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Market Value vs. Actual Cash Value vs. Replacement Cost

If your home or a rental property you own needs rebuilt after a disaster, it almost always will cost more than what you paid for it. While the terms “market value,” “actual cash value,” and “replacement cost” are the words that describe ways to pay for covered losses to your home, these terms are not interchangeable. These terms reflect very different concepts and can cause payouts to dramatically differ at the time of a claim.

Market value is defined as the estimated price which your property would be sold on the open market between buyer and seller. It is the amount a buyer would pay to purchase your home in its current condition. This often includes the value of land, site improvements to the land, and sometimes personal property. Market value is also influenced by factors such as proximity to good schools, availability of similar homes, and the local crime statistics.

The term market value can be used interchangeably with open market value, fair market value or fair value. However, it is not the same as actual cash value, which is when the insurance company calculates the replacement cost of a covered property and then depreciates it according with age. Some insurance companies are beginning to utilize an actual cash value payment on roof losses that are caused by wind or hail while the rest of the home may be covered on a replacement cost basis. This is to encourage homeowners to replace older roofs as a maintenance task.

Finally, replacement cost is the cost needed to rebuild a building or property at current prices. It factors in prices for materials, labor, overhead and fees at the time of the appraisal and does not include any sort of depreciation.

None of these valuation methods include the cost of land, as insurance only covers damage to physical improvements that are made on the land (houses, garages, barns, pools, etc.).

Again, in most situations, the replacement cost of a home is more than the market value because the costs to build home from the ground up is much higher as opposed to purchasing a finished home. Don’t be alarmed when your insurance shows a limit of insurance that is higher than the current market value of the property!

There are many different factors that play into replacement costs. Factors that affect property replacement costs are:

  • Having an older home. By having an older house, replacement of those materials used (especially with houses built before 1940) may be hard to find and could result in added costs. In addition, some of the construction techniques and features that were utilized earlier in the 20th century differ from today’s standards.

  • Contractor’s overhead and profit. Labor costs continue to increase, and it is more costly for a contractor to rebuild a single house after a total loss than it is for them to construct multiple homes in a new development.

  • Building code conditions. Bringing a home up to code after a loss can be costly, especially if the home is older and hasn’t been fully updated.

  • Materials and labor. The construction cost of the home may increase each year, and the price will also depend on the area. The costs of different classes of building materials has skyrocketed over the past year, so replacement costs have increased as a result in many cases.

  • Contactors cannot maximize savings. For new developments, materials and labor costs can be lower due to purchasing in bulk and having many available crew. However, ordering materials for one specific house and lining up the contractors needed to construct the house can be costly.

While most of our homeowner and rental dwelling insurance policies are written on a replacement cost basis, there are times where it makes sense to insure a property on a market value or actual cash value basis. Speak to your agent or account manager to further discuss this or to confirm how your coverage is provided.

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