codes after a covered loss.

What is market value?

Market value is the amount a buyer would pay to purchase your home and its land in its current condition in a competitive market. Unlike replacement cost, market value is influenced by factors beyond construction materials and labor costs, such as proximity to schools, local crime rates, the availability of similar homes and the local housing market. Land is part of market value, but land is typically not covered by the homeowners policy.

Why market value may not match rebuilding costs

If you select your dwelling coverage based on market value, your coverage amount may be much higher or much lower than the cost to rebuild your home.

For example, if you buy a home for $175,000 and set your dwelling limit at that amount, but the rebuilding costs are $225,000, a loss settlement based on market value may not be sufficient to rebuild your home.

Replacement cost vs market value at a glance

Actual cash value vs replacement cost value

Actual Cash Value (ACV) and Replacement Cost Value (RCV) are terms describing how a claim payment may be calculated in the event of a covered loss. The key difference between these loss settlement methods is depreciation. As property ages over time, the value of the property may depreciate due to wear and condition. An ACV loss settlement takes that depreciation into consideration, and a RCV loss settlement does not. Both settlement types are generally available for dwelling or personal property coverage, but some policies may settle certain individual items or components differently (for example, roof or siding claims). Coverage and loss settlement options vary by state, policy type and coverage type.

How RCV payment may work

With a replacement cost value policy, your loss settlement amount is typically based on the cost to repair or replace your damaged property with like kind and quality. Payment is subject to your deductible, policy limits and policy terms and conditions. Some RCV policies may require property repairs or replacement to be completed (or contracted) before you can receive full payment. They will typically start with an ACV payment and then pay the remaining amount of the claim once the work is complete (time limits may apply). RCV coverage is usually associated with a higher premium.

How ACV payment may work

An actual cash value policy calculates your loss settlement amount based on the age, wear and condition of your property at the time of loss. This is typically done by first estimating what it would cost to replace the property new and then applying a deduction based on the depreciation of the property at the time of loss. Payment is subject to your deductible, policy limits and policy terms and conditions. Because depreciation usually results in a reduced loss settlement amount, you may have more out-of-pocket cost to repair or replace your damaged property. ACV coverage is usually associated with a lower premium.

Taking a closer look

Example: If you have a 10-year-old roof, its condition has probably deteriorated over time due to weathering. Given the limited lifespan of a roof, its current value is now less than the original $12,000 you paid for it, and it would likely cost more than $12,000 to buy an entirely new roof of the same kind. If a covered loss occurs, the amount of your claim payment will depend on the loss settlement provision in your policy. An RCV loss settlement will commonly pay for new roofing materials of similar kind and quality at today’s prices (subject to policy terms, coverage limits and your deductible). Alternatively, an ACV loss settlement will generally subtract depreciation from the replacement cost value, resulting in a payment that may be less than your original $12,000.

How to tell whether your policy pays ACV or RCV

To confirm whether your coverage is settled on an ACV or RCV basis, check these places and ask targeted questions.

• Your declarations page or coverage summary for wording such as “replacement cost” or “actual cash value”.
• The section of your policy booklet titled “Loss settlement” or similar wording.
• Endorsements or add-ons that change how losses are settled in your policy (for example, replacement cost on contents).

Questions to ask your agent

• Is my dwelling settled at replacement cost or actual cash value?
• Is my personal property settled at replacement cost or actual cash value?
• Are there special settlement rules for roofs, siding or certain types of property?
• Do I have extended replacement cost, inflation guard or similar options that increase protection if rebuilding costs rise?
• Are there requirements to complete repairs or replace items to receive full replacement cost value?
• Do I have ordinance or law (code upgrade coverage) and what are the limits?

When you buy a house, getting insurance to protect it is just the beginning. Consider reaching out to your insurance agent and ask any questions you may have to decide what coverage options fit your needs. Once you are all settled in, learn tips about home maintenance and ways to help keep your property safe.

You can get a homeowners insurance quote now, or give us a few details and a State Farm® agent will reach out to you.