Understanding Losses: Property

February 4, 2014. Property insurance provides protection against most risks to property, such as fire, theft and some weather damage. However, if property has appreciated and there isn’t sufficient insurance for replacement value, any losses must be paid out of pocket. To protect your wealth from these kinds of losses, it is important to determine replacement values so you will have adequate insurance.

The Key Takeaways

• Insuring for replacement value prevents having to use personal wealth to cover losses.
• Determining replacement values, and keeping them current, can guard against being over- and under-insured.

Replacement Value vs. Actual Value

Replacement value is the amount it would cost to replace an item or structure at its condition before the loss occurred. When an item is covered by a replacement value policy, the cost of a similar item when purchased today determines the compensation amount for that item, regardless of depreciation. For example, say an item purchased eight years ago for $2,000 was destroyed in a fire and a similar item today would cost $4,000. After being reimbursed the full replacement value of $4,000 by the insurer, the owner would pay nothing to replace the item.

Actual cash value coverage provides for replacement minus depreciation. For example, consider the same item purchased eight years ago for $2,000 and a similar item costs $4,000 today. The insurance company determines all such items have a useful life of ten years; the destroyed item had 20% of its life expectancy left. The actual cash value is equal to: $4,000 (replacement value) times 20% (useful life remaining)—or $800. After being reimbursed $800 from the insurer, the owner would have to pay an additional $3,200 to replace the item.

What You Need to Know

Replacement value for your home is the building cost to repair or replace the entire structure; it does not include the cost of the land or the amount of any mortgage loans. A building contractor or professional replacement cost appraiser can give you estimated replacement costs. (Your insurance agent probably can give you some referrals.) Be sure to include the costs to rebuild any architectural details or unique features like upgraded bathrooms or kitchen, basement improvements, room additions, built-in cabinetry and so on.

Actions to Consider

• Aim for comprehensive coverage equal to at least 100% of your home’s estimated replacement cost.
• Be sure to increase your home’s estimated replacement cost when you remodel or improve your home.
• Some insurance policies include an inflation provision that automatically adjusts each year for increases in construction costs in your area. Check with your insurance agent to see if you have this automatic increase or if you need to update your coverage amount each year.
• Replacement coverage for household contents usually is calculated as a percentage of the value of the home. Items of exceptional value may need to be insured separately.

Visit the Goosmann Trust Law Counsel website to learn more.