Insurance

What Is Replacement Cost?

Updated on October 20, 2022

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Definition

Replacement cost is the dollar amount required to repair an insured asset such as a home, car, or personal belonging to its previous condition or acquire a new asset.

Key Takeaways

Replacement cost value is one method used to calculate how much money is needed to repair or replace your insured property with the comparable make, model, or materials, minus your deductible.
Most insurance companies require that you purchase enough insurance to cover at least 80% of your home's replacement value to be reimbursed for full RCV.
Replacement cost value can include all associated expenses, including labor, disposal, fees, and sometimes even sales taxes.
RCV insurance policies may have higher monthly premiums than other replacement cost policies, such as actual cash value ones.

How Does Replacement Cost Work?

The replacement cost is usually higher than the original price because it includes the asset's current market price plus any costs associated with replacing it. Depreciation is not included in replacement costs because it is assumed the policyholder will use new materials to replace or repair the property.

Alternate name: Replacement cost value, replacement cost coverage
Acronym: RCV

In the event of a loss, insurers may use this method to determine the damaged property's market value and how much it will cost to replace it entirely. You are not reimbursed for the depreciation of the old or damaged asset.

Example of Replacement Cost

If your house was damaged by a falling tree, depending on your homeowners insurance policy, your insurance company might offer replacement cost value (RCV) for your home. You would receive the money needed to restore the home to its previous condition, minus the deductible you must pay first. This RCV can also include the labor and material costs for debris removal, roof rebuilding, and attic repair.

Suppose you have a 2,200-square-foot roof, and the average cost to replace a roof in your area is between $3.50 to $5.00 per square foot. Your deductible is $750. In that case, you could expect your insurance company to offer between $6,950 and $10,250.

The math would be:

Cost to replace roof - Insurance deductible = Amount paid by insurance

Using the numbers from the above example, it would look like this:

Cost to replace a roof in your area	$7,000 - $11,000
Your insurance deductible	-$750
How much your insurance will pay	$6,950 - $10,250

Note

In some states, such as California, the law requires insurance companies to allow you to use the RCV funds paid out to buy a new home instead of rebuilding. This is not always the case in other states, whose laws are less clear and may only allow for repairing the insured asset.

How To Calculate Replacement Cost

To calculate RCV, insurance companies have two different approaches. One option is taking the current appraised market value of the asset (as if you were buying it new) and adding the costs associated with disposing of the old asset. The other method involves adding all the costs associated with restoring the damaged asset, including any labor, fees, and services required.

The RCV of tangible assets such as machinery, buildings, personal belongings, real estate, or vehicles is straightforward. However, determining the RCV of intangible assets such as patents, trade secrets, contracts, or trademarks is more complicated.

Taking the previous example, the insurance appraiser would multiply your neighborhood’s average rebuilding costs per square foot by your home's actual square footage. That amount will generally be your home’s replacement cost value.

Most insurance companies require you to purchase enough insurance to cover at least 80% of your home's replacement value. Failing to do so can result in your insurance company only reimbursing you for a proportionate level of coverage, not the total amount.

Keep this in mind when considering how much homeowners insurance coverage you may need. Extended replacement cost policies, which pay more than the policy limit, may also be a good idea.

Replacement Cost vs. Actual Cash Value

There are some important differences between replacement cost value and actual cash value, which is another valuation insurers may employ to determine coverage.

Replacement Cost Value	Actual Cash Value
Depreciation is not included in the coverage amount.	Asset depreciation is included in the coverage amount.
Higher monthly premiums, more coverage	Lower monthly premiums, less coverage
Complete replacement or repair of assets at market value	Complete replacement or repair of assets at market minus depreciation

Frequently Asked Questions (FAQs)

Why are premiums for insurance policies with replacement cost value higher?

RCV policies offer more substantial claim reimbursement amounts. Insurance companies must account for the risk that you may need to "cash in" on those more significant amounts. They do this by requiring higher monthly premiums. You may be able to lower your monthly premium by increasing your deductible amount.

Insurances with a total insurable value (TIV) or actual cash value (ACV) coverage put caps, or limits, on how much they can reimburse you in case of a claim. Since the insurer loses less money if that happens, monthly premiums are lower.

Who pays the sales taxes on replacement cost coverage?

Some insurance companies pay the full costs of replacement upfront, including sales tax. Others only reimburse part of your original cost upfront, then pay the rest after you've purchased your replacement items within a specific time period.

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Sources

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.

Texas Department of Insurance. “Home Policies: Replacement Cost or Actual Cash Value?”
California Legislative Information. “Insurance Code Law.”
Maryland Insurance Administration. “A Consumer’s Guide to Homeowner’s Insurance.” Page 20.
NV.gov. ”Extended Replacement Cost Endorsement Protector Plus Policy.”
New York State Department of Financial Services. "Homeowners & Tenants Insurance: What Consumers Need To Know." Page 8.