Home insurance terms: what is replacement cost?
The insurance industry has quite a few complex terms that can make the insurance world seem overwhelming to the average person. Although the term “replacement cost” doesn’t look complex, it’s a little term that can make a huge difference at claims time.
What is replacement cost?
Replacement cost is the cost to replace an item. Sounds simple right? In the case of a house burning down, the replacement cost would be whatever a similar house sells for, right?
Not so fast.
In home insurance terms, the price a house sells for is called the market value. Instead, the replacement cost of the house is related to the actual physical materials and labour costs necessary to rebuild a similar house with the same purpose. Another way that market value and replacement cost differ is that the market value of a house would include the cost of the land (perhaps $150,000 for the land and $350,000 for the house for a total market value of $500,000). Replacement cost for your home insurance policy in Canada only covers the $350,000 cost of the house.
For practicality reasons, most property insurance companies won’t provide an insurance cheque to the home owner but rather. Instead, the insurer pays exact re-building costs as they occur. Plus, since the insurance only covers houses that are being rebuilt for the same purpose, trying to convert your basement to an income suite on the insurance company’s dime isn’t going to happen.
Do I have replacement cost coverage with my Canadian home insurance policy?
Whether you have replacement cost coverage or not depends on your insurance policy. Some insurance companies provide both replacement cost coverage and actual cash value coverage, which vary slightly. The replacement cost coverage pays you the cost of buying a new Samsung Galaxy Note 5, but an insurance policy with actual cash value will give you the cost of a brand new Samsung Galaxy Note 5 minus the cost of depreciation. Depreciation refers to the wear and tear that you’ve put on the phone since purchasing it.
Obviously, buying a policy with replacement cost coverage sounds like a better deal. Who doesn’t want to receive the same amount of money required to replace a stolen item? However, many policyholders choose to have actual cash value coverage. With lower risk for the insurance company (not having to pay the replacement cost of an item), they are able to offer lower premiums for people who opt for actual cash value coverage. Insurance seekers who don’t know the difference between replacement cost coverage and actual cash value coverage can be easily tempted to purchase the home insurance policy with the lower premium.
Home insurance isn’t a very onerous amount of money though, especially if you don’t live in an expensive area or have many expensive items to insure. If you can afford to purchase replacement cost coverage, not only will it be easier to settle a claim (no depreciation costs to take into account), but you also receive enough money to repurchase all of your damaged or stolen items.