Replacement cost coverage is a type of insurance based on how claim values are calculated. It is used to determine how much an insurance company must pay in the event of a loss. One of three primary coverage types, replacement cost is also the basis for determining the premiums paid for homes, vehicles, and other types of property. Cash value, repair cost coverage, and replacement cost coverage each require different formulas to determine the value of an asset, and under what terms an insurance company will provide compensation for losses due to accident, damage, or theft.
All insurable assets gain or lose value over the lifetime of the asset. For example, electronics such as televisions and computers typically lose value as they age. Alternatively, assets such as homes or land gain value over time. Such changes in value affect how much insurance a person or business should have to cover such assets in the event of loss or damage. Actual cash value, or simply cash value coverage, is based on the current market value of the exact same asset. This coverage pays less due to depreciation and is therefore less expensive to purchase.
Comparatively, replacement cost coverage is more expensive because it pays out what it would cost to buy a comparable new asset on the open market. An old television is typically not worth much after a year. By purchasing replacement cost coverage for homeowner's insurance, the owner of the television ensures the insurance pay out will cover the cost of buying a new television of equal size. Likewise, inflation dictates that a house will cost more to rebuild in the event of damage, due to rising costs of materials and labor. As such, replacement cost coverage is determined based on current costs, rather than the original cost to build the home.
Repair cost coverage, for many insurance companies, is very similar to replacement cost coverage. When applied to home or other structure damage, repair cost pays to restore the home or other building to its pre-damage condition. In some instances, this may be the same amount that would be paid under a replacement cost coverage policy. Other assets, however, such as electronics, would result in a lesser pay out under repair versus replacement cost coverage. Rather than paying to replace the assets, as with replacement cost coverage, a repair cost policy would only pay what it would cost to fix the damage.
Typically the most expensive type of policy, replacement coverage offers the most protection to the owner of a particular asset. Such policies ensure that the owner can replace the asset, no matter how much the original asset depreciated. Should an old computer be stolen, a refrigerator damaged in a fire, or a car become a total loss after an accident, the insurance company must pay the insured an amount sufficient to purchase a new asset with similar features and benefits.