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Do I have to insure my building for replacement cost?

Chances are if you own a home or commercial building you have been perplexed as to why a building you bought for $250,000 has to be insured for $900,000?

Let me try and explain.

Most insurance agents use the replacement cost form when insuring property. The replacement form basically states that you have to insure your building for the total replacement cost and if you have a loss, they will pay the loss minus your deductible.

There are two other forms that can be used to insure property.

First, Actual Cash Value is an option when looking to insure property. This form basically states that the insured must insure the building for 100% of the actual cash value, which is determined by the total replacement cost minus depreciation. In some cases, market value is a good indicator of actual cash value. Using our example above, this would mean that you would only insure your building for $250,000. BUT wait…. the premium for this amount of coverage would be similar to the replacement rate AND at the time of loss, the company would depreciate the loss after the deductible. There are many good uses for this form, but for now, just the explanation!

Finally, Functional valuation is a rarely used, but GREAT approach to building insurance. I have a client that has a 50000 square foot building that cost about 5,000,000 to replace. They only use the first floor and second floor and the third floor remains unused. If the building were to become a total loss, they would NOT rebuild the same building, but they would replace it with a FUNCTIONAL building that fit their needs. I have that $5,000,000 building insured for $2,500,000, which is the cost to functionally replace their building. If they have a partial loss, a repair cost endorsement allows for there to be NO depreciation. This is the most expensive form of the 3, but at times can be the best choice.

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