The unexpected has happened, and now you’re wondering how you’ll pay for all these damages to your building. Luckily, you had insurance coverage in place and a claim has been filed to help offset these costs. But, how much will you be receiving from your carrier?

That depends on which primary valuation method your insurance carrier uses to determine the amount paid in the event of a loss. Two methods for establishing the value of insured property in the event of a loss are replacement cost and Actual Cash Value (ACV).

Replacement cost is usually the most favorable view from a business owner’s perspective because it compensates you for the actual cost of replacing the property which suffered a loss. The term “replacement cost” is defined or explained in the policy. Simply stated, it means the cost to replace the property on the same premises with other property of comparable material and quality used for the same purpose. This method applies unless the limit of insurance or the cost actually spent to repair or replace the damaged property is less.

In contrast, ACV is not as easily defined. Most courts have upheld the insurance industry’s traditional definition: the cost to replace with new property of like kind and quality, less depreciation at the time the property suffered damages. This means depreciation will be factored in to determine what the insurance company will pay. ACV is typically calculated in one of three ways:

  1. The cost to repair or replace the damaged property, minus depreciation
  2. The damaged property’s “fair market value”
  3. Using the “broad evidence rule,” which calls for considering all relevant evidence of the value of the damaged property

So what’s the difference?

The difference between replacement cost and actual cash value is a deduction for depreciation. However, both are based on the cost at the time of the loss to replace the damaged property with new or like kind property.

Based on these definitions, it’s critically important that you begin the process of setting an insurable value on your buildings by determining what the replacement cost is. Beginning here can be confusing because replacement cost has little to do with the amount that you paid for the building or the market value if you were to sell the property.

The key in setting the insurable amount for your property is to determine what you want to happen in the event of a loss. If it’s to replace the property to its condition before the loss, focus on replacement cost.

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